With the recovery faltering despite massive amounts of government aid, economists are now looking deeper for clues about where we might be headed. The obvious starting point: Japan.
For a while, the hope was that stimulus spending, Federal Reserve maneuvers, and other government aid totaling more than $3.5 trillion would be enough to springboard the economy out of recession and get it back on track. For a couple of quarters late last year and early this year, it looked like that was happening.
But now, the painkillers seem to be wearing off before the patient has healed. Hiring remains weak, with unemployment still likely to hit 10 percent before it finally peaks and starts to drift down. Home sales are depressingly low, with buyers ignoring record-low interest rates and sitting on the sidelines. Instead of hitting the malls, consumers are fretting over scarce jobs and a jittery stock market and putting their extra cash in the bank. By most accounts, the odds of a double-dip recession—or worse—are rising.
Japan went through an experience remarkably similar to all this starting in the 1980s, so that's become a natural case study for what we might face. In the '80s, Japan's economy was going gangbusters, rapidly catching up to the U.S. economy and then surpassing it in terms of GDP per capita, a key measure of a nation's prosperity. The fast growth stoked a real-estate bubble fueled by loose lending, just as it happened here in the early 2000s. When Japan's real estate bubble burst, around 1991, banks and investors lost billions. Many of Japan's homeowners ended up trapped in dwellings that were suddenly worth far less than they paid for them.
The collateral damage sent Japan's economy into a 10-year tailspin. While the '90s were mostly a boom decade in America, Japan's anemic economy grew just 0.5 percent per year, on average, from 1991 to 2000. Deflation reduced incomes and depressed spending. Living standards fell and per-capita GDP plummeted. Gloom displaced confidence, dragging down the economy even more.
The worry now in the United States is that we're facing our own "lost decade," a period of chronically slow growth that defies all the usual government remedies. A year ago, many economists thought the Federal Reserve would be raising interest rates by now, the usual response after a recession ends and the economy is starting to mend. Instead, the Fed is pledging to keep its short-term rates near zero for "an extended period," and openly discussing other extraordinary measures to prop up the sagging economy. "The U.S. is closer to a Japanese-style outcome today than at any time in recent history," wrote James Bullard, president of the Federal Reserve Bank of St. Louis, in a recent study.
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If it actually happened, America would look like an economic wasteland 10 years from now. Economists at Bank of America Merrill Lynch created a "Japanification" scenario to gauge the worst-possible outcome of near-zero interest rates and continuously falling asset prices. GDP growth would average just 1 percent per year—for the next 20 years. The Dow Jones Industrial Average would fall 60 percent from where it is today, and home prices would fall another 50 percent from already-clipped levels. Under that kind of duress, 10 percent unemployment would probably seem like the good ol' days.
But don't choke on your sushi just yet. Federal Reserve Chairman Ben Bernanke intently studied Japan's lost decade while a scholar at Princeton, and chided Japan's government for responding too slowly and weakly. When the U. S. economy hit similar obstacles, Bernanke's Fed deliberately avoided many of the mistakes now attributed to Japan's central bank in the '90s. The Fed cut interest rates to stimulate the economy more quickly and deeply than the Bank of Japan did. It also took the more unusual step of buying about $1.5 trillion worth of mortgage-backed securities, pumping money into the system, and stimulating demand for other types of securities—like stocks. That may have been one big reason the stock market surged between March 2009 and April 2010.
[See 4 reasons to fear deflation.]
Then there were the bank bailouts that began during the Bush administration. As unpopular as they were, those "capital injections" directly addressed a problem that bedeviled Japan in the '90s: "zombie" banks that were financially crippled but stayed in business, sitting on vast amounts of money that otherwise would have been loaned and invested, generating badly needed economic activity. The bailouts more or less worked: The U.S. financial system is healing, with bank lending to big companies pretty much back to normal.
Consumer and small-business lending still has a ways to go, and other parts of the economy will only get better with time. Housing is in a deep funk, for example, with Bank of America calling it a "double dip in home sales." Americans built up way too much debt over the last 10 years, and have only made limited progress so far in paying it off.
But instead of a decade's worth of retrenching, we may face just a couple more years' worth. "The U.S. has leap-frogged Japan's 'lost decade,' and more closely resembles Japan in the early 2000s," says Alan Levenson, chief economist at investing firm T. Rowe Price. That's partly because the U.S. banking crisis mushroomed more quickly once the housing bust was underway, and partly because the government promptly addressed it. The "stress tests" administered by the Fed to the nation's 19 biggest banks in 2009 are widely viewed as a decisive step toward evaluating the health of the financial system, just three years after the housing bust began. Japan put off that type of action for at least seven years.
If America endures a lost half-decade instead of a full 10 years, that would place a real recovery in 2012 or so, since the recession began at the end of 2007. That aligns with a lot of other convincing evidence. In a recent survey by consulting firm Accenture, for example, companies said they've stopped laying off workers for the most part, but don't plan to start hiring again in earnest for another 12 months. Most forecasts for the job market show the unemployment rate staying above 9 percent in 2011, and only falling below that in 2012. There's also an election in 2012, and if President Obama can't claim credit for a dramatically improved economy by then, he may as well not even bother to run.
There's still plenty that could go wrong: a worsening debt crisis in Europe, an accelerating vortex of unemployment and gloom, disastrous missteps in Washington, or something unforeseen that no government can control. And waiting another two years for a recovery to take hold will be agonizing to those under financial stress. But compared with 2017, 2012 doesn't seem so bad. Yes, that's what amounts to good news these days.