this is 1929 repeating, page-308

BOJ’s Shirakawa Says U.S. Faces ‘Painful’ Adjustment

April 23 (Bloomberg) -- Americans face a “painful” post- bubble economic adjustment, Bank of Japan Governor Masaaki Shirakawa said, drawing a parallel with his own country’s period of stagnation in the 1990s.

The U.S. will have to rid itself of excess debt and manufacturing capacity and shrink its financial industry, just as his country did in the so-called “lost decade” after its property and stock-market bubble burst, Shirakawa said in a speech to the Japan Society in New York today.

“This will be painful, but inescapable,” he said. “In view of Japan’s decade-long experience, there are no palatable alternatives.”

Shirakawa noted “remarkable similarities” between the U.S. and Japanese experiences. Both countries enjoyed a lengthy period of high growth and low inflation before the crisis, he said. Officials in both places were slow to recognize the bursting of a bubble and the implications that would have for the broader economy.

While policy makers should focus mainly on keeping prices stable, Shirakawa said they also must stand ready to deflate speculative bubbles and then clean up the aftermath. Former Federal Reserve Chairman Alan Greenspan, who has sometimes been blamed for fueling the U.S. housing boom with low interest rates, has said policy makers don’t have the tools to recognize or combat bubbles.

“As economic imbalances pile up insidiously, a narrow focus on price stability makes it more likely for policy makers to overlook dangerous signs emerging in the wider economy,” Shirakawa said.

G-7 Meeting

The governor is on his way to Washington, where he will attend a meeting of the Group of Seven finance ministers and central bank chiefs tomorrow. He didn’t discuss the current Japanese economy or the outlook for Bank of Japan monetary policy in his text.

In the aftermath of Japan’s 1980s bubble, bank lending shrank, unemployment more than doubled to 5.5 percent, and the country experienced three recessions between 1990 and 2002. From 1997 to 2007, consumer prices dropped 2.2 percent. In the U.S., prices climbed 29 percent in the same period.

Among the steps Shirakawa recommended are a number already being taken by the Fed, including providing adequate liquidity to financial markets and purchasing securities that aren’t being traded by investors. Policy makers must also move decisively to remove bad assets from banks’ balance sheets, he said.

Explaining Policy

Japan’s experience suggests that policy makers must spend considerable effort explaining to the public why actions such as capital injections are necessary.

Another lesson is that politicians and central bankers may need to take unpopular actions such as bailing out or closing banks much sooner and to a greater degree than they think.

“It is not always the case that ‘bold actions’ are judged to be bold afterwards,” he said. “Public capital injections tend to be insufficient and behind the curve.”

Although the Bank of Japan began lowering interest rates while its economy was still growing in July 1991, “we optimistically thought Japan’s economy would pick up once cyclical corrections in business investment had run their course,” he said.

The U.S. and Japanese financial systems also came under pressure after investment firms failed, leading to a liquidity shortage, and policy makers didn’t inject additional capital into the systems “until the market disruptions reached a critical point.”

‘Exceptional Scale’

A crisis that began in the U.S. has become global on “an exceptional scale,” Shirakawa said, and central banks around the world should consider the same actions.

“What we are confronting is not a garden-variety recession,” he said.

Japan’s economy has been among the hardest hit.

Gross domestic product shrank at an annual 12.1 percent pace in the three months ended Dec. 31, the steepest drop since the 1974 oil crisis. The economy may have contracted 10.9 percent in the first quarter, according to the median forecast of 13 economists in a Bloomberg News survey.

In January, BOJ board members predicted the economy would shrink 2 percent in the year through March 2010 before expanding 1.5 percent in the next fiscal year. Consumer inflation will tumble 1.1 percent this year and drop 0.4 percent next year, they said.

Interest-Rate Cut

The central bank in December cut the benchmark overnight lending rate to 0.1 percent and is buying commercial paper and corporate bonds to channel funds to companies. The bank also increased its monthly government bond purchases from lenders to 1.8 trillion yen ($18.4 billion) from 1.4 trillion yen last month.

“Overall, Japanese banks are in stable condition and we do not see a systemic problem in them,” Shirakawa said today.

He also warned against the temptation to protect domestic industries. Trade restrictions will slow growth and recovery, “the last thing we intend to achieve,” Shirakawa said.