Foot To The Floor At The Fed - But We Must Learn From Japan

Sydney Morning Herald

Saturday December 20, 2008

WHOOPEE, you might think. The official interest rate in the US was reduced close to zero, at just 0.25 per cent, this week. But it still far too early to declare that happy days are here again, or even in prospect. With the decision, the Federal Reserve, the US central bank, has fired the last shot in its interest rate locker - not that it had many, after running a lax monetary policy for more than a decade.

Many economists will be comparing the example of Japan, whose central bank shaved its key rate even closer to zero for a decade without lifting the economy out of stagnation. That, too, followed a spectacular crash in asset values. Japanese share prices had spiralled up by about 400 per cent between 1980 and 1989 when the financial markets believed Japan was set to overtake the US. They crashed by 70 per cent from the peak when it was realised Japanese companies were running out of new ideas. Urban land prices were also part of this bubble economy. They rose 500 per cent over 12 years from 1980, then over the early to mid-1990s fell by 85 per cent.

Much of the easier credit went not into funding new investment and consumption, but in covering the bad loans of the commercial banks and asset declines of established companies, while individuals hoarded their cash. Japanese companies were producing too much of everything, and consumers were not interested. The economy was too closed for them to be offered the goods and services from abroad that might have tempted them to spend. Eventually the Bank of Japan turned to pumping up the quantity of money by increasing its direct lending to the borrowers who might use it, and by buying more bonds from the government. It worked - just.

Under the former prime minister Junichiro Koizumi - the long-maned "Lion King", as the political maverick was known - Tokyo embarked on the deep structural reforms needed to fundamentally reinvigorate the economy and build up growth momentum. The Japanese public applauded with its votes. This was too much for Mr Koizumi's colleagues and their vested lobbies. Two years ago, he was replaced by a revolving door premiership, and the ruling party substituted jingoism for reform.

The lesson seen by many economists is that the Japanese started the "quantitative" monetary injection much too late. And by trying to shield those who borrowed or lent against inflated asset prices, diverted funds away from more productive new investments. The government effectively nationalised banks and institutions that should have been allowed to fail.

America, and the global economy, now await the massive fiscal stimulus that the president-elect, Barack Obama, has promised. There are some worrying signs that he, the outgoing President, George Bush, Britain's Gordon Brown and even our own Kevin Rudd are not fully heeding the lessons of Japan. The incumbent "Anglo-Saxon" leaders have rushed to pump rescue money into stricken mortgage lenders - Northern Rock in Britain, Freddie Mac and Fannie Mae in America - and hand out selective financing to commercial banks and investment houses. Industries producing things that consumers don't want - notably car makers - are being propped up.

However, unlike Japan where the Government already had a massive debt load from earlier bond issues, Washington has greater scope for extending central bank credit to the government, and taking advantage of seigneurage in the ownership of a reserve currency. Some central bankers have likened this to scattering banknotes from a helicopter in the hope that citizens will pick them up and spend them. Indeed, the chairman of the Federal Reserve, Ben Bernanke, is someone who has studied the Great Depression of the early 1930s and the Japanese example in depth, and thinks it might come to this to keep America out of a similar deflationary trap. "The US Government has a technology, called a printing press - or, today, its electronic equivalent - that allows it to produce as many US dollars as it wishes at essentially no cost," Dr Bernanke said in 2002 - earning the sobriquet "Helicopter Ben" in some circles.

With greenbacks at his disposal, he is bound to be more successful than the governor of the Bank of Zimbabwe.

© 2008 Sydney Morning Herald

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