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The Pulse of Capitalism

Issue Number 03-2, July 2003

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International Comparisons
Business Activity Indicators
Financial Indicators - United States
Selected International Transactions - United States

The Japanese Experience

In the last issue of the Pulse, we investigated the process of recycling income into consumption and investment. We concluded that the present economic downturn is due to a dearth of new opportunities for profitable investment. In virtually every activity we already have more than sufficient capacity to meet foreseeable needs. The technology sector that soaked up investment in the nineties reached a plateau much sooner than anyone expected, and the wild speculation that had taken place ended in huge losses. With no alternative options in sight, investment returns have dwindled to lifetime lows. The recycling process into investment, consequently, is providing little stimulus to economic activity. Overall, economic activity is still at a high level but is only sustained by extraordinary incentives such as refunds on new car purchases and no-down-payment programs for new home purchases. Without significant new growth, the financial underpinning of the economy becomes ever more fragile as unemployment grows and debt becomes ever more burdensome.

The question today is what will all this lead to? The past is not very helpful in answering this question because the conditions present today are new. Specifically, we have fiat money which can grow without limit as long as people are willing to lend, and we have no major new technologies in need of financing. Additionally, these conditions are present in all the developed nations, so that the problem is worldwide. One thing that may be helpful, however, is to review the experience of Japan over the past 13 years. Until 1990, Japan experienced an economic boom much like that of the U.S. in the nineties. But then its equities and property markets went through drastic declines, economic expansion faltered, and nothing has been found to restore the former upward momentum. We have to wonder whether our experience will mirror theirs, and for this reason, we will trace the sequence of events as they unfolded. Most of the following material including quotations is derived from the Britannica Year Books.

    Prologue - 1989

    "For the Japanese economy 1989 was a year of solid achievement. Overall economic growth, although somewhat slower than the exception- ally rapid progress recorded in the preceding year, was well above official expectations. Investment in manufacturing was maintained at a high level; consumption remained buoyant, and the large external payments surplus showed a small decline.


    "As in previous years, the mainstays of economic expansion were investment and private consumption, which collectively accounted for some 80% of GDP. ---- it was estimated that the full year saw a gain in consumer expenditure of around 4.5%, only half a percentage point below the increase recorded in 1988. This was principally the result of the continued rise in disposable income and strong underlying consumer confidence. ----average earnings were estimated to have risen by around 6%, up from 4.5% in 1988. Thus there was a good increase in disposable income.

    "The buoyancy of private demand had a beneficial effect on industrial output and investment. Industrial production during the first nine months of the year rose by some 6% compared with a gain of 9.5% for the whole of 1988. [There was] a 4% rise in the capacity utilization ratio to its highest level in more than 10 years. ---All in all the year appeared to be heading for a gain in private plant and equipment investments of some 14%, compared with 16% in 1988.

    Transition 1990-91 "The Japanese economy did well in 1990. GNP saw good growth for the fifth successive year and beat the gain achieved in 1989, with most domestic sectors of economic activity recording an advance.


    "The year's good all-around economic performance was the more impressive in that it was secured against a major collapse in equity prices, particularly in April and again in October, as well as a major hike in oil prices consequent on the Gulf crisis. Contrary to some fears, the sharp decline of the stock market failed to shake business confidence partly because of some timely government measures and partly because of the underlying strength of the Japanese economy.


    "As in 1989, 1990 saw a relative strengthening of domestic versus overseas demand as the engine of economic growth. Plant and equipment investments and consumer expenditure were particularly buoyant.


    "Given the relative buoyancy of domestic economic activity, ----the Bank of Japan [raised] its discount rate by one percentage point at the end of March and a further 0.75 point on August 30. This brought the rate to a relatively high level of 6% compared with 2.5% in March 1989.


    "The Japanese economy produced a satisfactory performance during 1991, although the level of business activity was less buoyant than in the previous year.


    "On the basis of economic indicators available in December 1991, it seemed that GNP for the year advanced by around 4.5% compared with an increase of 5.6% during the preceding year. This was a highly respectable performance by both Japanese and international standards - it was only marginally down from the average annual gain chalked up in the previous five years and was massively above the estimated average GDP gain for the OECD of around 1.3% in 1991.


