WASHINGTON, March 25 (UPI) -- William Hogarth's 1747 classic "The Industrious Apprentice and the Idle Apprentice" may be about to demonstrate its continued pedagogical strength in the international economy, where Japan and the United States have enjoyed contrasting fates for a decade.
In Hogarth's masterpiece, the idle apprentice enjoys life at first, but then spirals rapidly downhill to execution at Tyburn. The industrious apprentice, derided at first, ends up as Lord Mayor of London.
In the case of the United States and Japan, the question is not so much idleness versus industry as the spendthrift versus the saver. For the past decade, the United States has operated on a consumer savings rate near zero, and has run a balance of payments deficit that has since 2000 climbed to around $400 billion, while all the time its financial markets have flourished and the dollar has been strong, owing to an influx of foreign savings, a substantial portion of which originated in Japan. The Japanese, meanwhile, have enjoyed a decade of continued thrift, minimal growth and continual banking difficulty, while their savings have gone to enrich the lifestyles of the U.S. elite.
Not only is this unfair, it is also in the long run unsustainable. And the credit card bill for the excesses of the '90s may be coming due.
The Clinton administration, of course, had a solution for Japan's problems, as it did for everything else. Reflate the economy by massive public works projects, reduce Japan's trade surplus by forcing the yen up to levels where the country's exporters cannot export, while foreign consumer goods flood in, and deal with the inevitable bad loan problems of the Japanese banking system by further injections of public money and suitably austerity minded public sector managers. For Japan -- but of course never, never for the United States -- the Clintonistas prescribed "root canal" economics -- treatment that could be demonstrated to work if only it could be made to hurt sufficiently.
Like most of the Clinton administration's policies, this advice reflected entirely the short-term desires of the U.S. voting public, and, when tried with considerable enthusiasm from 1995 to 2001, did nothing to produce the economic revival that the Japanese expected. The high exchange rate was deflationary, but so also was the steady increase in government spending and the fiscal deficit, which as I have written previously tends to correlate highly with poor growth performance. Hence, Japan's savers were being asked to pay higher taxes, receive negligible domestic interest rates, suffer currency losses on their foreign bond and stock holdings, and drive their domestic economy into a decade of senescence, all to feed the consumption frenzy of the United States and provide investment capital for that country's economic growth.
John Maynard Keynes, who grew to economic maturity in the high unemployment, senescent growth, overvalued-parity economy of the British late 1920s, would have recognized Japan's problem as being foreign rather than domestically caused, and for once would have been right.
At some stage, even the politest people, consistently given advice like this, start to think for themselves and reject further jawboning, becoming, in the words of the famous Japanese nationalist tract "the Japan that can say No." With the election of Prime Minister Junichiro Koizumi in April 2001, Japan reached this stage, and began to look for its own solution to its economic woes.
Crucially, since the beginning of 2002, Japanese policymakers have come to realize that the U.S. balance of payments deficit was the United States' problem, not Japan's, and that no law of God or man required Japanese savers endlessly to finance the United States' credit card addiction. Reflation of the Japanese economy requires a lower yen/dollar parity, and it is up to the United States to correct the imbalances in its own economy that require an endless and increasing inflow of foreign capital at the rate of 4 percent of U.S. gross domestic product or more.
With devaluation, Japanese capital can be used once more to grow Japanese industry, and to produce a boom in the Japanese stock market. A secondary result will be a rapid improvement of the Japanese banks' balance sheet positions -- no more "root canal" economics.
The recent recovery in the Nikkei stock index suggests that this policy is working; it remains to be seen whether the Japanese have the strength to stick to it, in the face of what may become extremely unpleasant Western pressure.
There is a third apprentice involved in this economic Hogarth series -- the European Union, an apprentice even idler, albeit marginally less spendthrift, than the United States, and equally prone to try to solve its own problems at the expense of the industrious. In the long run, the EU countries' total failure to fund their pension schemes properly and the demographic disasters pending in Germany and Italy, are likely to make the European Union's fate even more unpleasant that that of the United States. In the short run, however, the EU economy may perform somewhat better, because there is an enormous amount of room for improvement in its sclerotic economic structure, and at least some evidence that the improvement is taking place.
