Don't Blame the Fed

Japan's woes slow U.S. economy, but real estate rocks on.

October 1, 1998

This summer William McChesney Martin died at the age of 91. Martin was chairman of the Federal Reserve Board for 19 years in the ’50s and ’60s. He's famous for remarking that the job of the Fed was to take away the punch bowl when the party was getting good. It’s ironic that after Martin's death, someone seems to have taken away the punch bowl from this economy.

It clearly wasn't the Fed. Consistently, Chairman Greenspanand his colleagues have warned about the exuberance sweeping through financial markets. But they’ve held monetary policy steady for more than two years. That’s as it should be: Good policy is marked by necessary action only.

Now the rate of growth is slowing, and the stock market seems troubled. The roots, however, lie outside our control. The problem is the failed Japanese business model.

In the summer of 1997, an attack on an obscure currency, the Indonesian rupiah, led to a 500-point drop in the Dow. The subsequent contraction in the economies of Southeast Asia had little direct impact on the United States. But the problem has had enormous impact on Japan, and that’s how it reached our shores.

The Japanese have built their economic power by selling goods into the emerging economies of Southeast Asia, and doing it through a business model that became wisely admired throughout the world. It knitted government, business, and finance into a seemingly monolithic economic machine.

When the economies of Southeast Asia began to fall apart, flaws in the Japanese business model began to appear. As markets shrank and exports dropped, corporate revenues and profits fell. Declining revenues generated higher domestic unemployment and reduced domestic demand. Lower profits reduced stock prices and hurt banks’ capital.

In addition, Japanese banks have broad lending exposure in Southeast Asia and may now be sitting on as much as $1 trillion in bad loans. Finally, a laxness in government regulation was revealed as troubles mounted.

This sequence resembles the U.S. savings and loan crisis of the ’80s. There, too, a business model that had worked well for years was shown to be one that worked only if certain economic conditions held. Think of the Japanese as the savings and loans of the ’90s—only bigger. The Japanese economy is the second largest in the world, and Japan is our biggest trading partner in Asia.

So it’s from Japan that this growth slowing and stock market correction come.Is this the end of the bull market of the ’90s and our long-lived expansion? No. The fundamentals of this economy are so strong they’ll swamp any negative impulses from Asia.

For real estate, there's nothing but good news here, even with slowing growth.

In their desire to avoid the Asian problem, investors and households have moved assets to U.S. Treasury securities and real estate. Interest rates are down, and existing-home sales in 1998 will set a third consecutive record. So even as the economy grows more slowly, the real estate market rocks on.

Finally, the Asian crisis has made Japanese real estate affordable. In a complete reversal of the ’80s, Americans are buying chunks of downtown Tokyo. Who'd have thunk it!

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