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COMMENTARY: WHY AMERICA WON'T BE NEXTIt could happen in America, too. That's what some observers are saying about the U.S. economy, which has some disturbing resemblances to Japan's in the late 1980s. In both cases, a substantial boom was propelled by a single leading sector--manufacturing in Japan, high tech in the U.S. Both countries evinced an overflowing confidence. And not least, the stock market in both countries soared to astounding heights. At its 1989 peak, the Nikkei Index was five times its level in the first quarter of 1982. The U.S. market is even hotter--it's up tenfold from the same point (chart). To pessimists, the message is clear: Since Japan saw its bubble burst, the U.S. could easily suffer the same fate. Pessimists overlook some crucial differences, though. U.S. companies and individuals are less dependent on leverage and debt than the Japanese were. U.S. execs are still downsizing, restructuring, and investing to boost productivity. And there is scant evidence in the U.S. of the excesses and overbuilding that plagued Japan, and for that matter the U.S., in the 1980s. But there's a more fundamental reason that the U.S. is less vulnerable than Japan was: the quality of its economic policy. With valuations at sky-high levels, it's impossible to rule out the possibility of a sharp decline in U.S. stock prices. But in recent years, U.S. policymakers such as Federal Reserve Board Chairman Alan Greenspan have shown that they understand how to limit the damage of a financial crisis. By contrast, Japan's central bankers, politicians, and bureaucrats still pretend that the economic lessons of the past 70 years--learned at great cost by the U.S. and Western Europe--don't apply to them. That's an important reason why the long decline of the Nikkei sent the Japanese economy into a tailspin. By itself, a crash is not a disaster. Certainly, financial firms suffer, and consumers cut back. But after a crash, the productive muscle of the economy--factories, human capital--are still there. The long-term danger arises when a financial crisis feeds on itself. A damaged financial system may not be able to provide the lending and investment needed for growth. In the most extreme case, people stop trusting financial institutions, and financial institutions stop trusting borrowers. That's what happened in the Great Depression. Based on that disaster, and 70 years of subsequent experience, there's a clear rule book for a central banker faced with a stock market crash or other financial crisis in an otherwise healthy economy. First, flood the economy with money, because in a crisis liquidity dries up and sound institutions go under when everybody gets scared. Most economists now believe the Federal Reserve's reluctance to open the monetary spigots turned the crash of 1929 into the Great Depression. Second, get the financial system functioning again by closing insolvent institutions and taking bad debt off the books of the private sector. U.S. policymakers have shown they understand these lessons. After the 1987 crash, the Fed pumped large amounts of money into the economy, guaranteeing that large brokerages and banks would not go under. And the savings-and-loan bailout of the 1980s effectively freed up the banking system for the boom of the 1990s. The same cannot be said of the Japanese. The Tokyo stock market started slumping at the end of 1989, but policymakers kept a tight rein on money growth until well into the 1990s--the same mistake made in the U.S. in 1929. Subsequent inaction allowed this financial crisis to damage the real economy in ways that are difficult to reverse. Stock markets can dive--that's a normal part of any capitalist economy. Banks can make loans and lose money. But the key is whether policymakers can address the problems--and that's where the U.S. has Japan beat, hands down.
By Michael J. Mandel RELATED ITEMS
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Updated May 7, 1998 by bwwebmaster
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