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Richard C. Koo Chief Economist Nomura Research Institute Tokyo May 2008
Exhibit 1. US Housing Bubble Lasted Two Years Longer than Greenspan Expected
(y/y %) 20 (%) 8
6 10
0 2 -5
unexpected bubble
0 2005 2006 2007 2008
5.5
4.5
4.0
3.0
Source: Financial Times Weekly Review of the Fund Management Industry Aug. 6, 2007. Watch out for another wobble
Yin
Weak or non-existent demand for funds (III) Normal NPL disposal Pursue accountability (IV) Slow NPL disposal Capital injection
Type (I): the 1989 S&L crisis Type (II): the Latin America debt crisis of 1982, the nationwide credit crunch in the US between 1991 and 1993, and the Nordic banking crisis in the early 1990s Type (III): Japan prior to 1995 (for example, problems at two credit cooperatives) Type (IV): Japan since 1996, Taiwan since 2000, the US Great Depression of the 1930s, and US and UK subprime crisis since 2007
Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japans Great Recession, John Wiley & Sons, Singapore, April 2008 (forthcoming).
Credit Crunch
40
Bubble Burst
"Takenaka Shock"
20
S i haded areas indicate periods of BOJ monetary tightening j Source: Bank of Japan, "Tankan".
Exhibit 6. Capital Injection Is Politically Difficult when the US Economy Is Doing Well
(%, Seasonally adjusted) 86 (%, Seasonally adjusted, inverted) 3.5
84
4.0
74
6.0
6.5
Futures
Composite Index Futures (as of Sep. 19, 2007)
260 240 US: 10 Cities Composite Home Price Index 220 200 180 160 140 120 100 80 60 40 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Japan: Osaka Area Condo Price (per m2, 5 months moving average)
Composite Index Futures (as of May. 22, 2008)
US Japan
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
Sources: Bloomberg, Real Estate Economic Institute, Japan, S&P "S&P/Case-Shiller Home Price Indices", as of May. 22, 2008.
5000
11
3 99 00 01 02 03 04 05 06 07 08
Fiscal Policy
Monetary Policy
Weaker Dollar
Risks: May trigger foreign capital outflow leading to higher interest rates Accelerate already serious commodity price inflation Oil price denomination in US dollar may be jeopardized, which may lead to a dollar collapse
10
40000 30000 20000 10000 0 -10000 -20000 -30000 -40000 -50000 -60000 -70000 -80000
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
US trade deficit with China US trade deficit with Japan US trade deficit (Census Basis) US Running Federal Budget Surpluses
Sources: US Department of Commerce, US Department of Treasury, Ministry of Finance Japan National Bureau of Statistics of China These data are seasonally adjusted by Nomura Research Institute.
11
Exhibit 12. Japanese Companies Had Been Paying Down Debt even with Zero Interest Rates
Funds Raised by Non-Financial Corporate Sector
(% Nominal GDP, 4Q Moving Average) 25 (%) 10
-5
-2
-4
12
120
TOPIX Land Prices in Six Major Cities (Commercial) Golf Course Memberships
100
80
60
-53%
40 -95% 20
-87%
-81% -94%
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
Sources: Tokyo Stock Exchange, Japan Real Estate Institute, Nikkei Sangyo Shimbun
13
Exhibit 14. Cumulative Capital Losses on Shares and Land since End-1989 Reached 1,500 Trillion Yen
400 (Tril. yen) (Capital Gain)
Land
0
Shares
-400
-800
-1200
(Capital Loss) 97 98 99 00 01 02 03 04 05 06
14
Exhibit 15. Japans GDP Grew even after the Bursting of the Bubble
(Tril.yen, Seasonally Adjusted) 600 Nominal GDP (Left Scale) 800 (Mar. 2000 100)
550
700 500 Real GDP (Left Scale) 450 500 400 Land Price Index in Six Major Cities (Commercial, Right Scale) 400 600
300 200
300
250
100 0 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
200
15
Exhibit 16. Government Fiscal Stimulus Largely Neutralized Corporate Debt Repayment
Financial Surplus or Deficit by Sector
15
10
Households
-5
-10
(Financial Deficit)
-15 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 Sources: Bank of Japan, Flow of Funds Accounts , and Government of Japan, Cabinet Office, National Accounts Note: For fiscal 07' figures, 4 quarter averages ending with 4Q/07' are used.
