Written for First Post
August 13, 2011- The market correction in the US over the past few days and the policy choices of world's largest economy have raised a scary specter. America is down the path Japan took to stagnation for more than 20 years. The US  turning into Japan is not good for the world economy and emerging countries such as India.

The shocks, the steps the US economy took to fight the financial crisis and great recession are eerily similar to Japan.  Let's list them:

The US and Japanese economies saw a massive real estate bubble fueled by low interest rates. The low interest rates also led to an over leveraged economy.

Both economies saw a real estate bust that was followed by a financial crisis due to the bad mortgage assets in the bank's books

Japan and the US bailed out the banks with massive tax payer funding. The countries also relaxed accounting to rules to prevent banks for taking the painful decision of recognizing, provisioning or writing off bad loans. The governments essentially interfered in the market and stopped the de-leveraging required to bring the economy back to health.

Both the countries then continued to keep interest rates low, print money and provide massive stimulus to the economy. Japan has been trying to stimulate the economy with currency intervention and government spending for more than 20 years. The US has gone down that path aggressively for the past few years with zero interest rates, quantitative easing and government stimulus. 

The over spending by both governments resulted in a massive debt-to-GDP ratio, taking away the fiscal and monetary cushions of the economy.The Japanese policy choices which is a play book of Keynesian economics has failed. The exhaustion of Keynesain recession fighting tools resulted in a slow decay of the Japanese economy. The proof is the Japanese stock market.  The Nikkei 225 index, which stood near 40,000 in 1989 was below 9000 last Friday. That's a lost double decade. 

Click here for the chart of Nikkei 225 Index

If the policy choices of the US make it another Japan, the reverberations will be felt across the world. A shrinking of demand in the US markets will affect the shop floors of China and the software to textile producers in India. We believe that the stock markets across the world are discounting the possibility of a global malaise.

But all is not lost yet. The small businesses and freedom minded people in the American society are revolting. It's called the Tea Party. First time the Tea Party politicians forced to government to cut spending. If the principles of Tea Party -- small government, lower taxes, strong private sector, balanced budgets, supply side economics and individual responsibility -- prevail in the US, we will see a period of growth again. 

Supply side economics essentially increases the supply of goods and services through lower taxes, less regulation and promoting entrepreneurship. Increased supply reduces prices stimulating demand. Demand is also increased by jobs created to increase supply. Keynesian economics on the other hand promotes demand by redistributing wealth. This works as long as the government has other people's money to redistribute. Once money runs out so does demand leading to economic slowdown again, just like it's happening in the US now. Additionally increasing demand without increased supply leads to inflation hurting the weakest in society. 

The Keynesian model failed in the US when Jimmy Carter was president and now with Obama. It failed in UK till Margaret Thatcher stepped in with supply side economics. The US began it's longest lasting boom when Ronald Reagan implemented supply side economics. Big government and their stimulus programs using other people's money has failed again and again. Just look at Japan and the PIGS (Portugal, Italy, Greece and Spain). 

Insanity is defined as trying to the same thing over and over again expecting a different result. Let's hope for the good of the global economy that the big stimulus era comes to an end and the private sector repairs the damage created by governments.