I copied this from the Daily Reckoning:

The economic engineers in Washington, too, might be just a little bit curious. Opening the jets of both monetary and fiscal stimulus, they may at least wonder about what it takes to set them on fire...and spark a real recovery.

There has been only one major experiment with such vigorous rate cuts in a fully modern economy. It was conducted under imperfect conditions. Still it may be worth studying.

In the 1980s, the Japanese economy was a marvel, the most successful, most dynamic, most self-confident economy the world had ever seen. American businessmen cringed and quaked before the threat of Japanese competitors and the Japanese economy grew at 4% per year throughout the decade.

But epic levels of confidence, like epic P/Es, eventually give way. Japanese economic power soon proved an illusion. Stocks crashed in January of 1990...and the economy went into a slump.

Of course, by 1990 books by Milton Friedman and John Maynard Keynes could be found in any good Japanese library...and it was not long before Japanese policymakers were doing exactly as the two great economists counseled. Interest rates were cut...and cut...and cut. Rates fell below 1% five years ago. Since then, they've dropped all the way to zero. Did the Japanese economy bounce back?

No, it didn't. GDP has grown only about 1% annually since 1991. And unemployment rose from 2.1% in 1991 to around 5% today. This number is probably low. In Japan it is disgraceful to be unemployed...so it is often unreported. Bankruptcies and suicides have surged.

You may recall a note in Daily Reckoning more than a year ago. So many Japanese businessmen were committing suicide by jumping in front of trains that the rail stations began to put large mirrors on the edge of the tracks so those planning suicide could "reflect" before doing themselves in.

Zero interest rates are not new to the world. They were a feature of the Depression in the U.S. too...when rates dropped as low as 0.02%. Then, as in modern Japan, they seemed to have no effect.

U.S. economists may want to reflect on that. And on what effect fiscal policy can have on such an economy. Yesterday, a $78 billion "stimulus package" was announced in Washington.

But, here too, there is empirical evidence on which to draw. Japan has already subjected itself to the stimulating effects of spending the taxpayers' money before the taxpayers earn it. In the 1980s, Japanese consumers went wild...getting, borrowing, and spending with the confidence of a teenager. In the following decade, their confidence declined as their savings and frugality increased. Government stepped in to fill the gap, spending money people did not have on projects they did not need.

"Think of it as the W.P.A. on steroids," suggests economist Paul Krugman, writing in Sunday's New York Times magazine. "Over the past decade Japan has used enormous public works projects as a way to create jobs and pump money into the economy. The statistics are awesome. In 1996, Japan's public works spending, as a share of G.D.P., was more than four times that of the U.S. Japan poured as much concrete as we did, though it has a little less than half our population and 4% of our land area. One Japanese worker in 10 was employed in the construction industry, far more than in other advanced countries."

In 1992, Japan ran a budget surplus. In that year, too, it had public debt of about 60% of GDP - in line with other modern economies. Today, after 10 years of vigorous boondoggling, the public debt in Japan is the highest in the developed world, at 130% of GDP.

And still no economic turnaround. In fact, a dozen years after the slump began...things look worse than ever.

"We're in a very bad way at the moment and things are getting worse," says James Malcolm, senior economist at J.P. Morgan Securities (Asia) Ltd. Kazuhiko Ogata. "Japan is no longer in recession," adds a colleague, "it's a depression."

For all their stimulating effects, neither fiscal nor monetary policy has aroused the Japanese economy. Why?

As promised, here is the answer.

"Alan Greenspan's aggressive rate cuts are proving to be a complete failure," writes Dr. Kurt Richebacher. "They ought to have reinvigorated the U.S. economy long ago...when was the last time the Federal Reserve cut interest rates 8 times in a row and the stock market still kept falling?

"It is indeed different this time..." Dr. Richebacher continues. "The single most important, most unusual, and also most ominous feature in the U.S. economic development during the past few years has been the steep drop in profits, which started at the pinnacle of the boom. It's definitely the downturn's one key cause. Everything else - the protracted plunge of stock prices, the savage cuts in business capital spending and the shrinkage of consumer income growth - is but a consequence of the profit carnage."

Profit levels, generally, have made no progress since 1997. Nasdaq companies, according to the Wall Street Journal, "haven't made a collective dime since the fall of 1985."

Without profits, as Keynes once pointed out, "the whole process [of capitalism] comes to a halt." No profits, no new investments. No new employees. Instead, companies cut costs - including laying off employees - in order to become profitable again. That is the real source of the slump - not consumers, not terrorists, not high interest rates.

Does lowering interest rates help? Not when companies do not want to borrow. They borrow to build new plants and buy new equipment. But the problem they face is that they can't make any money on the capacity they've already got. Instead of investing in new capacity... they're liquidating the bad investments they made when they were more confident.

Floyd Norris, in the N.Y. TIMES, elaborates:

"Broadly speaking, companies raise capital for two reasons, because they need the money to pay bills or because they want to make investments that appear attractive. Markets are not eager to provide cash to those who need it the most, and the volume of investment spending has fallen sharply from peak levels because some industries, notably telecommunications and technology, have excess production capacity. That glut is not likely to ease soon..."

If lower rates and massive public spending do little good, might they, in fact, do harm? Possibly. The glut of capacity will not ease as quickly if businesses are encouraged - by low interest rates - to continue adding capacity, even in a downturn. And public works - which produce no profits - may also have a negative effect, absorbing resources that might have been invested profitably elsewhere else.

Why else has the Japanese economic malaise lasted so long, if not for all their efforts to cure it? Even in this post-ironic age...Mr. Market still sniggers.

Wow, does any of the foregoing look familiar?

-- Guy Daley (guydaley1@netzero.net), October 04, 2001

Answers

Just read where U.S. utilization of capacity was down to 76%, and falling.

-- Uncle Fred (dogboy45@bigfoot.com), October 04, 2001.