    "Throughout the first half of the year, the authorities maintained the modestly restrictive monetary policies instituted in 1990 in an attempt to take some heat out of demand. By the second quarter of the year, the success of this policy was evident in terms of both growth and inflation indicators. In fact, because growth fell away unexpectedly rapidly, the Bank of Japan felt it expedient to cut its discount rate by half a percentage point to 5.5% in July ----the central bank ----announced a further reduction in the discount rate to 5% in mid-November. "The easing of domestic demand in Japan, particularly for capital goods, had a marked effect on industrial output and construction during 1991. The underlying trend of the industrial output was flat in the first quarter, followed by a gentle decline in subsequent months. -----the output of investment-related products was particularly weak.

    Downturn: 1992 - 93

    "It (1992) was a disappointing year for the Japanese economy. Although the government pursued reasonably growth oriented policies, there was a severe slowdown in most areas of business activity compared with the preceding year. One of the main reasons for this was a significant loss of confidence among both consumers and corporations arising out of a structural readjustment of real estate and equity values. Stock prices rose rapidly in the four years to 1990 greatly outperforming other major stock markets and giving rise to unsustainable price-to-earnings ratios. This gave rise to a strong downward correction in 1990, but instead of the widely expected sharp but short adjustment, prices continued to plummet throughout 1991 and most of 1992. -----Real-estate prices which rocketed in the mid 1980s also fell back rapidly, and since property companies and developers relied extremely heavily on bank finance, the slump in the market resulted in a massive rise in bad debts, forcing banks to adopt a much more restrictive approach to lending.


    "-----The Bank of Japan reduced its discount rate from 4.5 to 3.75% in April and to 3.5% in July. -----Consumer's expenditure was also affected by the virtual saturation of the market for certain products such as automobiles and consumer electronics.


    "-----Faced with this (deteriorating) prospect, the government announced an unexpectedly large $85 billion demand-boosting package in August. According to established practice, approximately 60% of the $85 billion boost was for additional public works projects. A further 20% was earmarked for housing loans and land purchases in an attempt to stimulate the real-estate market, while the remaining 20% went to financial institutions for nonhousing lending purposes. The authorities also announced the allocation of an extra $8.5 billion to be devoted to equity purchases by public bodies in the hope that this would underpin stock market prices. Further measures included changes to tax and other regulations with a view to making it easier for banks to write off bad debts arising out of the collapse in property values.


    "Hopes for an upturn in the Japanese economy [in 1992] which had declined for nearly two years were short-lived. Despite stimulatory measures introduced by the government in 1992 and again in April 1993, economic recovery stalled. A rapid rise in the value of the yen, combined with an exceptionally wet and cool summer, pushed the economy back onto a downward track. Continuing adjustment by the corporate and finance sectors (and to a lesser extent by households) to the sharp fall in stock prices and real estate prices that had occurred in 1991 and 1992 was also a drag on the economy. The net effect of this adjustment process was reduced willingness by corporations to invest and greater caution by financial institutions in lending, particularly for high-risk projects. It also reduced consumer's propensity to spend.


    " ----- The new government of Morihiro Hosokawa ----introduced a new packet of stimulation measures in mid-September. The Bank of Japan quickly cut its discount rate by 0.75% to 1.75 - a larger than expected cut - to curb the strength of the yen and improve confidence. ----- Since April 1992 four packages of stimulatory measures had been introduced, some spending had been brought forward into the first half of the fiscal year, and various new public works projects had been planned. A 13.2 trillion yen package was announced in April 1993 - the largest ever introduced by a Japanese government. In addition to government spending on infrastructure projects, easier loan conditions were introduced to promote investment, together with training programs and measures to support imports and the stock market. As these proved ineffective in stimulating the economy, a further 6 trillion yen package was announced in mid-September.


    "Despite these repeated measures, which in normal times would have sparked an economic growth, most components of demand remained weak."

    Malaise: 1994 - 2002

GDP Growth Industrial Production
Stock Index Unemployment Rate Current Acc't Balance $bn
1994 0.9 91.5 19,723.1 2.8 129.7
1995 2.2 94.4 19,668.2 3.4 110.5
1996 3.1 96.6 19,361.4 3.4 66.0
1997 -0.2 100.0 15,258.7 3.5 94.7
1998 -2.8 93.5 13,842.2 4.4 121.6
1999 nil 94.1 18,934.3 4.7 107.2
2000 2.8 99.5 13,785.7 4.7 117.7
2001 1.9 92.3 10,542.6 5.0 91.2
2002 2.8 91.0 8,580.0 5.4 115.0
Source: Survey of Current Business, Economic Indicators

