The "Japanization" of America may be here, as the U.S. begins a long period of weak growth
The U.S. may face a prolonged period of stagnation. That's the warning from a Reuters op-ed written earlier this week by PIMCO CEO and co-CIO Mohamed El-Erian. He worries that the U.S. could be on a worse path than Japan was when it began its "lost decade." But he ends with a note of optimism, saying that policymakers have the power to avoid Japan's fate. Both their willingness and ability to do so should worry us, however.
Why We Face a Lost Decade
What has gone so wrong that the U.S. could be in for a decade or more of sluggish growth and relatively high unemployment? The problem all began with too much borrowing -- on all levels. Consumers, states, and the federal government borrowed too much money. The problem for homeowners is particularly acute, since many now have assets worth less than what they owe due to the housing bubble. Rapidly growing student loan debt makes matters worse.
What you end up with is a troubling cycle. Unemployment is high, so consumer sentiment is low. And as a result, Americans aren't spending enough money to cause firms to hire more aggressively -- so unemployment stays high. And the debt burden Americans are under cuts spending by even more. Many are trying to whittle away at their mortgages, credit card balances, home equity loans, and student loans. Others are trying to rebuild their nest eggs. Weak sentiment combined with deleveraging is a recipe for very slow spending growth.
Housing having been the source of the bubble makes economic growth even harder. It often helps lead a nation out of recession, but this time around it is contributing zero growth.
This begins to point to one of the nation's structural problems. For more than a decade, the U.S. developed a thriving and robust housing market as the center piece of its economy. But it was built on the sand. The tide came in and washed it away. Now it has millions of unemployed Americans who supported that industry in jobs like construction or financial services. The trillions of investment dollars that flowed into real estate industry over this period could have gone to technology or other sectors to provide sustainable growth. Instead, that money was squandered.
Manufacturing is another major source of job losses. Those jobs also aren't coming back. The U.S. can add some new jobs in this sector, but most of those lost are simply more economically viable elsewhere. Most of those now-unemployed workers need to find a new field, which likely requires training. And that takes time and money.
Of course, it doesn't help that the global economy is a disaster. The European Union continues to struggle to agree on an exit from their sovereign debt troubles. Any solution that would ensure stability will also necessarily constrain growth in the region, because some austerity must result.
Why It Could Turn Out Worse Here
As bad as this sounds, the U.S.'s lost decade could actually be worse than Japan's, according to El-Erian. He notes that Japan had a few advantages over the U.S. during the period.
First, he says that the U.S. does not have the same level of "social cohesion" as Japan. In particular, the nation provided a broader, more effective safety net that can benefit a nation in a time of weak growth and high unemployment. Although the U.S. does have some measures meant to help those struggling, their impact is limited. For example, in the U.S. jobless benefits remain capped at 99 weeks. If unemployment is prolonged for several years, those payments will quickly run out for many Americans.
Second, he notes that Japan had a net creditor status. The U.S., however, is a net borrower. As a result, capital inflows helped Japan to recover more quickly. The U.S. doesn't have the same luxury.
Why It Might Turn Out Better
As bad as all this sounds, the U.S. might also have some advantages over Japan. Back in May, I spoke to S&P about why Japan was downgraded in 2001, while the U.S. hadn't been downgraded despite its similar level of debt-to-GDP. The rating agency provided several reasons why it considered the U.S. to have better prospects now, than Japan had then.
- The U.S. has better fiscal indicators, both on the stocks and on the flows.
- U.S. prices are more stable, while Japan flirts with deflation.
- The dollar remains the key international currency, while the yen is a distant third.
- U.S. growth prospects are better.
- Japan has particularly troubling demographics, as its population is aging and skews towards the elderly.
The first two points do appear to give the U.S. a slight edge. But the U.S. may not get much benefit from the others.
The dollar's status as the international reserve currency of choice could quickly change. In fact, back in June I showed survey results that indicated that the dollar would cease to be the most important reserve currency as soon as this year.
Some economists might also challenge the point about the U.S. having better growth prospects. We certainly aren't seeing very strong growth over the past year. And the obstacles mentioned above show that achieving stronger growth will be difficult, since spending will be restrained for an extended period as unemployment remains high and consumers deleverage. Remember, consumer spending is responsible for about 70% of GDP.
Finally, the U.S. also has an aging population. The problem may have been more severe in Japan, but as the Baby Boomers retire the U.S. faces a similar challenge. In coming years, the nation will have millions more Americans relying on entitlements in the form of Social Security and Medicare. This large population of retirees will drain far more money from the government than they provide in revenue. This will require either more taxes, a smaller safety net, or both. That combination is precisely what you don't want when a nation is struggling with low growth and high unemployment.
How Do We Fix It?
But El-Erian remains surprisingly optimistic. He says that the Obama jobs bill and housing reform in the works are good first steps to minimize the possibility of a painful lost decade. Still, he says that the U.S. government must do more and suggests options like new infrastructure spending, additional immediate stimulus, and more aggressive housing market intervention.
If you follow politics in Washington, however, then you know that reality is much different from El-Erian's imagined government intervention. The Obama jobs bill is dead. A few of its provisions could ultimately pass, but their impact will likely be very minimal. The mortgage refinancing program will also have a subdued effect. Fannie and Freddie estimate that it will only help lower the monthly payments of between 800,000 and 1 million additional homeowners. Mortgage interest rates have also begun rising, which could limit its impact. At most, the effort will amount to a few billion dollars in new stimulus per year.
The mood in Congress is for austerity. So we shouldn't expect much additional spending on non-necessities over the next decade. That darkens the possibility of unplanned stimulus or new infrastructure spending. Both parties are concerned with the deficit. Republicans want to fix the problem with less spending. Democrats are looking at ways to increase revenue. Either option will slow economic growth.
And that's even assuming that more government intervention would help. Evidence of that isn't exactly compelling: despite a $787 billion stimulus in February 2009 and several other measures since then aimed at creating jobs, underemployment remains painfully high 16.5%. More tax breaks could just result in additional deleveraging. More takes breaks or stimulus injections for firms could boost profits, but that money could just flow into corporate coffers, instead of into the paychecks of new workers. Companies may continue to think that weak demand doesn't support more hiring.
Eventually, consumers and businesses will have to start spending. But if it takes them a few years to become more comfortable doing so, their newfound optimism could coincide with more aggressive austerity measures in the U.S. hitting. Taxes hikes and spending cuts will have to come before too long, as the nation's borrowing must slow. If Washington implements those measures too soon, then they threaten to erase the little growth that we're seeing. But even if they don't hit for several years, they will cut growth to a more modest pace at that time.
If you add that all together, you get a prolonged period of slow growth and relatively high unemployment. This doesn't appear to be a problem that policy can easily solve. Americans may just be in for some pain as consumer and government debt loads recede to more reasonable levels.
Image Credit: REUTERS/Yuriko Nakao