Land of the Setting Sun

By John Lumbard.

When news came that we had not, like lemmings, jumped over a Cliff, celebrations broke out across the nation. Nearly a million people jammed the streets around Times Square, and the party lasted well after dawn. As the sun rose—coincidentally the first day of a new year—revelers quietly rejoiced over the $62 billion a year in tax increases and $1.2 billion in spending cuts that had resulted from weeks of pitched battle in the bowels of the Capitol.

That’s billion with a B. Last year the nation raised $2.4 Trillion in taxes, and spent $3.5 Trillion. We’ve never raised $3.5 trillion in taxes, either in dollars or as a percentage of GDP. Not even in World War II!!  So, in 2013 Congress will continue to massively stimulate the economy, at a trillion-dollar-a-year rate, even as the Federal Reserve stimulates massively by printing money and holding interest rates near zero.

Consumers have responded by purchasing autos and homes, and factories are humming. But it seems clear that the Cliff Jump should be an annual event, in which the voters are asked whether they really want to borrow another trillion dollars to juice the economy for a mere 12 months.

Greece, Italy, Spain, Portugal, France (new to the club, recently added by the IMF) and Japan have also been overspending for decades, so it’s clear that you can’t count on the political class to step up to its responsibilities. All of us are flailing around at the tail end of a global super-cycle of debt accumulation, in which we consumed more—at both the personal and government levels—than we could afford.

For the most part consumers have cleaned up their acts, but governments are another story entirely. Japan is the country to watch. The island nation’s debt–a quadrillion yen—is the biggest in the world; worse than Greece, Iceland, Portugal, Eritrea, Sudan, or Zimbabwe, and actually bigger in dollar terms than our own. It was able to reach that lofty level because Japan’s citizens—some of the world’s most diligent savers—were willing to lend the government as much as it wanted. Now the hard-saving older generations are retiring, and the government is beginning to borrow from foreigners.

Japan’s economy is shrinking, and the former export powerhouse has become an importer. The electronics industry is reeling from a long series of bad decisions, missing the entire wireless revolution and instead betting on cameras and the hypercompetitive TV market. Sharp has warned of looming bankruptcy.

How did it get this bad? The spending binge started in 1991, in response to the simultaneous bursting of gigantic bubbles in the stock market and in real estate. Stimulus seemed like a reasonable thing in the first couple of years—they said they were “priming the pump”—but the bridges to nowhere quickly morphed into vote-buying and all manner of social spending, undermining the national work ethic even as it pulled ever-greater chunks of the economy under the thumb of bureaucrats and politicians. Year by year Japan’s innovation, entrepreneurialism, and drive were slowly crushed by the weight of government, as spending and budget deficits grew larger and larger.

Spending is now twice as large as revenues, but the best idea the political class can come up with is to spend more. The newly-elected government plans to build more bridges to nowhere and increase defense spending to pick a fight with China. Yes, China; Japan’s largest trading partner and home to a thousand Japanese manufacturing plants. Really?

The new prime minister also wants to push up the inflation rate to 2%, to give consumers a reason to buy today rather than waiting for lower prices tomorrow. That might be worth a shot, apart from the fact that a 2% interest rate on Japan’s debt would mean that half the nation’s tax revenue would be consumed by interest payments. As debt gets larger, a nation’s options and policy choices shrivel to nothing.

Japan is probably beyond the point of no return, but it didn’t have to be this way. In 1993, as the land of the rising sun was steadily ramping up her deficit spending, Canada’s debt had grown to the point where interest was consuming more than a third of all tax revenue. The Canadian dollar had been nicknamed the “northern peso”, and The Wall Street Journal called Canada an honorary member of the Third World. The nation went on a crash diet under the leadership of a Jean Chretien, a Liberal who was well-positioned to resist the pleas of the many constituencies created by the overspending of his predecessors.

It was a remarkable act of courage. As time passes those constituencies—votes purchased by government spending—become larger and more powerful. The debt grows, the interest on the debt rises, and the required spending cuts become more and more severe. Yet Canada’s GDP grew—it accelerated—over the course of the next four years, even as her budget went from massive deficits to surplus.

Yes, they had help from a strengthening US economy, and we’re too large to ask that they return the favor when we tighten our own belts. We’re going to have to do this on our own, but it can be done and must be done. The first step is to tell the voters the truth.

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