Saturday, October 16, 2010

Is there a threat of liquidity trap and "W" shape recovery part 2

Continuing from last week's my posting of liquidity trap and W shape recovery, I am of the opinion that every region, state or country undergoes a broad macroeconomic cycle of different time frame depending on their structural issues in terms of age, gender, income/saving/spending nature, export/import oriented, regulations in financial systems and etc.

Here I would like to give comparison between US and Japan because they are World's largest economies (except China overtaking Japan recently) and almost they are in same position now.

Japan experienced rapid growth from 1960s to 1990s, helped by post 2nd world war massive US investment, high savings led to high investment in their own country due to currency appreciation, low interest rates & etc. Japan witnessed an average GDP growth of 10% in 1960s, 5% in 1970s & 4% in 1980 indicating a slowdown in real growth after 1980s. It experienced asset price bubble in late 1980s followed by Bank of Japan's sudden increase in interest rate & crash of Nikkie in 1989 when it was around 39000.

Many economists feel, after crisis Japan didn't act quickly, it took 5 years to boost money supply in real economy, which was definitely very late reaction. Out of ten years from 1990 to 2000 Japan witnessed 9 times deflation measured by WPI, Nikkie has given 4 times negative annual return, 4 times less than 10% and just 2 times positive.

Now coming to US, it witnessed the Great Depression in 1930s which produced great economists like Sir John Maynard Keynes and in turn the great Keynesianism theory. From 1945 to 1970s US witnessed higher growth helped household income increased 55% or 1.6% annually but since 1973 household income growth rate fell to 10% or 0.3% annually due to various reasons like fall of Bretton Woods System(Nixon Shock) in 1971, followed by Oil shock or crisis in 1973, Recessions in 1981-1982 and after that several economical cycles of recessions in successive intervals.

In 1980, the US Debt was equal to 33.3% of America's GDP, by 1990 it became 56% of GDP. Debt levels rose quickly in the following decade and based on the 2010 US Budget, total national debt will grow to nearly 100% of GDP, versus a level of approximately 80% in early 2009.

Present financial crisis caused by sub prime mortgage, securitization structures and financial engineering along with FED's low interest rate policy to avoid the 2001 dot com bubble effects. Between 1997 and 2006, the price of the typical American house increased by 124% and at same time household debt v/s annual disposal income was 127% at the end of 2007, versus 77% in 1990.

So both the countries experienced rapid growth for 2-3 decades and after that they are feeling the heat of slowdown in their respective economies due to different reasons, which is nothing but natural economical cycle.

Prof. Raghuram Rajan, economic adviser to Prime Minister Mr. Manmohan Singh, in an interview about Currency conflicts mentioned same structural issues in US which I pointed above. Click here to read the full interview. I read an article in mint on similar note (about Japan & US similarities & differences of crisis, advise of Mr. Bernanke to Japan in late 1990s and he being at top job at present crisis!) its good article, click here to read. The paper presented in late 1990s from present FED chairman Ben Bernanke to Japan about its crisis. It contains lot of important data & structural issues with good explanation, click here to read that.

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