A Warning to be Heeded — Or Ignored

Today’s New York Times contained an article discussing the alarming similarities between today’s economic situation in the U.S. and the situation in Japan in the late 1990s.  Here’s the link:

http://www.nytimes.com/2010/10/30/world/asia/30japan.html

To put the article in a nutshell, in the late 1990s, just as Japan was crawling out of a severe recession brought on by an economic “bubble”, the Japanese government decided that the country’s ballooning deficit needed to be brought under control.  Consequently, the government enacted a tax increase (from 3%  to 5% in their national consumption tax) to bring in additional revenue.  The result, however, was to decrease the nation’s money supply and slam the door on economic recovery.  Here’s a direct link to a graph that shows what happened to the Japanese CPI as a result:

http://www.nytimes.com/imagepages/2010/10/30/world/30japan-graf01.html?ref=asia

Essentially, the decrease in money supply led to a deflationary spiral that took years to pull out of.   Even today, more than ten years later, Japan is still suffering from anemic growth.  (Of course, the recession that began in 2008 didn’t help matters, but you’ll note that the graph only goes up to 2007, when the rest of the world was still experiencing boom-like expansion.)

What’s the relevance to the U.S.?  The current election portends an increase in Republican political power, with most observers predicting that the Republicans are poised to take over control of the House, if not the Senate as well.  Part of the Republican mantra is the prime importance of decreasing the size of the federal deficit.  While Republicans don’t propose to increase taxes — quite to the contrary, they propose to extend all of the Bush tax cuts indefinitely; they do propose to dramatically decrease federal spending, primarily by eliminating spending on federal social programs.  The reduction in federal $$ pumping into the economy will have a similar effect to a tax increase.  It will decrease the size of the money supply.  With less money available, there will be less demand for goods, and consequently prices will fall — deflation.  In short, the Republican economic strategy appears likely to result in a variation on Japan’s economic mistakes of the 1990s.  It’s possible that by 2012, when Obama is up for re-election, the stupidity of this policy will have become apparent enough that the public will repudiate the Republicans, re-electing Obama and restoring a Democratic majority in both houses.  It’s even possible that repudiation will be intense enough that it will give the Democrats a filibuster-proof majority and perhaps eliminate some of the Democrats-in-Name-Only who currently side with Republicans in obstructing Obama’s legislative agenda.  Even so, the U.S. will have lost two years of growth, as well as continuing back-asswards environmental policies at a time when that can be ill-afforded. 

Even worse, however, it’s possible that by 2012 the American public still won’t “get it” and will elect a Republican president and congress in the hope that further reducing the deficit will prove to be a cure-all.  (Americans have always loved magical thinking.)  If that happens, we can look forward to repeating Japan’s mistake in spades, and perhaps dropping off the first tier of world economic powers, to be replaced in all likelihood by China and India.

To look at the bright side, we probably will no longer be able to enforce the “Pax Americana” and there may be a little less warfare in the world overall.  Have a nice day!!

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