(FY)
16
Exhibit 17. Japanese Companies Made Huge Progress in Reducing Debt Overhang
(Yen tril., Seasonally Adjusted) 450 400 350 300 250 (as a ratio to nominal GDP, %)
90
Credit Extened by the Banks to Corporate Sector as a Ratio to Nominal GDP (Right Scale)
85/4Q
80
70
200 150 100 50 0 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Sources : Bank of Japan, "Loans and Discounts Outstanding by Sector" "Loans to Individuals", Cabinet Office, Japan "National Accounts" Notes: 1. 'Credit Extened by the Banks to Corporation' is extended to 1970 by NRI after adjustment for discontinuities in statistics in 1993 and again in 1975. @ @ @ 2. As a percentage of nominal GDP. For GDP statistics before 1979, 68 SNA is used.
60
last seen in 1956
50
17
(Times)
Japan
3 US 2
0 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
18
Exhibit 19. Japanese Companies Have Finished Debt Repayments, and Are Now Rebuilding Financial Assets
30
(as a ratio to nominal GDP, %) (as a ratio to nominal GDP, %)
-30
Left Scale
Financial Assets
20
-20
10
-10
-10
10
-20
Financial Liabilities Right Scale
20
-30
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Office, National Accounts Note: For fiscal 07' figures, 4 quarter averages ending w ith 4Q/07' are used.
30
19
25 20 15 10 5 0 -5 -10 -15
Left Scale
Financial Assets
Financial Liabilities
Right Scale
10 15
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Office, National Accounts Note: For fiscal 07' figures, 4 quarter averages ending w ith 4Q/07' are used.
20
Exhibit 21. Premature Fiscal Reforms in 1997 and 2001 Actually Reduced Tax Revenue and Increased Deficit
70
(Yen tril.) (Yen tril.)
Hashimoto (initial budget)* Koizumi fiscal Obuchi-Mori fiscal reform fiscal (with supplemental budget)* reform stimulus
70
60
50
50
40
40
30
30
20
20
10
10
0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
(FY) Source: Ministry of Finance, Japan *: estimated by MOF
21
Credit Extended to Others (Mostly Government) Credit Extended to the Private Sector Money Supply (M2+CD)
Quantitative Easing
22
December 2007
Assets Liabilities
621.5 tril.
601.6 tril.
140.4 tril.
Foreign Assets (net)
153.2 tril.
32.7 tril.
23
Exhibit 24. Monetary Aggregates Behave Totally Differently under Balance Sheet Recession
(1990/1Q=100, Seasonally adjusted) 300 High-powered Money (Average Balance) Money Supply (M2+CD, Average Balance) 250 Credit Extended to the Private Sector
Quantitative Easing
200
150
Down 30%
100
50
1990/1Q
0 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Note: Private sector borrowings seasonally adjusted by Nomura, adjustments made for discontinuities in line with BOJ's "Monetary Survey" Source: Bank of Japan
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Exhibit 25. Yin Yang Cycle of Bubbles and Balance Sheet Recessions
Yin (=Shadow)
Bubble
Yang (=Light)
(2) Collapse in asset prices leaves businesses with excess liabilities, forcing them into debt minimization mode. The economy falls into a balance sheet recession. (3) With everybody paying down debt, monetary policy stops working. Fiscal policy becomes the main economic tool to maintain demand. (4) Eventually companies finish their debt repayments, ending the balance sheet recession. But they still have a phobia about borrowing which keeps interest rates low, and the economy less than fully vibrant. Economy prone to mini-bubbles.
China
(8) With the economy healthy, the private sector regains its vigour, and confidence returns.
India
(7) Monetary policy replaces fiscal policy as the main economic tool.
Germany Japan US
(6) Private sector fund demand recovers, and monetary policy starts working again. Fiscal policy leads to crowding out of private investment.
(5) Corporate phobia towards borrowing gradually disappears, and companies take a more bullish stance towards fund raising.
Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japans Great Recession , op.cit.
25
Yang
1) Phenomenon 2) Fundamental driver 3) Corporate financial condition 4) Behavioral principle 5) Outcome 6) Monetary policy 7) Fiscal policy 8) Prices 9) Interest rates 10) Savings 11) Remedy for Banking Crisis a) Localized b) Systemic
Textbook economy Adam Smith's "invisible hand" Assets > Liabilities Profit maximization Greatest good for greatest number Effective Counterproductive (crowding-out) Inflation Normal Virtue Quick NPL disposal Pursue accountability Slow NPL disposal Fat spread
Yin
Balance sheet recession Fallacy of composition Assets < Liabilities Debt minimization Depression if left unattended Ineffective (liquidity trap) Effective Deflation Very low Vice (paradox of thrift) Normal NPL disposal Pursue accountability Slow NPL disposal Capital injection
Source: Compiled by Nomura Research Institute based on Eizo Kinoshita, Keizai wo shihai suru futatsu no housoku, Denki Shoin, p. 92.
26