[Nasional-e] Susumu Saito: Don't follow advice of orthodox economists

[Ambon]

Editorial


POINT OF VIEW/Susumu Saito: Don't follow advice of orthodox economists

---The conversion of Japanese policymakers to the current economic orthodoxy
has quickly thrown the Japanese economy into a depression and a financial
crisis since 1997. Prime Minister Junichiro Koizumi and his cohorts still
appear to wear the trappings of the current economic orthodoxy.---
In the field of economic and political philosophy there are not many who are
influenced by new theories after they are 25 or 30 years of age, so that the
ideas which civil servants and politicians and even agitators apply to
current events are not likely to be the newest. But, soon or late, it is
ideas, not vested interests, which are dangerous for good or evil.
These remarks from the concluding pages of John Maynard Keynes' ``The
General Theory of Employment, Interest and Money,'' published in 1936, are
still useful for explaining why most economists are so confused when it
comes to diagnosing and prescribing remedies for each nation's economy, and
the global economy as a whole, which are still reeling from the bursting of
the global financial bubble in 2000.
Among most economists, the orthodoxy of the 1980s and 1990s was basically a
rehabilitation of classical or laissez-faire economics.
Major slogans of the days were as follows: (1) Liberalize financial and
non-financial markets through deregulation and let markets take care of
economic activity; (2) Fiscal policy is not very effective; and (3) Let more
powerful monetary policy take care of smoothing out business cycles.
---Stuck to orthdox views---
Most economists currently active in academia, public office and businesses
have been steeped in the above-mentioned orthodoxy for the past two decades
or so.
Accordingly, the ballooning and bursting of a global financial bubble was
beyond their comprehension. It simply could not and should not have
happened. Even after the bubble burst, most have stuck to their orthodox
views in their diagnosis of economic activity and policy prescriptions,
maintaining a blind faith in conventional monetary policy as a tool to
revive economic activity. The financial and economic situation for the past
two years or so, however, appears to belie the current orthodoxy held by
most economists.
The U.S. Federal Reserve has cut the federal funds rate by 4.75 percent, to
1.75 percent, since the bubble burst, but the U.S. stock market has not
displayed any sign that it has already bottomed out. The most comprehensive
index, the Wilshire 5000 index, is down 51 percent from its peak, recorded
in the spring of 2000. And U.S. long-term interest rates are still sliding,
suggesting a further stagnation of U.S. economic activity ahead.
The euro-zone countries have largely stuck to the growth and stabilization
pact that forces member countries to keep annual budget deficits below 3
percent of gross domestic product, though France lately appears to be
deviating from that pact. The stock markets in continental Europe, however,
have performed more miserably than those in the United States; the German
DAX index and the French CAC 40 index are down 69 percent and 62 percent,
respectively, from their peaks in 2000.
Indeed, sharply lower short-term interest rates have worked to supply new
credit for the U.S. economy. Outstanding credit market debt has expanded by
$4.3 trillion to $30.5 trillion, from the first quarter of 2000 to the
second quarter of 2002. The decline in the sum of total market
capitalization of stocks and mutual funds by $7.9 trillion, down to $17.2
trillion, however, has overwhelmed the effect of lower interest rates during
the same period.
In other words, overall credits outstanding for the U.S. economy as measured
by the sum of credit market debt outstanding, total market capitalization of
stocks and mutual funds have contracted by 6.9 percent, or $3.6 trillion,
during the above-mentioned period. No wonder that the U.S. economy has
continued to stagnate for the past two years or so.
In a sense, the bursting of the stock market bubble is a correction of
excessive indebtedness that had been created through stock markets for the
past two decades or so.
The same process will begin to take place in financial markets other than
stock markets when the Federal Reserve runs out of ammunition-lower interest
rates-to force-feed new credit for stimulating the U.S. economy. Simply put,
nominal interest rates cannot go lower than zero.
Only then will the real peril to the U.S. economy arise. Without the
