Absorbing Lesson from Japan, Greenspan Slow to Trim Rates

By WILLIAM PESEK

As anxieties about the U.S. economy intensify by the day, investors and pundits are asking: Where's Alan Greenspan? Why isn't the Federal Reserve chairman coming to Wall Street's rescue?

By now, even ardent George W. Bush fans are questioning his administration's fitness to stabilize things. Each time the president steps to the microphone to soothe markets, he manages to spook them. And Bush's economic team is being dismissed in many corners of the globe.

All of which leads back to Greenspan, and why he hasn't surprised markets with a morale-boosting rate cut. The reasons may have everything to do with Japan, an economy Greenspan knows much about and one he's looked to for lessons in recent years. Japan's experience over the last 12 years offers a cautionary tale of booms and busts in a globalized world.

A year ago, anyone who suggested the U.S. might become another Japan was labeled a quack. These days, the view that the U.S. is headed for a decade of recession and deflation is still a minority one. Yet, as Greenspan well knows, the U.S. financial system is far more fragile than even pessimists fathomed just as Japan's proved to be.

"It would absolutely be a tragedy if we didn't learn from Japan's experience," Richmond Fed President Alfred Broaddus said in May.

Panic signal

Those lessons may explain why the Fed isn't anxious to trim rates especially between policy-making meetings. Few moves are more dramatic than acting outside meetings, yet it's something Greenspan has tried to avoid. The Fed already has lowered rates to 40-year lows this year, giving Greenspan even less incentive.

Pushing the overnight bank lending rate below the current 1.75 percent could be seen as a sign of panic. The bigger risk, though, is getting into a Japan-like dilemma of using all your ammunition too early. Doing so might short-circuit the painful but necessary correction of the financial excesses that got the U.S. in trouble in the first place.

It's here where Japan's experience is instructive. The details of its late 1980s stock bubble are well known in economic circles. Following a sharp recession in the mid-1980s, the Bank of Japan slashed rates and fueled an explosion of investment and consumption. The economy grew between 6 percent and 7 percent a year as liquidity zoomed into stocks and real estate.

A classic speculative bubble followed. Cheap financing encouraged manufacturers to over-invest in plants and equipment. Real estate developers threw up unnecessary office towers that would sit empty for years. An explosion in stock-created wealth helped fuel the excesses. In 1989, the total value of Japanese stocks was 150 percent of gross domestic product.

Enter the central bank's new governor, Yasushi Mieno, who feared surging asset values and rampant speculation threatened Japan's health. In late December 1989, he began warning of higher rates. Over the next 10 months, he boosted borrowing costs from 3.75 percent to 6 percent. By October 1990, the Nikkei had lost almost half its value.

In retrospect, the blame for Japan's implosion and its "lost decade" may not lie with Mieno, but his predecessors. Japan's central bank had long conducted interest-rate policy at the behest of the Ministry of Finance. It simply left the monetary spigot open too long and let things get out of hand.

Yet Mieno and his successors made some policy missteps of their own: Lowering interest rates too much. By the time Mieno resigned in late 1994, the bank's official discount rate was at 1.75 percent a historic low back then.

Walking in place

It may seem an odd point to make about an economy that was in virtual freefall. But by printing so much yen, the Bank of Japan softened the purging process that's necessary after a period of speculative excesses. Increased liquidity helped banks put off writing down bad loans. And companies, by borrowing more, delayed restructuring. It bailed out the economy.

Twelve years later, Japan hasn't dealt with the full aftermath of the bubble years. Interest rates are now zero percent and yet the economy continues to limp along. Public debt is approaching 140 percent of gross domestic product and banks' bad loan problems have worsened. Japan essentially subsists on monetary and fiscal steroids. The result: the economy is walking in place and the central bank has used up its conventional tools to revive things.

Greenspan is intimately aware of Japan's dilemma. Not just from his own analyses, but his chats with current Bank of Japan Governor Masaru Hayami and other Tokyo officials. He's also a diligent student of Japan's economic history. When he made his infamous comments about "irrational exuberance" in December 1996, he was speaking about Japan.

The challenge for Greenspan is to avoid "Japan disease" in the Unites States. If the Fed continues cutting rates, the Dow Jones Industrial Average might stabilize, or even surge. But that might only help Corporate America sidestep the natural post-boom purging process. It might re-inflate the stock market, leaving the U.S. vulnerable to problems down the road.

The U.S. stock swoon goes beyond the typical post-bubble correction. The collapse of WorldCom Inc. and Enron Corp. and a rash of other accounting scandals a side effect of what Greenspan calls "infectious greed" spooked investors. If the Fed ran to the rescue, it might only cover up other companies still cooking their books. And given that stocks aren't yet trading at bargain levels, the Fed may feel little urgency.

The catch, of course, is that Greenspan can't be too timid about helping the economy. That risk was summed by this passage from a recent Fed study: "The failure of economists and financial markets to forecast Japan's deflationary slump in the early 1990s poses a cautionary note for other policy makers in similar circumstances: deflation can be very difficult to predict in advance."



William Pesek is a columnist with Bloom-berg News.

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