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Lost and Foundering?

Why we (probably) won't repeat Japan's infamous "lost decade."

The news about the economy hasn’t been good for some time, but in early February it got worse. The Labor Department reported that the United States had shed 598,000 jobs in January, the worst monthly loss in 35 years, for a total of 3.6 million jobs lost since the recession began in December 2007. The unemployment rate climbed to 7.6 percent, a level last reached 16 years ago. Meanwhile, the S&P 500 stock index remained 45 percent below its October 2007 peak, and millions of Americans dreaded checking their 401(k) balances. Housing prices, which lay at the root of the crisis, were down 25 percent from the 2006 peak of the S&P/Case-Shiller index and expected to fall further.

The economy, in short, is deteriorating at an alarming pace. In its annual budget and economic outlook, the Congressional Budget Office said the recession “will probably be the longest and the deepest since World War II,” lasting “well into 2009.” As of March the recession is 15 months old; by comparison, the longest postwar downturns, beginning in November 1973 and July 1981, lasted 16 months apiece.

On Capitol Hill, Democrats and Republicans wrangled over the provisions of an $800 billion stimulus bill, prompting an exasperated President Obama to scold Congress for the “inexcusable and irresponsible” delay. Treasury Secretary Timothy Geithner unveiled a new plan to bail out the nation’s troubled banks, into which the government has so far poured hundreds of billions of dollars, with little visible effect — except that the banks are still in business.

To a growing number of observers, the current recession is beginning to look like something much worse than 1973 or 1981. It shares key hallmarks of the recent Great Stagnation in Japan — the “lost decade” of the 1990s, an economic slump and financial crisis that actually lasted longer than 10 years. The U.S. economy, many fear, may be on the verge of its own lost decade.

The basic outline of Japan’s lost decade is familiar. Japan’s “bubble economy” of the 1980s saw an astronomical run-up in the values of stocks and property. Famously, the land under the Imperial Palace in Tokyo was said to be worth more than the entire state of California. When the Bank of Japan raised the discount rate from 2.5 percent to 6 percent in 1990, first stocks and then real estate values plummeted. Suddenly saddled with bad loans they were loath to write off, banks curtailed lending to healthy companies, yet refused to pull the plug on insolvent “zombie” companies. Growth fell, and the Bank of Japan steadily lowered the discount rate to 0.5 percent in 1995, holding it there for the rest of the decade. Still, deflation set in.

The consensus is that quick, aggressive action by Japanese authorities would have abbreviated the crisis. Instead, they reacted first by denying that there was a problem, then by trying to bail out banks in a piecemeal fashion, and finally by starting a full-blown bank-recapitalization effort. By the end of the 1990s, many banks were thought to be insolvent.

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