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posted on 07 March 2018

Japan Led The World Into Excessive Private Debt

by Steve Keen, Steve Keen's Debtwatch

Preface to the Japanese Edition of “Can we avoid another financial crisis?"

Can we avoid another financial crisis? has been published in French and Italian, and it will come out in Japanese in the middle of the year. This is the preface to that translation.


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Japan's "Lost Decade" should have been the "canary in the coal mine" that alerted the world to the dangers of excessive private debt. Instead, the lessons that Japan's crisis could have taught the world were ignored. One and a half decades later, the USA, the UK, and several smaller European countries (Denmark, Ireland, Portugal, and Spain) fell into the same trap. Now, many more countries stand on the verge of the same trap. The most significant is China, but my current list of "Debt Zombies To Be" includes also Canada, South Korea, Australia, Belgium, Norway, and perhaps France, Singapore, and Sweden.

The Japanese data is clear and unequivocal: the "Bubble Economy" began when credit - which is demand financed by borrowed money - rose from 12% of GDP in 1986 to over 27% of GDP in 1990. Since that new money is spent buying both goods and assets, both Japan's economy and its asset markets boomed.

However, borrowing at this rate necessarily dramatically increased the level of private debt, from under 170 percent of GDP at the start of the Bubble Economy to 210 percent when the crash began, and a peak level of 220 percent some years later. The plunge from very high positive levels of credit - as high as plus 27% of GDP in 1989 - to very high negative levels - as low as minus 14% of GDP in late 1999 - was the cause of Japan's crisis, and the long malaise that followed.

As I explain in this book, total demand in the economy comes from four main sources: the circulation of existing money, net exports, net government spending, and credit. Of these four, credit-based demand is by far the most volatile. The Lost Decade occurred because this significant component of demand simply disappeared. Between 1965 and 1989, the average level of credit-based demand was equivalent to about 17% of GDP. From the start of the crisis in 1991 until mid-2013, its average level was minus 0.7%. Rather than credit adding to the demand, it actually subtracted from it. Only since mid-2013 has this source of demand started to return, but even so it is not on the same scale as it was before the Bubble burst.

Credit is currently equivalent to about 5% of GDP, which is enough to stimulate the economy somewhat. But the credit stimulus will never reach the scale it was before the crisis. With a still-high level of private debt, the room for sustained credit growth is low, and the chance to fall back into negative credit again is high.

Once, Japan was alone. Now, it has the company of the USA and the other countries that experienced a debt crisis in 2008. They fell into the same trap as Japan because the economists whom politicians turn to for advice do not understand money, or banking, or debt, and they therefore ignored the data I have shown here.

This might sound like an outrageous claim: surely economists are the experts on money? I agree that they should be. But remarkably, the majority of economists completely ignore the role of banks, private debt, and money in the economy. The most that they will do is admit that, during a crisis, private debt can be a problem. But in general, they argue that both the level and the rate of change of private debt are unimportant except during extraordinary periods like financial crises.

Their model of banking treats credit, not as a creation of new spending power, but as a redistribution of existing spending power from a lender to a borrower. The rise in one party's spending power is offset by the fall in the others, and they therefore assert that, to quote ex-Federal Reserve Chairman Ben Bernanke, "pure redistributions should have no significant macroeconomic effects" (Bernanke 2000, p. 24), whether debt is rising or falling.

I explain why this view is wrong in this book, but a simple glance at the correlation between credit and unemployment in Japan is enough to show that it must be wrong. If it were correct, the correlation between credit (the annual change in private debt) and unemployment would be not significantly different from zero. It is in fact minus 0.91, which is an almost perfect negative correlation: unemployment falls when credit rises, and rises when credit falls.

One other lesson that Japan's data should have taught the rest of the world has also been ignored. This is that a government in a country which has its own currency, and which is running a trade surplus, can sustain virtually any level of government debt. There are no practical limitations on its ability to do so, since everyone in that country accepts government money. The only dangers are the consequences - causing too high a level of inflation, or creating a trade deficit through too high a level of aggregate demand.

Similarly, running a budget surplus is a bad idea, because it either destroys money in that economy and brings aggregate demand down with it, or it encourages the private sector to borrow too much money from banks, leading to a blowout in private debt levels, and ultimately a crisis.

Japan actually reduced its government debt levels during the Bubble Economy period, and won the applause of mainstream economists for "good fiscal management". In fact, this was only possible because the private-credit-fuelled Bubble allowed government spending to fall and tax revenue to rise. Once the Bubble burst, government debt rose dramatically - from 55% to 220% of GDP.

The most orthodox of mainstream economists kept predicting ruin from this high level of government debt, but in fact Richard Koo was right when he argued that this extra government spending made the difference between Japan experiencing a Lost Decade and a Great Depression.

But it is also only masking the symptom, not treating its cause.

The additional demand from government net spending has stopped the economy collapsing - as it did in Spain, where the Euro and the Maastricht Treaty's rules prevented government spending from counteracting the plunge in private sector credit-based demand. But it has only indirectly reduced the real cause of the Lost Decade, the excessive level of private debt. The government stimulus, and the Central Bank's policy of buying private sector debt ("Quantitative Easing") would have been far more effective if they had been used to reduce private non-financial sector debt directly. I call this policy a "Modern Debt Jubilee", and I explain it in the final chapter of this book.

The unusual composition of Japan's private debt makes an additional tweak to this policy necessary: the money that would go to households that have no debt should be used to purchase corporate shares that must be used to reduce corporate debt. This would both reduce the high debt levels of Japanese corporations, enabling them to finance innovation and investment once more, and it would partly democratize share ownership, at a time when both finance and the misguided policy of Quantitative Easing have seriously exacerbated inequality.

These and other policies explained in my conclusion could allow Japan, which was the first country to fall into the trap of excessive private debt, to also be the first country to escape from it. Whether that happens in fact will depend far more upon you, than on politicians whose minds are still too ensnared in the fallacious, and economically damaging, views of mainstream economics. It's time you told them to change their minds.

Econintersect note: Steve Keen is conducting a Patreon campaign to enlist financial support that will enable him to continue his unique research outside of the academic world heretofore his home. Econintersect strongly endorses this campaign.

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