expansion of new credit through financial markets, not only will aggregate
demand falter further, but also a substantial portion of credit market debt
outstanding will turn bad. Remember that it is a relative scale of economic
activity that determines whether a certain level of indebtedness is
excessive or not.
Since 1981, when the U.S. stock market began to exceed historical rises,
credit market debt outstanding has increased 5.8 times, to $30.5 trillion,
in the second quarter of 2002 while gross domestic product (GDP) has
expanded 3.3 times to $10.4 trillion.
If it had increased only in proportion to the scale of economic activity as
measured by GDP, credit market debt outstanding should have expanded only up
to $17.5 trillion, or $13.0 trillion less than actual credit market debt
outstanding.
This gap of $13.0 trillion, or 42.8 percent of actual credit market debt
outstanding, represents the accelerating pace of indebtedness of the U.S.
economy for the past two decades, and has been rationalized only on
expectations that the scale of economic activity, or aggregate demand, will
continue to grow. Otherwise, this huge sum will quickly turn out to be
potentially bad financial debt after all.
The size alone of potentially bad debt is large enough to cause a major
financial crisis in the United States unless an up-trend in aggregate demand
is somehow maintained. No financial system can stand if more than 40 percent
of its debt, which is by definition equal to assets in the system as a
whole, becomes potentially, if not actually, bad.
The other side of the coin of ``excessive'' indebtedness is ``excessive''
capital stock, or production capacity, relative to the level of aggregate
demand. There are only two ways for the U.S. economy to get out of this
situation. The first is to let excessive capital stock be depleted through
bankruptcies; a sure way toward a great depression, given the
above-mentioned size of potentially bad debt. The second is to let aggregate
demand balloon until it is re-balanced with the existing level of debt or
capital stock. A re-balancing of the U.S. economy back to the 1981 level in
this way will require annual GDP to expand up to $18 trillion from about $10
trillion of late.
The remaining tools for the United States are only fiscal policy and an
unconventional monetary policy by which the Fed underwrites all the new
Treasury securities to finance an expansionary fiscal policy.
Given ``excessive'' capital stock, it is no wonder that conventional
monetary policy, if it is intended to stimulate business capital spending,
is ineffective until capital stock is depleted substantially or aggregate
demand is expanded to a certain level through other policy tools.
As conventional monetary policy has been almost exhausted, the remaining
burden of re-balancing the U.S. economy will fall to fiscal policy and/or
the adjustment of the private sector of the economy through bankruptcies and
unemployment. Given the magnitude of adjustment as suggested by the scale of
potentially bad debt, the burden on the national treasury will be
particularly heavy, if the nation gives priority to maintaining the level of
employment. In this sense, the choice of policy is highly political.
After the bursting of the bubble, Japan somehow managed through fiscal
policy to prevent what might otherwise have been a full-fledged depression
until 1996.
---Conversion to economic orthdoxy---
The conversion of Japanese policymakers to the current economic orthodoxy,
however, has quickly thrown the Japanese economy into a depression and a
financial crisis since 1997. Prime Minister Junichiro Koizumi and his
cohorts still appear to wear the trappings of the current economic
orthodoxy.
There are few economists in the United States able to evaluate the Japanese
experience from a balanced perspective. For example, Paul Krugman of
Princeton University, who writes a regular column for The New York Times,
claimed in the Dec. 27, 2000, column titled ``We're Not Japan'' that cutting
interest rates would likely do the trick of overcoming the aftermath of the
U.S. bubble economy. Early this month, he came close to admitting that the
interest rate cuts were not enough. In Paul Krugman, I see at least a bit of
intellectual honesty. In Koizumi and his cohorts, however, I see none of the
same quality.
* * *
The author is the director of Trilateral Institute, Inc. (Sankyoku Keizai
Kenkyusho), a private economic think tank based in Tokyo. His column usually
runs on the third Wednesday of each month. He contributed this comment to
the International Herald Tribune/ The Asahi Shimbun.

(IHT/Asahi: October 17,2002)