Since 1994, as the above data indicate, the Japanese economy has basically moved sidewise. GDP has been up some years and flat or down others, with no trend in either direction. Industrial production since 1997 has actually declined nine percent. The Nikkei stock average has been up and down but is currently at a post 1989 low. Unemployment increased steadily to a rate of 5.4% in 2002. The current account surplus has increased in some years, declined in others without trend. In addition, retail sales have tended to fall, the consumer price index in 2002 was unchanged from 1994, the Bank of Japan has followed a zero short term interest policy, and the U.S. dollar value of the yen has fluctuated widely. Internally, widespread nonperforming and uncollectible loans have weakened banks and corporations, and the government has run a budget deficit exceeding five percent of GDP since 1998.

The 2003 Britannica Year Book describes the current condition in these words:
"A major concern of policy makers was the health of the banking system and the size of its bad loans. A new classification system for bad loans was put in place that resulted in a more than fourfold increase in the estimate of non performing loans to 43 trillion (about $362 billion). This was the equivalent of 8% of GDP, and it was feared that even this was an understatement and that the true size of the debt could be double that amount. The problem was compounded by the fact that the value of the banks' shareholdings, which had been falling, could be included for capital adequacy purposes. ----- In the meantime, "zombie" companies, which the banks failed to foreclose on, continued to produce goods and services at a loss. This was perpetuating the deflationary pressures and undermining the profitability of more viable companies."

This, 12 years after the first major fall in the Nikkei stock market index!

If much of what we heard about the Japanese economy sounds familiar, it is. Actions such as discount cuts by the Bank of Japan, stimulant packages by the government, and continued high spending by consumers are precisely the things we are currently hearing about the American economy. The disturbing thing is that they did nothing to ignite anything more than a temporary boost to the economy. In particular, they did nothing to revive investment spending.

There are some distinct differences between the Japanese and the U.S. economies. One is the difference in foreign trade. Japan has been the world's largest current account creditor while the U.S. has been the largest debtor. How this difference will affect the U.S. economy remains to be seen.

Another major difference is the real estate market. In Japan the stock market and the property market collapsed at about the same time whereas in the U.S. the stock market collapsed, but the property market has continued to boom. If job growth continues to falter, however, this may not continue. In addition, there are many dissimilarities in the functioning of the two financial systems and in the role of government.

One great similarity is the role that debt played, first in underwriting the boom and then hampering any recovery. "A major concern of policy makers was the health of the banking system and the size of its bad loans. A new classification system for bank loans ----- resulted in a more than fourfold increase in the estimate of nonperforming loans to 43 trillion (about $362 billion ----, the equivalent of 8% of GDP."

The U.S. has not experienced such a massive financial collapse, but the ingredients are there. During the past five years, total credit market debt has grown an amazing $10,452 billion or 49% whereas GDP has increased $2,127.2 billion or 26%. These disparate rates of growth cannot continue, yet the economy cannot thrive without continued debt growth. Eventually we may well face debt default problems just as severe as Japan's.

International Comparisons
Canada Germany Japan United Kingdom United States
GDP (% chg. one year ago)
0.9 -0.1 -1.9 1.6 0.5
3.9 0.5 2.8 2.1 2.9
    FQ 2003
2.6 0.2 2.6 2.2 2.1
Industrial Production (1997=100)
111.0 112.8 92.7 101.2 111.2
112.9 111.6 91.5 97.7 110.5
    FQ 2003
114.1 113.3 93.8 96.9 110.5
Retail Sales (volume chg. at annual rate)
5.7 -4.1 -4.4 5.7 6.5
1.4 -3.2 -3.0 6.4 4.9
    FQ 2003
2.3 -4.0 -0.8 4.3 4.6
Consumer prices (1995=100)
169.1 144.8 120.1 203.6 177.1
172.9 146.7 119.0 207.0 179.9
    FQ 2003
177.5 148.1 118.4 210.6 183.0
Unemployment Rates
7.2 9.4 5.0 3.2 4.8
7.7 9.7 5.4 3.1 5.8
    FQ 2003
7.4 10.5 5.4 3.1 5.8
Interest Rates (3 months)
3.98 4.26 * --- 4.97 3.40
2.61 3.32 * --- 3.99 1.60
    FQ 2003
2.94 2.68 * --- 3.56 1.14
Stock Indices (ending)
7,688.41 5,160.10 10,542.62 5,217.40 10,021.50
6,614.54 2,892.60 8,578.95 3,940.40 8,341.63
    FQ 2003
6,343.29 2,423.87 7,972.71 3,613.30 7,992.13
Current Acc't Bal's ($bn) latest 12 months
18.9 10.2 91.2 -25.1 -393.3
11.0 50.4 115.0 -13.1 -503.4
    FQ 2003
13.9 48.0 109.9 na -510.2
Foreign Exchange Rates
1.55 0.90 * 121.57 1.44 126.08
1.57 0.95 * 125.22 1.50 127.19
    FQ 2003
1.51 1.07 * 118.95 1.60 123.96
Currency units per U.S. $
UK pound in U.S. $s
U.S. dollar: index of dollar against major trading partners, January 1997=100
* Euro area (US$/Euro)
Sources: Economist, Economic Indicators,
F.R. Bulletin, Survey of Current Business

