The fear of “Japanisation” has, once again, prompted monetary authorities on both sides of the Atlantic to consider additional monetary easing — but for all the wrong reasons. The extended periods of slow growth and low inflation seen in Japan since 1990 and in the west since 2008 are caused by the disappearance of borrowers, not by the lack of lenders. Monetary policy, which controls the availability of financing, does not work well when there is no appetite for debt.
The Japanese demand for borrowing disappeared after the bursting of its bubble in 1990. During the process, commercial real estate prices fell almost 90 per cent nationwide, falling back to the levels of 1973, destroying the financial health of all those who borrowed to purchase property and those who used it as collateral for borrowing.
With pre-1990 liabilities still on the books but no assets to show for them, millions of borrowers started to pay down debt to remove their debt overhang, even with zero or negative
interest rates. It was a journey that took nearly two decades to complete.
Regaining financial health is a must for individual households and businesses. But when everybody does it at the same time, not only do borrowers disappear, but the economy also implodes. This happens because at the national level, if someone is saving money, including paying down debt, someone else must be borrowing and spending those funds to keep the economy going.
In an ordinary economy, interest rates adjust, often with central bank help, to make sure that all saved funds are borrowed and spent. For example, when the economy is strong, with too many borrowers relative to savers, interest rates are raised to discourage some borrowers. Where there are not enough borrowers, the reverse applies.
When a large part of the private sector is preoccupied with debt overhang and not borrowing money, the un- borrowed savings stuck in the financial sector become a leakage to the income stream, pushing the economy into a deflationary spiral called a balance sheet recession.
During the Great Depression, which was the last time this type of recession was allowed to continue unattended, the US lost 46 per cent of its nominal gross national product from 1929 to 1933.
Post-1990, Japan suffered balance sheet damage that was three times larger as a percentage of gross domestic product than the damage the US sustained during the Great Depression. But instead of shrinking 46 per cent, Japan’s GDP in both nominal and in real terms never fell below the peak of the bubble, and its unemployment rate never rose above 5.5 per cent.
This miraculous achievement in the face of massive private sector deleveraging was made possible by the government borrowing and spending the excess savings in the private sector.
Today, Japan’s unemployment rate is 2.3 per cent and private sector balance sheets are fully repaired. But businesses are still not borrowing because of the trauma created by the dreadful experience of paying down debt. The Ameri
