Greenspan: Stuck Between Japan and a Hard Place
16 March 2001

By George Friedman

Investors fear that the U.S. markets, which are at cycle lows, have a long way to go before bottoming out. If the economy is not in a recession, it is doing a good impression of one. The Federal Reserve, which has received much criticism for not cutting interest rates faster, seems prepared to let this continue.

Federal Reserve Chairman Alan Greenspan is trying to space the cuts out as widely as he can; more widely than investors and financial analysts think is necessary to jumpstart the economy. To many, this makes no sense. But considered in terms of Japan - the world’s second largest economy - Greenspan’s strategy adds up: Another round of serious interest rate cuts might break apart the Japanese banking system.

Greenspan sees that the Japanese economy is near its breaking point. He does not want it to crack and, if it does crack, Greenspan does not want the United States to be the catalyst.

Japan’s economy is so close to the edge it will not take much to nudge it over. As the United States cuts interest rates, money flows into countries with higher interest rates, weakening the U.S. dollar particularly in relation to European currencies. This makes American exports more competitive with Japanese exports in Europe. Simultaneously, the slowing U.S. economy will cut Japanese exports to the United States. While normally of little significance, a drop in cash flow due to declining exports could be the straw that breaks the camels back.

Greenspan does not want to provide that straw by continually cutting interest rates. In fact, he would rather not cut interest rates since U.S. banks have significant exposure in Japan. Each additional exposure makes it harder for banks to deal with losses. An expanded Japanese banking crisis caused by sharply plummeting U.S. interest rates could turn this normal, cyclical recession into a substantial event, dramatically affecting U.S. banks’ balance sheets. This could force a lending contraction at the worst possible moment, causing a more prolonged and intense recession than the current one.

Greenspan has a sanguine outlook for the U.S. economy. We are nearing a selling climax as the non-NASDAQ averages start to capitulate. The economy has slowed substantially and a healthy recession is wiping out pseudo-businesses left and right. If he wasn’t worried about a Japanese crisis, Greenspan might loosen earlier, bringing about a 1961-like short recession.

While it frustrates U.S. investors, Greenspan’s strategy is understandable. A somewhat longer American recession - providing the Japanese house of cards does not tumble - is preferable to bringing down Japan in a vain attempt to shorten the U.S. recession, thereby creating a truly profound problem that would take a year or more to work out.

The Japanese collapse can be delayed, but not stopped. Obviously, it would be more opportune a few months down the road. The U.S. recession, however, is driving the Japanese collapse. If we could delay it a few months, the impact would not be so serious.

Would it be better to get the U.S. economy out of its recession soon to fortify it against Japan? No, because the recession is strengthening the U.S. economy. Banks are reining in lending and reducing credit exposure. This process must run its course or the U.S. will move down the Asian path. It does no good to avoid medicine for so long that the disease can no longer be cured without killing the patient.

Greenspan wants a short but intense slowdown; however, he doesn’t want to break Japan so he is postponing the jumpstart. He is trapped between two American needs: having a healthful recession and stimulating the U.S. economy with lower interest rates, both must be done without splitting Japan wide open.

In terms of Japan, Greenspan’s behavior makes sense. But, regardless of how well
he plays it, can Greenspan’s hand come up a winner?

aus:
http://www.stratfor.com/home/giu/archive/031601.asp#Greenspan


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