The first quarter brought little to cheer about in the world economy. Four economies experienced lower growth in the latest 12 months than in 2002, with Britain showing a small increase. But Britain was also the only one of the five to register a fall in industrial production. Retail sales showed no growth in Germany and Japan and a declining trend in Britain and the U.S. Canada's rise was from a very low base in 2002.

Consumer price inflation was strong in Canada, Britain, and the U.S. Energy prices and currency valuations both influenced these results. Unemployment was relatively unchanged except for a rise in Germany. Short term interest rates continued to fall except in Canada; the U.S. rate is now below the inflation rate. Stock indices likewise continued to fall in the first quarter although the U.S. index has rallied from its low.

The German current account surplus remained high due to a trade surplus that now surpasses Japan's. The U.S. deficit again grew, now surpassing half a trillion dollars per year.

The U.S. deficit may finally be having an effect on the dollar, which has weakened against other major currencies. The euro recently reached its highest level since it was launched in 1999.

Business Activity Indicators - United States
2001 2002 FQ 2003
Industrial Production (1992=100) 111.2 110.5 110.5 *
    Capacity Utilization Rate (% total industry)
77.3 75.6 75.1
Manufacturers' New Orders (billions of $s) 321.4 318.9 326.2 #
New Construction Expenditures (billions of $s) 842.5 846.1 871.2 *
Real Gross Priv. Dom. Invest. (chained[1996]$s) 1,574.6 1,589.6 1,609.0
Business Sales - Mfg. & Trade (billions of $s) 813.3 821.0 842.2 #
Business Inventories (ending) (billions of $s) 1,132.3 1,156.1 1,165.9
Retail Sales (billions of $s) 262.8 270.5 277.7 #
Retail Inventories (ending) (billions of $s) 405.6 436.3 443.5
Per Cap. Personal Consump. Expend.'s (chained [1996] $s) 22,390 22,877 23,076 *
Nonagricultural Employment (millions) 131.9 130.8 130.6 #
    Goods Prod. (millions)
24.9 23.8 23.5 #
    Services Prod. (millions)
107.0 107.0 107.1 #
* Annual Rate
# Monthly average
Source: Economic Indicators

Real GDP grew 1.4 percent in the first quarter of 2003, virtually the same as in the fourth quarter of 2002. The strongest contributor to growth was personal consumption expenditures, mainly for nondurable goods. Private investment's contribution was negative, despite continuing strength in the residential sector.

After falling in the two preceding years, industrial production was unchanged in the first quarter. Durable and nondurable goods both followed this pattern. The capacity utilization rate declined, but manufacturers' new orders edged up a bit.

Residential construction surged in the first quarter while commercial and industrial fell. Government construction was little changed.

Real gross investment increased due to strong residential activity; nonresidential investment fell.

Manufacturing and trade sales reached new highs in the first quarter and inventories rose but not to new highs. Retail sales and inventories rose to new highs. These data emphasize again that the current economic weakness is investment-related, not consumer related. This calls into question the current policies aimed at stimulating consumption. Despite tax cuts and rebates as well as historically low interest rates, per capita personal consumption expenditures rose only $66 in the first quarter.

Payroll employment fell each month from January through April by a total of over a half million. Both goods producing and services producing employment fell, with a slight increase in government employment. These losses undermine efforts to raise consumption.

