A Threat Worse Than Deflation

This month, the Fed began their second round of quantitative easing, a $600 billion that seeks to pump liquidity into the economy. While the policy has its critics, its defenders drew justification from a compelling source – the story of Japan’s ruined economy – where fiscal inaction had plunged the country deeper into a deflationary spiral. However, while they are wise to learn from Japan’s mistakes, U.S. policymakers risk ignoring the larger part of Japan’s story, where deflation only plays a small part. The collapse of Japan’s economy has also seen the collapse of its government’s credibility, resulting in a state of things that appears almost impossible to redeem now.

Consider this: since Koizumi’s exit in 2006, Japan has seen six different prime ministers, eleven agricultural ministers, eight finance ministers, seven defense ministers, and six foreign and interior ministers. Things have become so bizarre that former Brazilian prime minister Lula remarked: “It’s so hard to do business with Japan nowadays – you meet one prime minister for breakfast, and then another one for lunch.” This week, justice minister Minoru Yanagida was claimed as the latest victim of Japan’s dysfunctional politics, where an ironic comment he made was blown out of proportion. Once considered the paragon of Asian democracy, references to Japan’s government nowadays almost always used in the negative.
Japan’s problems are especially chronic because their economic and political problems feed off each other in a vicious circle. As the economy worsens, voter disillusionment grows. Opportunistic politicians seize upon these sentiments, and come into power through reactionary campaigns. Without a common mandate, the government gets caught in legislative deadlock, causing policy capabilities to be hamstrung. Unable to intervene, the economy plunges even further, and the circle makes another turn.
If America isn’t careful, it risks falling into the same problem. Writing about America’s decline, the Atlantic’s James Fallows describes America’s biggest problem as its lack of effective government: “That is the American tragedy of the early 21st century: a vital and self-renewing culture that attracts the world’s talent, and a governing system that increasingly looks like a joke.” At a time when clear and urgent leadership is necessary, the economy has become an issue that has undermined and polarized American leadership. Politicians seem intent on pursuing ideology for the sake of ideology, as opposed to studying the broader, long-term picture.
Despite an increasingly divided government, there are some who still remain bullish about recovery. One such person is Michael Boskin, a professor of economics at Stanford, who points towards historical trends: “With divided government, many expect partisan gridlock on major legislation. But there is reason to be hopeful: the American economy, labor market, and stock market have historically fared a bit better in years of divided government.” Boskin, however, overlooks a simple fact: America is now sitting on its most severe recession since the Great Depression, so the historical references are hardly analogous.
Nonetheless, not all is doom and gloom. Unlike Japan, democracy in the U.S. is more mature in its institutions, so a prospect of a Japan-style leadership crisis appears very remote – at least for now. The question still remains open though: while the Fed may be able to rescue America from Japan-style deflation, who will rescue America from its darker twin: government infirmity?
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