Japan’s Lost Decades and what it means for Singapore

Toh Beng Chye

Japan had a huge asset bubble in its property and stock market from 1986 to 1991. Its subsequent collapse has contributed greatly to Japan’s lost decades in which she suffered sub-par economic growth, recurrent recessions and deflation.

Nobel Prize winner economist Paul Krugman believed that Japan is in a liquidity trap. US Federal Reserve chairman Ben Bernanke proposed that the Japanese Central Bank should drop cash from a helicopter to save her from the liquidity trap, earning him the moniker “Helicopter Ben”.

Despite heroic effort in quantitative easing (QE) of the Japanese Central Bank and fiscal spending by the Japanese Government (so much so that her public debt is 233% of her GDP as of 2011), Japan remains stuck in a economic morass.

According to Richard C. Koo of Nomura Research Institute, Japan is suffering from a Balance Sheet Recession after the collapse of its asset bubbles. A balance sheet is a summary of the financial position of an individual, company or government.

Example: an individual purchases a property for 1 million dollars with 200 thousand in cash (equity) and 800 thousand in borrowing (liability), his balance sheet will look like this :

Balance Sheet 1
Liability 800,000
Total Asset 1,000,000

If the property loses its value and is now worth only 700,000 the liability (borrowing) remains the same but the equity part will have decreased. The balance sheet, will now look like this:

Balance Sheet 2
Liability 800,000
Total Asset 700,000

So seeing the negative equity in their balance sheet, companies and individuals will attempt to pay down their debt through cutting their spending and investment and causing a fall in economic activities. This process is know as deleveraging and its effects is to create a drag on the economy.

Economists will advocate stimulating the economy through monetary and fiscal policies. Monetary tools include cutting interest rates close to zero (to stimulate borrowing) and quantitative easing (through purchase of financial assets to support asset prices). The government may increase fiscal spending to support the GDP.

Alas, for Japan, all these tools have failed to work sufficiently to counter the adverse effects of deleveraging causing two decades of non-economic growth. Hence, the Lost Decades.

Unfortunately, this deleveraging process is now apparent in the USA and Europe after the US subprime crisis.

What the above chart shows is that there is a massive contraction in the private sector debt (of 6 trillion dollars) in the US since 2008, suggesting strongly that the process of deleveraging is ongoing.

Thus despite QE1, QE2, Operation Twist and Zero Interest Rate Policy (ZIRP) by the Federal Reserve, the US economy remains moribund and the unemployment rate stays stubbornly high.

If we go by Japan’s experience, we can expect US economic difficulties to last just as long.

How does all these impact Singapore? The obvious answer is US and Europe are our major trading partners, if their economies are in trouble, our export and growth will be severely curtailed. Thus we can expect much more financial and economic turmoil.

We can also expect much slower growth. We should look for more ways to diversify our economy. The difficulties that the Federal Reserve has in countering the process of deleveraging suggests that we are in for a long rough ride and we should start preparing for it.

Also by Toh Beng Chye Lesson from Spain

Dr Toh Beng Chye is a medical doctor and is a member of the SDP’s Healthcare Advisory Panel.

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