Financial Indicators - United States
2001 2002 FQ 2003
National Income (billions of $s) 8,122.0 8,347.9 8,532.4 *
    Percent change
1.7 2.8 2.2
Per Cap. Disp. Personal Income (chained [1996]$s) 23,692 24,479 24,702
Avg. Real Gross Wkly Earnings (1982=100) 273.26 278.31 278.66
Gross Saving " 1,662.4 1,572.9 1,518.6
    Personal "
169.8 291.0 310.1
    Business "
1,229.5 1,303.8 1,305.6
    Government "
263.1 -21.9 -97.1
Commodity Price Index (1995=100) 65.4 74.7 75.1
Producer Price Index (1982=100) 140.7 138.9 143.2
Corp. Profits (with i.v.a.&c.c.a.) (billions of $s) 731.6 787.5 804.0 *
Interest Rates - 10 year Treas. 5.02 4.61 3.92
Money Supply - M3 (ending) " 7,995.3 8,519.5 8,595.4
    Percent change
12.7 6.5 0.9
Federal Gov't. Current Surplus or Deficit (NIPA) " 72.0 -199.9 -266.1 #
Commercial Bank Credit (ending) " 5,445.1 5,896.8 5,993.9
Consumer Credit (ending) " 1,666.8 1,726.4 1,742.4
Credit Market Debt (ending) " 29,397.8 31,725.2 32,281.0
    Household Sector "
7,686.4 8,454.4 8,603.3
    Nonfinancial Business "
6,935.8 7,144.2 7,214.4
    Total bankruptcy filings (thousands)
1,492 1,578 413
* Annual rate Sources: Economist, Economic Indicators, F.R. Bulletin, F.R. Flow of Funds

National income has now risen for six consecutive quarters and the first quarter increase was fairly strong. Per capita income growth was similar while real weekly earnings changed little.

Gross saving again fell due entirely to the rising government deficit; government saving has fallen $532.8 billion since 2000.

The commodity price index rose in the first quarter led by fuels. Metal prices remained weak with an index of 69.2. Producer finished goods prices reached a new high with strength in nondurable goods. Durable and capital goods prices were virtually unchanged.

Corporate profits increased 2.1 percent (a.r.) in the first quarter, mainly due to higher profits by financial corporations including the real estate sector.

Interest rates continued to fall through May with the ten year rate at 3.39 percent. The primary effect of these low yields continues to be a massive refinancing of home mortgages.

M-3 money supply growth slowed in 2002 from 12.7 percent to 6.5 percent, and this lower rate continued in the first quarter of 2003. Money supply growth has greatly exceeded GDP growth since 1994. The federal deficit (a.r.) reached its highest level since 1993.

Investment in securities and real estate led commercial bank credit higher; commercial and industrial loans again fell. Consumer credit growth slowed in 2002, and this reduced rate continued in the first quarter. Credit market debt grew about as fast as in 2002. The household sector grew 10.0 percent compared with 10.9 percent in the fourth quarter (a.r.) while business debt grew 3.7 percent compared with 4.3 percent. Since 1997 household debt has grown 56.0 percent whereas personal income has grown 34.8 percent, which helps to explain the rising rate of bankruptcies.

Selected International Transactions - United States
2001 2002 FQ 2003
Trade Balance on Goods & Services ($bns) -357.8 -418.0 -121.6
    Goods "
-427.2 -482.9 -136.0
    Services "
69.4 64.8 14.4
US Owned Assets Abroad, net " -349.9 -179.0 -75.9
Foreign Owned Assets in US, net " 765.5 707.0 188.7
    Net change in US Int'l Inv. Pos'n. "
415.6 528.0 112.8
Net change in Foreign Owned U.S. Securities
    Treasury Securities & Cy Flows "
27.1 160.9 36.5
    Other U.S. Securities "
433.3 325.2 61.7
Sources: Economic Indicators, Survey of Current Business

The trade balance on goods and services again deteriorated in the first quarter to an annual pace of -$486 billion. Exports of goods rose slightly from the fourth quarter while imports fell. Imports and exports both decreased, but the decrease in imports was considerably larger than that in exports.

Foreign investment in the U.S. topped U.S. investment abroad by $113 billion in the first quarter versus $144 billion in the fourth quarter and was lower than the 2002 pace.

Foreign investors reduced their purchases of Treasuries slightly in the first quarter, but their purchases of other U.S. securities slowed considerably, continuing the trend shown in 2002.

Copyright © Andrew Caughey, 2003

The Pulse of Capitalism is published quarterly. Comments may be sent to Pulse Publication, P.O. Box 140, Gibsonia, PA 15044. Telephone: (724) 443-2396
Material may be reprinted with acknowledgement of the source. Economic statistics are revised routinely and may, therefore, differ from one report to another.

Published August 2003

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