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Jubak's Journal
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Why the U.S. isn't Japan
Could the U.S. financial markets be in for a decade-long crash like that of Japan? The possibility cant be laughed away, but the United States has an often-overlooked edge.
By Jim Jubak
Japans Nikkei index peaked at 39,000 in 1989. Twelve years later, its at 9,400, and rather than recovering, it hit a new 20-year low this month.
The economy isnt in any better shape. Revised first-quarter numbers raised fears that Japan is about to slip back into recession.
Twelve years with no recovery in sight. Could that happen here? Every failed rally that prolongs the U.S. bear market for another month seems to increase the number of perma-bears predicting just that.
But these predictions of disaster overlook the greatest strength of U.S.-style capitalism. Were really good at ruthlessly destroying our mistakes. And that ruthlessness, which causes immense pain in the short run, works to speed up U.S. recoveries in the long run.
A poor proposal
Consider the latest recovery medicine proposed just this month by the Bank of Japan. The bank, the Japanese equivalent of the U.S. Federal Reserve, will buy stocks directly from the portfolios of Japanese banks.
That's just another gimmick to bail out the banks at government expense. And by supporting stock prices, it will prevent Japans least efficient banks and least profitable businesses from failing.
In the United States, on the other hand, important corporate icons, companies that are landmarks of our economy, could be gone by the time this economic cycle is over. Xerox (XRX, news, msgs), WorldCom (WCOEQ, news, msgs), Adelphia Communications (ADELQ, news, msgs), Lucent (LU, news, msgs) and Nortel Networks (NT, news, msgs) face a real possibility of going under.
Why is the contrast in destructive capability between the United States and Japan so important? Because the crisis in both countries was caused by a fundamental misallocation of capital. Too much money went into what turned out to be non-productive assets.
Homeowners as millionaires
In Japan, capital flowed into real estate, sending prices so high that average Japanese homeowners were multimillionaires on paper. And that paper wealth fed into the prices of Japanese stocks. Banks were more than happy to extend loans to almost any customer able to put some of those constantly appreciating shares into the deal.
In the United States, capital flowed into the latest Internet company, into funding yet another maker of communication chips, into phone companies that would circle the world with fiber. And as the paper profits mounted, more companies offering almost identical products raised money in the capital markets and went into business.
All that excess capital wasnt good for either Japanese or U.S. companies because it sent managers and investors false signals. In Japan, nobody worried about cutting costs, or about the fact that Japanese companies earned almost nothing on that invested capital. In the United States, all that capital encouraged the illusion that demand would catch up to supply eventually. Who in management cared if profits were indefinitely far off since there was plenty of new capital available to fund losses?
Capitalism regularly swings to excess like this. Capitalism is the best system evolved so far at allocating capital in an economy, but its not perfect.
Built-in governor
Eventually, however, capitalism's built-in governors kick in. As the market starts to send new and more accurate signals about where capital earns a decent return and where it doesnt, the market starts to weed out the inefficient, the ineffectual and the unnecessary.
The process of adjusting to these new signals isnt painless, and its not fair. Thousands of workers will be fired through no fault of their own. Communities will be devastated as long-time corporate linchpins downsize or go bust. Many individuals will see savings cut in half just when theyre needed.
But despite airline loan guarantees and steel tariffs, and despite the Federal Reserves continued evolution into a much more liberal lender of last resort, by and large U.S. capitalism is doing its job of creative destruction now. You can trace the progress in the headlines.
And in the long run thats a good thing. Were only in danger of turning into Japan if, like the Japanese, we chose to prevent the necessary destruction.
In my next column Ill explain why if U.S. capitalism is so good at destruction, its taking so long to correct the excesses of the bubble.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET. Selected CNBC stories can be found in the TV Reports index. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Lucent Technologies. He does not own short positions in any stock mentioned in this column.
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