The global economy could suffer a “Japanese disease,” heralding a prolonged period of stagnation if policy makers don’t work harder to prevent bubbles, according to a Morgan Stanley executive.
“I am increasingly worried that the world economy is at risk of falling into a Japanese-like quagmire,” led by the U.S. and Europe, Stephen Roach, Morgan Stanley’s non-executive Asia chairman, wrote in a note. “If we’re not careful, the Japanese disease could continue to mutate, infecting other major economies, including those in developing Asia.”
The lessons to learn from Japan’s experiences include that while asset and credit bubbles can’t be prevented, they must be viewed as “potentially serious threats” to financial stability, Roach wrote. “Monetary policy must play the key role in leading a pre-emptive assault on bubbles.”
Japan’s bubble burst in 1990. The size of its economy remains almost the same as 20 years ago. Land prices have fallen for 19 straight years and wages have dropped to a 19 year low last year, according to government reports released last month.
“Policy makers have insisted for years that the glaring mistakes of Japan were so painfully obvious, that they would be relatively easy to avoid,” Roach wrote. “Unfortunately, that does not appear to have been the case.”
An economy will take a while to return to a sustainable growth after a bubble bursts to rid itself of excess employment, debt and production capacity, Bank of Japan Governor Masaaki Shirakawa said this week. “We find a striking similarity in the inflation developments between” U.S. trends from 2007 and Japan after its bubble collapsed, he said in a speech in Washington on Oct. 10.
Unprecedented easy monetary policy should be continued, but not for too long considering its possible side-effects, Shirakawa said. In the U.S., a worse-than expected jobless report last week increased speculation that the Federal Reserve will embark on another round of so-called quantitative easing.
Super-easy monetary policy is difficult to end, according to Roach.
“A major problem with zero policy rates and quantitative easing is that they end up being the functional equivalent of a narcotic,” he wrote. “Once the patient gets the drug, withdrawal is painful and prone to relapses.”
Monetary easing and fiscal stimulus won’t offset the deleveraging occurring in the post-crisis world, Roach wrote.
In the U.S. a “post-bubble shakeout” of consumer spending growth could last 3 to 5 years because of heavy household debt burdens and low saving rates, he wrote.
To avoid bubbles, central banks ought to have a mandate to seek financial stability, according to Roach.
“Only then would monetary authorities have the political cover to attack asset and credit bubbles before they had dangerously destabilizing impacts on markets and wealth- and credit-dependent economies,” he wrote.
Roach also called for a new framework to set hard guidelines for fiscal policy.
Developing countries that rely on exports for growth need to be mindful of the risk of the bursting of overseas bubbles hurting their own economies, he said.
The dependence on exports leaves them beholden to “the ability of the major advanced economies to cope with post crisis hangovers,” Roach wrote. “Today’s great currency debate over” the yuan “only underscores those challenges.”
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