Why the US Now Isn't Japan Post-Bubble

In November 2009, I was talking to a hedge fund conference in London about the Japanese post-bubble experience, trying to answer whether Japan's posts-bubble experience was coming America's way.

It took 45 slides for me to conclude 'probably not', on the grounds that there was a big difference in how deleveraging cycles played out, depending on whether your debt overhang was concentrated in the corporate sector or the household sector. And I still think that's important. In Japan's case, the debt overhang was in the corporate sector, and as corporate Japan deleveraged, the process inevitably crushed corporate ROEs. The result of that was that the capital investment motor to the business cycle spluttered indefinitely without ever really coming to life.

In Japan's case, too, the complex and all-pervading financial repression which had been such a vital structural support to Japan's corporate debt habit at first delayed the message getting through to corporate Japan, and also, of course, discouraged the sort of household spending which could have moderated the impact of corporate deleveraging.

In the US case, I said, the debt overhang is in the household sector, which can come down very quickly. Meanwhile, unlike in Japan post-1990, ROCs in the US were rising sharply, so we could and should expect to see an investment cycle begin to kick in.

Well, that's what I thought, and two years later, the same questions are still being asked, and the assumption that the US might well be in for a Japan-type experience is becoming ingrained. And I still think 'probably not.'

So here are three charts comparing the underlying cyclical trajectory of Japan, starting 1Q90, and the US, starting 4Q08.

The first shows the difference between the direction of ROC, calculated in my normal manner of expressing GDP as a flow of income from a stock of capital estimated by assuming 10 year straight-line depreciation on all gross fixed capital formation. The problem for Japan was that even 17 quarters after the Bubble burst, ROC was still declining, and when it stopped declining, it barely ticked up. That, overwhelmingly, was the impact of sustained corporate deleveraging. Meanwhile, in the US, the decline in ROC bottomed out within a year of the financial crisis, and continues to rise quite vigorously. One should expect this rise in ROC eventually to give rise to a recovery in capital spending, which in turn becomes a motive source for a positive business cycle. Confidence may ebb and flow, but if ROC is rising, it's very safe to assume that capital spending will too.  

In fact, that's what's happening – in sharp contrast to Japan.As the chart shows, it took corporate Japan a couple of years to reverse the build-up of capital stock, and start a long drawn-out slowdown from which it has barely recovered. For the US there was less corporate delusion from the get-go, with the stock of capital shrinking within 18 months, and very quietly beginning to show signs of sustained recovery.

And the third chart helps explain why: the average age of the US capital stock was already significantly higher than Japan's then (or Europe's now). As capital ages, the argument for re-tooling becomes increasingly urgent.

Now the US has its problems, and household sector deleveraging isn't a painless experience. But, crucially, it does not by itself take out the capital-spending cycle – a key accelerator of any business cycle. However the US's deleveraging plays out, it's not going to be a carbon copy of Japan's experience.