A Recession in Dog Years

Combine Japanese cultural tendencies toward formality, politesse, and indirection with the usual central banker's love of opacity and econo-jargon, and you'd expect that a meeting with the Deputy Governor of the Bank of Japan would be a one-way trip into a cloud of vagueness. But in a meeting Monday, Kiyohiko Nishimura, Yale-trained economist, former Tokyo University professor and deputy governor of the Bank of Japan, gave one of the most lucid and useful explications of the credit crisis and its aftermath that I've heard– and I've heard a lot of them. And even more surprisingly, it was pretty optimistic.
 
A Japanese central banker is well situated to comment on the current global crisis, given Japan’s own sad history of dealing with the overhang of a credit/real estate bubble—or, more accurately, of not dealing with it. The government and private-sector's uncertain policies condemned Japan to a traumatic lost decade of slow growth.
 
Nishimura shared a talk he's been giving—including at a Federal Reserve Bank of Chicago conference in May—about the comparative post-bust experience of Japan in the 1990s and the U.S. today. It's titled: "The Past Does Not Repeat Itself, But it Rhymes." The rhyming can clearly be seen in a chart showing what he dubbed a "remarkable resemblance in developments between the U.S. crisis and Japan's 'lost decade.'"
 
Nishimura dates the onset of the Japan crisis to the fourth quarter of 1990, when commercial land prices began to fall, and tracks the policy responses (rate cuts in 1991, stimulus in August 1992 and following years, expanding bank insurance in 1995, bank failures in 1997, injections of public funds into banks in 1998, zero-interest rate policies in February 1999.) The Japanese economy began to grow again in 1999, but slipped back into recession in 2001. The final turning point for Japan came in October 2002, when Japan's authorities urged banks to deal more aggressively with problem loans. "The Japanese economy was, in general out of the woods around 2005," Nishimura concludes. (Of course, it's deep in recession now, with the rest of the global economy.)
 
If the first chunk of this story sounds familiar, you're right. On an adjacent chart he shows how the U.S. crisis, which he dates to the decline in mortgage-backed securities prices in February 2007, has followed a remarkably similar course. But that doesn't mean the U.S. is in for 15 lean years. The resemblance lies more in the sequence of events than in their duration, the rhyming rather than the repeating. In fact, the U.S. is acting in what might be considered dog years. In the early stages, he said, "one month in the U.S. looked approximately equal to three months in Japan in the early stage." But since September 2008, he said, it's more like "one month in the U.S. is equal to six or seven months in Japan."
 
Why the accelerated pace? It has to do in part with changing global circumstances. Nishimura argues that both crises started because problems in the property and credit markets contributed to an adverse feedback loop between financial distress and economic activity. But information, events, and distress move much more quickly around the globe today than they did in the 1990s. With just-in-time production systems, and with 21st century communications technology, bad news travels much more quickly—and farther. In the 1990s, much important exchange of international market information was still done by fax. In addition, traders can now act more quickly on real-time bad news. In the early 1990s, analysts had to wait several months to for data. And since the level of financial integration was much less intense in the early 1990s, Japan didn't export its financial problems.

The upshot: In the current crisis, "the velocity of market dysfunction has been much faster and its contagion much more widespread than in Japan's case." And so the damage has been more devastating.
 
Of course, the duration of the crisis also has something to do with the mentality and action of the first responders. A lesson from both crises, he argues, is that once an adverse feedback loop is established, it's difficult and very expensive to break it and restore confidence. It took a very long time for good news to gain a critical mass in Japan in the 1990s, in part due to the slowness of the policy response. But this time, it's different. The Federal Reserve—and indeed, global central banks and governments—have responded with alacrity. Japan's central banks didn't adopt a zero-percent interest-rate policy until more than eight years after the crisis started; The Fed did so within 20 months. It took Japan nearly eight years to inject funds into troubled banks, compared again with 20 months for the U.S. to do so. And, Nishimura argues, efforts like the stress tests and TARP exits are bolstering confidence.
 
According to Nishimura's schema, in less than two and a half years, the U.S. has experienced as much trauma and recovery as Japan did in about 12 years. All of which means, if the dog months analogy continues, things could start looking up by early next year. But we shouldn't get too far ahead ourselves. There are other lessons to be learned from Japan's experience of starts and stops. "We should be careful not to be very optimistic," Nishimura concluded. "That's my advice to myself."