Here’s my worst nightmare: That America becomes like Japan, stuck in the mud. Could it happen?

Imagine living in Japan, where the last time the stock market hit a new high was 18 years ago. (Not to mention the marked absence of really first-rate desserts, such as chocolate volcano cake.) While we are caterwauling over a poor six months, the Japanese have lived with a poor economy and declining asset values for almost two decades. The worst of it is that the Japanese government doesn’t seem to have any idea how to turn things around.

The G7 is about to meet in Japan, and that country’s finance minister, Fukushiro Nugaka, has already expressed opposition to any joint effort to boost global economic activity. The Financial Times reported Mr. Nugaka as saying: “We have learned what such fiscal spending could mean from our experience after the burst of the bubble.” I doubt it.

At least our government is doing its utmost to stave off a recession. If history serves, the sharp rate cuts, tax rebates, and efforts to mute mortgage resets will likely ease the country out of recession, or possibly avert an actual downturn altogether. We’ve had 10 recessions since World War II, and such policies have each time proved successful.

But there’s always that niggling fear that this time will be different. Is there a possibility that in this slowdown, America, like Japan in the 1990s, will not respond to traditionally successful stimuli?

The CEO of Annaly Capital Management, Michael Farrell, wrote in his latest address to shareholders about “the Keynesian nightmare: The nightmare of economies powered by huge amounts of debt and inescapable liquidity traps.”

In brief, the nightmare is that the usual government rescue of increased deficit spending and pump-priming won’t work. Why? Because increasingly it has been the consumer rather than the government who has borrowed to spend, and that dogged spender is faced with asset deflation and an inability to borrow more.

Mr. Farrell points out that “it now takes $3.25 of total debt in the U.S. to generate $1 of GDP, a significant increase from 1952, when it took just $1.30 in debt.” He points out that in 1952, government debt made up 55% of total American obligations, while today the government’s portion of America’s $45 trillion indebtedness is only 16%. Household debt has grown to nearly double the amount owed by the government, compared to one-third as much in 1952. The ability and inclination of the consumer to borrow, consequently, is key.

“When we’re faced with asset deflation, we’re trained to delay purchases. It becomes a self-fulfilling prophecy,” he says.

The “liquidity trap” that Mr. Farrell describes refers to the Keynesian notion that under some circumstances, lowering interest rates elicits no incremental demand for funds, and thus becomes useless as a policy tool. This always seemed to me a purely theoretical hypothesis — until Japan sank into one of the greatest liquidity traps of all time. Interest rates in Japan were 9% in 1980. They were steadily lowered through the 1990s and into the current decade, bottoming at 0.10% (yes, 10 basis points) in 2001, where they languished for years. And the impact of that incredibly low rate? Not much.

Mr. Farrell cites Japan as an example of consumers being weighed down by falling property prices and refusing to step up spending, even when encouraged by ultra-low borrowing costs and fiscal stimulus.

“The lesson from the Japanese is to ease early and hard, and put a floor under assets” Mr. Farrell says, suggesting that the Japanese government waited too long to stimulate the economy and, once started, moved much too slowly. Mr. Farrell thinks the American stock market is trying to find the bottom on real estate prices. “I think we’re in a recession,” he says. “This is the first real-estate-led recession since 1989–1992. All the economic models are struggling to deal with home prices falling. We have no experience with that.”

He also cites the impact of home equity loans on consumer spending. “I’ve seen home equity loans used for education, for SUVs, for that trip to Disney Land. We estimate that mortgage equity withdrawals averaged $750 billion per year over the past four years,” he says.

Well, this isn’t Japan. Our demographics are more positive for long-term expansion and our open trade policies are more constructive as well. Moreover, our government has moved quickly and with resolve to boost liquidity and stem the downturn. Leading Wall Street economist Ed Hyman is still projecting a mid-cycle slowdown. His team at International Strategy & Investment Group uses all kinds of barometers to take the economy’s pulse, and recent findings do not conclusively indicate a recession. In particular, the purchasing managers’ index for manufacturing is still considerably above recession levels, while unemployment claims at 325,750 are way below the 400,000 that would suggest a downturn. Also, inventories are not high and rising as they should be entering a recession, and no wage/price spiral has occurred.

Also bullish is the jump in the number of mortgage refinancing applications pouring in, which will put cash in the consumer pocketbook, and the prospective tax rebate. Another item in the plus category is yesterday’s reading on productivity, which came in above expectations. As the Fed attempts to jump start the economy, inflation concerns should not be a significant constraint.

It may take an anxious six months or so before we know the dimension of the current downturn, but that’s certainly preferable to 17 years.

peek10021@aol.com