Has the bubble economy burst?
By Alex Callinicos
GEORGE W Bush and Japanese prime minister Yoshiro Mori met on Monday after a terrible week for the world's stock markets. The great Wall Street bubble of the 1990s has definitively burst. Whether this financial crisis turns into a full scale global recession depends crucially on what happens in the world's two biggest economies.
Japan is in a desperate state. After a decade-long slump the economy shrank in the third quarter of last year. A fortnight ago the finance minister, Kiichi Miyazawa, told Japan's parliament that state finances were "approaching a state of collapse".
According to the Financial Times, "general government debt is close to 130 percent of gross domestic product, greater than any leading economy in modern history". The American economy is in much better shape, having grown increasingly rapidly since the early 1990s. But it is now slowing down fast. Industrial production hasn't grown since September.
The fates of the two economies are closely intertwined. The boom in the US was fuelled by massive increases in household consumption. Middle class families invested heavily in the stock market. As share prices rose they felt richer, so they stopped saving and borrowed heavily in order to buy more goods and services.
The resulting increase in demand was good for the American economy, but it led to two growing financial imbalances. First of all, the private sector went into debt as households and firms spent more than their income. Secondly, the balance of payments went into record deficit as the boom sucked imports into the US. With economies, as with people, if you spend more than you earn you have to find the money somewhere. In the case of the US, it came from Japan.
Japan has a phenomenally high savings rate-about 30 percent of income is saved. A large proportion of these savings has been lent to the US by buying American shares and government bonds. Japan, in other words, has been financing the US consumer boom.
It has been able to do so because Japan runs a balance of payments surplus with the US. So dollars earned by Japanese companies through exporting to the US have been lent back to the US, allowing American consumers to buy yet more Japanese imports.
Since the Second World War the Japanese economy has been geared to exporting. The close links binding the big corporations to the state and the banks allowed them to tolerate what commentator George Friedman calls "the lowest rate of return on capital of any industrial economy", so long as exports continued to grow. This system began to fall apart in the late 1980s. A speculative boom-the so called "bubble economy"-encouraged the banks to invest heavily in the stock market and real estate.
When the Japanese bubble burst in 1990, the banks found themselves saddled with huge bad loans. At the same time industrial companies were stuck with massive over-capacity built in the boom years. Enormous public works programmes and zero interest rates haven't been enough to reignite growth. The Japanese economy has been kept afloat by exports.
But the American slowdown means the virtuous circle binding the US and Japanese economies together could turn vicious. For one thing, as workers are laid off and shares fall, consumers will spend less. For another, an American recession will strengthen the protectionist lobbies in Congress and sections of industry. But Friedman suggests that "Japan's economy is so close to the edge it will not take much to push it over the edge-a drop in cash flow due to declining exports could be the straw that breaks the camel's back".
Another danger is that the US itself will slide into the same condition of stagnation that Japan has been trapped in since the early 1990s. Over-investment, particularly during the past few years, has created massive surplus capacity in American industry that will be hard to use profitably. Free-marketeers argue that the Japanese government should dismantle the close links between the state and private capital, and allow insolvent banks and firms to go bust. But, as the economist Taggart Murphy points out, this "risks turning a recession into full fledged depression". The world's two biggest economies are bound together so closely that, if one topples, they both do.