Is US the next Japan? Why the Tea Party is better than Obama

By George Albert

The market correction in the US over the past few days and the policy choices of the world’s largest economy have raised a scary spectre: America is going down the path Japan took to stagnation for more than 20 years.

If the USbecomes a Japan, it is not good for the world economy and emerging countries such as India. When Japan, the world’s second largest economy, went into a recession it did not affect other countries much. The US economy provided the growth engine for the world. A failure of the US now can lead to a vacuum in the world economy. The BRICs (Brazil, Russia, India and China) are not yet ready to be the global engine of growth.

As things stand now, the Tea Party activists - dubbed as a bunch of loonies by mainstream media - seem to have better economic instincts that either of the mainstream parties (of which more later).

Let’s first look at the shocks delivered to the US economy, and how the efforts to fight the financial crisis and great recession are eerily similar to Japan’s in the 1990s.

One, the US and Japanese economies saw a massive real estate bubble fuelled by low interest rates. The low interest rates also led to an overleveraged economy.

Two, both economies saw a real estate bust that was followed by a financial crisis due to bad mortgage assets in banks’ books.

Three, Japan and the US bailed out the banks with massive taxpayer funding. They also relaxed accounting rules to prevent banks for taking the painful decision of recognising, provisioning or writing off bad loans. The governments essentially interfered with the market and stopped the deleveraging required to bring the economy back to health.

Four, both the countries then continued to keep interest rates low, and printed money to provide a massive stimulus to the economy. Japan has been trying to stimulate the economy with currency interventions and government spending for more than 20 years. The US has gone down that path aggressively for the past few years with zero interest rates, quantitative easing and government stimulus.

Five, the overspending by both governments resulted in a massive debt-to-GDP ratio, taking away the fiscal and monetary cushions of the economy. The Japanese policy choice - textbook Keynesian economics - has failed. The exhaustion of Keynesian recession fighting tools resulted in a slow decay of the Japanese economy. The proof is in the Japanese stock market.The Nikkei 225 index, which stood near 40,000 in 1989, was below 9,000 last Friday. That’s a lost double decade. View Chart

If the policy choices of the US make it another Japan, the reverberations will be felt across the world. A shrinkage of demand in the US market will affect shopfloors in China and software and textile producers in India. We believe that stock markets across the world are discounting the possibility of a global malaise.

But all is not lost yet. Small businesses and freedom-minded people in American society are revolting. It’s called the Tea Party. Tea Party politicians forced the government to cut spending. If the principles of the Tea Party- small government, lower taxes, a strong private sector, balanced budgets, supply side economics and individual responsibility - prevail in the US, we will see a period of growth again.

Supply side economics essentially increases the supply of goods and services through lower taxes, less regulation and promotion of entrepreneurship. Increased supply reduces prices, stimulating demand. Demand is also increased by jobs created to increase supply.

Keynesian economics, on the other hand, promotes demand by redistributing wealth and stoking inflation. This works as long as the government has other people’s money to redistribute. Once money runs out, so does demand, leading to an economic slowdown again - as is happening in the US now. Additionally, increasing demand without increased supply leads to inflation, hurting the weakest in society. This is what is happening in India too with food inflation.

The Keynesian model failed in the US when Jimmy Carter was President and is failing now with Obama. It failed in the UK till Margaret Thatcher stepped in with supply side economics. The US began its longest lasting boom when Ronald Reagan implemented supply side economics. Big government and their stimulus programmes using other people’s money have failed again and again. Just look at Japan and the PIIGS (Portugal, Ireland, Italy, Greece and Spain).

Insanity is defined as trying to do the same thing over and over again and still expecting a different result. Let’s hope, for the good of the global economy, that the big stimulus era comes to an end and the private sector repairs the damage created by governments.

George Albert is a Chicago-based trend watcher and edits www.capturetrends.com