In Italy, for example, a highly intelligent reform by the Berlusconi government has permitted Italian savers to repatriate their savings from Switzerland and elsewhere at the cost of only a modest 2.5 percent tax. This was expected to have only a small effect, but has in fact produced a repatriation of no less than $44 billion -- more than 2 percent of Italy's GDP -- by the end of February into the Italian banking system. Since this money, once the tax has been paid, is now "legal," it can be used to finance Italian small business and there must be a high probability that at least some of it will do so. The Italian stock market, too, should benefit -- readers wishing to have a modest flutter based on this information, as I did, should consider the Italy Fund (NYSE-ITA) which would give them a broad exposure to the market and is currently standing at a discount to its net asset value.
Elsewhere in Europe, Portugal has just thrown out a social democrat government that had presided over public sector sclerosis; while the German election due in September is now rated too close to call, with the Christian Democratic Union-Christian Social Union candidate Edmund Stoiber, from free-market Bavaria, running a strong challenge. It seems far away from 1999, when the whole of the European Union except Spain and, arguably Ireland, was Socialist-run.
More ominously for the world economy, the two idle apprentices have started fighting, perhaps realizing that their period of carefree prosperity may be ending. The European Union Monday imposed retaliatory tariffs on steel after the States' 8 percent to 30 percent steel tariff imposed earlier this month. The EU tariffs will not block U.S. steel imports to Europe, which are negligible, but will attempt to extract more resources for Europe's idle steel apprentices from the industrious apprentices of Brazil, Japan, South Korea and elsewhere -- they are intended to attack the problem of "diversion" of steel imports from the United States.
The industrious apprentice in Japan is still being mocked repeatedly in the Western media as each new economic statistic emerges. In fact, however, the picture is brightening daily. Japanese service employment is up 20 percent since 1990, not much less than the 28 percent growth in the United States, while productivity overall in Japan has risen at 3.5 percent per annum, again not much less than the United States' 4.1 percent "miracle" in much more difficult economic circumstances. As services become an ever more important part of the Japanese economy, this relative strength produces corresponding strength in the economy as a whole. Meanwhile, Koizumi's economic team is beginning to focus on fiscal stimulus, not by means of increased government spending but by means of cuts in income and corporate taxes, a much more promising approach. U.S. and EU protectionism will slow the growth of the Japanese export sector, and retard progress, but that can always be countered by a further modest depreciation of the yen, which will reflate the domestic Japanese economy and stabilize the situation. Japan's prospects, in short, are much brighter than they were a year ago, in spite of the blizzard of economic bad news in the intervening period.
For the U.S. Idle Apprentice, on the other hand, the game may very nearly be up. With its balance of payments deficit spiraling ever higher, with Japanese investment into U.S. bonds and stocks drying up as Japanese investors find more attractive opportunities at home, with the U.S. housing market beginning at long last to turn down, thus removing the prop from the consumer bubble that had continued into 2001-2, and with protectionist battles weakening world trade in general, the United States is indeed likely to find itself facing a double dip, and quite probably a sharp withdrawal of confidence in U.S. financial markets. After all, in the last 30 years, the country has turned from the world's largest creditor into its largest debtor.
With high debt, an inability to export sufficiently, a bloated public sector -- swinging now into substantial deficit -- and a bankrupt consumer base, the United States may soon be facing a highly unpleasant fate of a Hogarthian kind -- the Spendthrift at last meeting his Just Reward.
There is, after all, a horrid example of an even idler, more spendthrift apprentice than the United States and Europe, which has recently come to the end of the road -- Argentina. That country was as recently as 1998 considered a paragon, with a strong exchange rate and an apparently reformed economy. Its fall since then should have reminded U.S. policymakers, Bill Clinton, his Treasury Secretary Lawrence Summers, Federal Reserve Chairman Alan Greenspan and current Treasury Secretary Paul O'Neill in particular, that a focus on short-term gains, while failing to address festering long-term structural problems, in the end leads to economic collapse.
Hogarth would have drawn it so much better than I can!
(The Bear's Lair is a weekly column which is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the past 10 years, the proportion of "sell" recommendations put out by Wall Street houses has declined from 9 percent of all research reports to 1 percent. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
