By the late 1980s, Japanese companies, banks and investors had inflated a massive asset bubble. In an effort to deflate the bubble, the Japanese finance ministry increased interest rates in December 1989. Rather than create a safe landing, the move triggered a catastrophic market crash marking the beginning of Japan’s “lost decades” of economic contraction. Half-measures, framed around a reluctance to allow bank bets to fail exacerbated and prolonged the crisis. Recent actions in Europe suggest that the Eurozone is on the cusp of its own lost decades.
Both regions experienced real estate booms ahead of their financial crises, took on large levels of un-payable debt, created by domestic banks expecting any loss to be socialized.
Once the Japanese bubble burst, the debt crisis infected the banking sector. Rather than allow insolvent banks and companies to fail, Japan pumped money into bailout schemes and created “zombie” institutions loaded with bad debt. Intimately tied to government bureaucracy, the Bank of Japan failed to respond nimbly to reform bank policies. Only the high rate of savings and low unemployment among the Japanese people spared them from the worse consequences in the Lost Decades.
This does not bode well for the Europeans. Responses to the debt crises in member nations have followed an eerily similar pattern to Japanese approaches. Bailout funds have rewarded institutions that overextended on a feast of debt and removed any sense of moral hazard. The troika of the European Commission, European Central Bank and the International Monetary Fund imposed so-called “austerity” programs for citizens rather than government, deficit spending increased along with taxes. Just as in Japan, patching up the insolvent with cash from the competent zombifies the EZ economy, threatening lost decades ahead.
Even Mark Carney, incoming governor of the Bank of England, has raised the alarm:
Europe remains in recession, with economic activity constrained by fiscal austerity, low confidence and tight credit conditions. Deep challenges persist in its financial system. Without sustained and significant reforms, a decade of stagnation threatens.
The Dutch central bank also foresees an imminent lost decade, asserting that European banking systems are too dependent on central bank funds (read: taxation without representation) and too weak to regain consumer confidence.
Meanwhile, savings rates are being undermined in the Eurozone, one of the few factors that kept some stability to Japan’s economy. Indeed, the confiscation of savings (Cyprus) and conversion of bank accounts into stock accounts (Spain) attack citizens’ ability to cushion future uncertainty with present saving. Combined with Europe’s plague of high unemployment, the lack of private safety nets is a recipe for massive social and political unrest—tastes of which have already shaken Greece and Spain. Barry Eichengreen with the Wall Street Journal raises just such a spectre:
Although we are seeing lots of media headlines recently contending that “Austerity Has Failed” in Europe—the Eurozone’s deepening recession and serial bank and debt crises as evidence—the fact is, true austerity has never been implemented. What is needed is to cut public spending, reduce taxes, eliminate wage and price controls and subsidies, allow bankrupt banks and corporations to fail, allow interest rates to reflect to market values... in a nutshell, allow the free market to function freely. Tough times would ensue, initially. But the EU economy would rise in the wake of the correction, and probably much more quickly than we think it would.
But the Eurozone, like most of the world, is married to the global fiat currency system and centralized planning. So it may publicly debate, from time to time, whether stimulus or austerity is the better course. Just don’t be fooled that bailing out failed banks with taxpayer funds or artificially suppressing interest rates is austerity—true austerity has yet to be given so much as a trial run.