Comparing Crises

In 2007-9, this ultimately unsustainable pattern started to unravel in a largely unanticipated way. Most observers had reckoned that investors would eventually lose faith in an ever more deeply indebted United States and withdraw their money from its markets, thereby triggering a dollar crash that would increase U.S. exports and curtail imports. The current account deficit would thus contract significantly. What actually happened, however, was a more harmful resolution of the imbalances, one affecting exclusively the import side of the ledger. The adjustment started when trouble manifested in the U.S. subprime market, revealing that a range of financial institutions in the United States, Europe, and elsewhere had assumed dangerously large volumes of debt. Like their counterparts in Japan in the 1990s, these firms reacted by selling assets and calling in loans. As the value of market securities began to erode, other lenders saw their balance sheets deteriorate and decided that they, too, needed to raise cash. The resulting wave of asset sales has so far wiped out close to $15 trillion in U.S. wealth alone, which has caused consumers to expand their savings severalfold. Because of this sudden reduction in demand, the U.S. current account deficit will decline from its 2006 peak of six percent of GDP to less than two percent of GDP in 2009 and will remain depressed for several years.

Since global exports of capital must mathematically equal global imports of capital, creditor countries will see their current account surpluses shrink. This is already evident. Japan's surplus will probably drop from a high of 4.8 percent of GDP in 2007 to just 1-2 percent of GDP this year. Beijing announced in March that China's exports fell by 26 percent between last February and the previous February. Comparable results should be expected for Germany and other major trading powers, as well as for the smaller economies that depend on these countries. This year, accordingly, promises to be the first since 1945 in which global GDP actually decreases.

THE JAPANESE RECOVERY

Given that the world today suffers from a shortage of demand similar to that which afflicted Japan in the 1990s, what lessons can be gleaned from Tokyo's attempts to recover? With consumption and investment decreasing and strong growth in net exports precluded by foreign opposition, the only source of new demand available to Japan at that time was the state. So the government budget swung inexorably from a slight surplus at the beginning of the decade to an ever-larger deficit. Tokyo recapitalized its banks in 1998, and a few years later the central bank lowered short-term interest rates to zero and embarked on a modest program of quantitative easing. But these measures only managed to stabilize the financial system, while enormous deficits -- between 1989 and 2003, Japan's national debt rose by the equivalent of its 2003 GDP -- filled the gap in demand and generated an average annual economic growth rate of about one percent.

Japan began a stronger recovery in late 2002. Domestic reforms contributed marginally to this improvement, but progress was primarily the doing of the surge in growth in China, the United States, and East Asia, which began buying more exports from Japan. The ensuing expansion in Japan's trade account produced roughly one-third of the country's GDP growth over the next several years, and corporate investment designed to meet future overseas demand also contributed significantly. Prime Minister Junichiro Koizumi and other Japanese leaders took credit for the commercial efflorescence, de-emphasizing the crucial dynamic from overseas and arguing that they had finally imposed the requisite structural reforms. But this was not true. When the collapse in U.S. consumption eviscerated global demand in late 2008, Japan's exports, industrial output, corporate profitability, and investment plummeted in sequence. The country is now poised for a 5-6 percent contraction in GDP this year, its worst performance since 1945 and a powerful rebuttal to the claim that sagacious policy was responsible for the 2002-7 recovery.

A GLOBAL RECOVERY?

The world now stands roughly where Japan did in the early 1990s, when it had made some progress on its task of reducing leverage but was far from done. The question is whether the United States and other countries are doing enough today to stabilize the world economy and precipitate growth in similar circumstances. Largely ignoring the international aspects of the financial crisis, Katz focuses on Washington's policies, explains that they are more aggressive than Tokyo's were at first, and concludes that the United States will therefore recover more quickly. This analysis, however, rests on four dubious propositions.