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January 17, 2003

St. Augustine Versus SM Economics

Peter Tasker (Arcus Investment)

This article originally appeared in the "Japan-U.S. Discussion Forum" ( on January 15, 2003; posted here with the author's permission.

"Do as I do, not as I say" that is the message to Japan of US economic policy. For the harsh medicine the US is recommending to Japan is quite different from the treatment it is proposing for itself.

George Bush recently announced a ten year stimulus package of $ 670 bn, the bulk explicitly targeted at the stock market. This follows on from the $1.3 trillion package of tax cuts announced last year. Altogether this is a vast sum, and will tip the US into a substantial fiscal deficit. Still the White House confidently states that "budget surpluses are good, but growth creates surpluses, not the other way round."

Meanwhile the Fed, by sharply reducing interest rates to below the rate of inflation, has triggered a mortgage binge that has sent house prices soaring. Zero real interest rates have also had the effect of causing the dollar to dive against the Euro and the yen, thereby helping the competitive position of US companies at home and abroad.

Altogether this comprises one of the most powerful pro-growth policy mixes seen for decades. Strangely enough, in his speech to Congress George Bush didn't call on the American people to endure several years of pain, nor did he warn that there could be no recovery without years of pain. On the subject of America's most serious structural defect, the low savings rate, a Fed board member commented as follows - "the US certainly needs to save more - but now is not the time." This is reminiscent of the prayer of the young St. Augustine, "Lord give me chastity, but not yet."

What about Japan? Here the US government continues to support the Koizumi administration's sado-masochistic policies, which prioritize fiscal discipline above all else. But to borrow the logic of the White House, "economic shrinkage creates deficits, not the other way round". And indeed the major factor behind Japan's fiscal deficit is not public works spending, which has already been squeezed dramatically, but the collapse in tax revenues caused by the recession.

Rather like the military in the last stages of the war, the Japanese authorities seem incapable of admitting their errors and reversing course. Instead they are already preparing for the next policy blunder - raising the consumption tax to 15% in stages over 10 years. It is clear from the experience of 1996 what will happen a collapse in demand. Back then the economy still had some resilience left and the recession was not too severe. But since 1996, stock prices and land prices have fallen a further 30-50%, unemployment is higher, the financial system is more fragile, and even top-ranking electronics companies are struggling to survive. In these circumstances raising the consumption tax would be like sending out a warship with a one-way supply of fuel. The only possible outcome is disaster.

The Nikkei comments that the US, unlike Japan, is fortunate in having the leeway to embark on large fiscal stimulus. But this is nonsense. The US is a country which has to borrow money, via its current account deficit, equivalent to 4% of GDP. Much of this comes from Japan, which generates an excess of savings of 2-3% of GDP. Rather than having no leeway, Japan has money coming out of its ears. The best proof of this is the interest rate on 10 year government bonds. Despite all the hysteria about a collapse in the bond market, the yield on 10 government bonds has dipped below 0.9%. This means that the Japanese government can borrow money on the most favourable terms in world history.

The reality is that Japan has never tried a Bush-style package of large-scale tax cuts aimed at individuals and asset markets. In fact throughout the 1990s it never established a long-term growth strategy of any sort. On the fiscal side policy responses were always too little and too late, and aimed at propping up the status quo through inefficient public works. On the monetary side the pace of interest rate cuts was slower than the fall in inflation so real interest rates remained positive. At the same time the yen was allowed to remain overvalued. Given the severity of Japanese asset deflation far greater than the current adjustment in the US stock market - these measures were completely inadequate. It is no surprise that the outcome has been the end of Japan's brief reign as an economic superpower.

At this stage it's going to be difficult to turn the situation around, but not impossible. The austerity fetish must be overcome, and ordinary Japanese people given renewed confidence that they live in a rich country with tremendous financial resources. Every year the Japanese private sector is generating a massive surplus of savings. They can either carry on lending this to George Bush, or they can spend the money on themselves. I know which I would choose.

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