Free Markets, Free People

asset prices

The “Economics” of Obama’s First 100 Days, Part 2

In addition to Bruce’s post below, chartng the rise in debt since Pres. Obama took office, I think it’s important to look at whether we can find historical parallels, and try to identify how closely such parallels may apply to the current economic situation in the US.  Fortunately, a historic parallel–and a very close on at that–comes easily to hand.

Does this look familiar?  If not, it probably will...

Does this look familiar? If not, it probably will...

The chart on the right is a comparison of how Japan’s increase in debt since 1989 compares with the performance of the Nikkei stock index.

As the authors of the chart point out:

[I]f large increases in government debt were the key to economic prosperity, Japan would be in the greatest boom of all time. Instead, their economy is in shambles. After two decades of repeated disappointments, Japan is in the midst of its worst recession since the end of World War II. In the fourth quarter, their GDP declined almost twice as fast as that of the U.S. or the EU. The huge increase in Japanese government debt was created when it provided funds to salvage failing banks, insurance and other companies, plus transitory tax relief and make-work projects.

In 2008, after two decades of massive debt increases, the Nikkei 225 average was 77% lower than in 1989, and the yield on long Japanese Government Bonds was less than 1.5% (Chart 6). As the Government Debt to GDP ratio surged, interest rates and stock prices fell, reflecting the negative consequences of the transfer of financial resources from the private to the public sector (Chart 7). Thus, the fiscal largesse did not restore Japan to prosperity. The deprivation of private sector funds suggested that these policy actions served to impede, rather than facilitate, economic activity.

They say that insanity can be defined of repeating past actions with the expectation of a different outcome.  If so, how do we characterize the current government activity in response to the economic situation?

Happily–if that is the appropriate word–we may be able to put to rest fears of hyperinflation.

The bottom line, however, is that it is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. That is not happening. Too much and poorly financed debt has rendered monetary policy ineffective.

So, we’ve got that going for us.