The World in Balance Sheet Recession: What Post-2008 ......The World in Balance Sheet Recession: What Post-2008 West Can Learn from Japan 1990-2005 Richard C. Koo Chief Economist Nomura

The World in Balance Sheet Recession: What Post-2008 West Can Learn from Japan 1990-2005

Richard C. Koo Chief Economist

Nomura Research Institute Tokyo

August 2012

1

Exhibit 1. US Housing Prices Are Moving along the Japanese Experience

40

60

80

100

120

140

160

180

200

220

240

260

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

US: 10 Cities Composite Home Price Index

(US: Jan. 2000=100, Japan: Dec. 1985=100)

Note: per m2, 5-month moving averageSources: Bloomberg, Real Estate Economic Institute, Japan, S&P, S&P/Case-Shiller® Home Price Indices, as of Jul. 26, 2012

Composite Index

Futures

Japan: Tokyo Area Condo Price1

77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99

Japan: Osaka Area Condo Price1

Futures

USJapan

Exhibit 2. House Prices in Europe also Experienced Bubble

2

75 100 125 150 175 200 225 250 275 300 325 350 375 400 425 450 475 500 525 550

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Ireland

Greece

Spain

Germany

(end of 1995 = 100)

Notes: Ireland's f igures before 2005 are existing house prices only. Greece's f igures are f lats' prices in Athens and Thessaloniki. Germany's latest f igure is estimated f rom the house price index of Europace AG.Source: Nomura Research Institute, calculated f rom BIS and Europace AG data.

90

303

342

514

Ireland262

Greece271

Spain238

Germany100

Exhibit 3. Drastic Rate Cuts Have Done Little to Revive Employment or House Prices

3

0

1

2

3

4

5

6

7

8

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

(%)

Sources: BOJ, FRB, ECB, BOE and RMB Australia. As of Jul. 26, 2012.

Australia

EU

US

UK

Japan

4

Exhibit 4. US Economy Is still a Long Way from Previous Peak

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.083

85

87

89

91

93

95

97

99

101

103

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

(%, Seasonally adjusted, inverted)

Unemployment Rate(right scale)

Sources: US Department of Labor, FRB

(2007=100, Seasonally adjusted)

Last seen

in 2006

Last seen in 1997

Industrial Production(left scale)

Last seen in 1983

5

Exhibit 5. Euro-Zone Economy Is still a Long Way from Previous Peak

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

11.585

90

95

100

105

110

115

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

*No data before 1995Source: Eurostat

(%, Seasonally adjusted, inverted)(Seasonally adjusted, 2005=100)

Industrial Production(left scale)

Unemployment Rate(right scale)

Worst on record*

Last seenin 2005

Exhibit 6. Except in Germany, Industrial Production in Europe Is still Weak

6

70

75

80

85

90

95

100

105

110

115

120

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Spain

France

Italy

Germany

(2005 = 100, Seasonally Adjusted)

Source: Eurostat

Level last seen in

2007: Germany

1997: France

1987: Italy

1994: Spain

Exhibit 7. Japan’s Industrial Production Fell to the Level of 1987 after the Earthquake

7

65

70

75

80

85

90

95

100

105

110

115

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Note: Forecasts are calculated f rom METI's survey on planned production.Sources: Ministry of Economy, Trade and Industry (METI), and Ministry of Health, Labour and Welfare

Job offers to applicants ratio(left scale)

(Seasonally adjusted, 2005=100)(Seasonally adjusted)

Industrial production (right scale)

Last seen in 1987

Lowest on record

Last seen in 1983

Last seen in 2004

forecast

Last seen in 2002

Exhibit 8. Drastic Liquidity Injection Failed to Increase Money Supply (I): US

8

80 100 120 140 160 180 200 220 240 260 280 300 320 340

Monetary BaseMoney Supply (M2)Loans and Leases in Bank Credit

(Aug. 2008 =100, Seasonally Adjusted)

Down 25%

0.5 1.0 1.5 2.0 2.5 3.0

08/1 08/4 08/7 08/10 09/1 09/4 09/7 09/10 10/1 10/4 10/7 10/10 11/1 11/4 11/7 11/10 12/1 12/4

(%, yoy) Consumer SpendingDeflator (core)

Sources: Board of Governors of the Federal Reserve System, US Department of CommerceNote: Commercial bank loans and leases, adjustments for discontinuities made by Nomura Research Institute.

311

129

96

+1.82%

Exhibit 9. Drastic Liquidity Injection Failed to Increase Money Supply (II): EU

9

90

100

110

120

130

140

150

160

170

180

190

200

Base MoneyMoney Supply (M3)Credit to Euro Area Residents

(Aug. 2008 =100, Seasonally Adjusted)

0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2

08/1 08/4 08/7 08/10 09/1 09/4 09/7 09/10 10/1 10/4 10/7 10/10 11/1 11/4 11/7 11/10 12/1 12/4 12/7

(%, yoy)CPI core

Sources: ECB, EurostatNote: Base money's figures are seasonally adjusted by Nomura Research Institute.

194

108104

+1.6%

Exhibit 10. Drastic Liquidity Injection Failed to Increase Money Supply (III): UK

10

70

100

130

160

190

220

250

280

310

340

370

Reserve Balances + Notes & CoinMoney Supply (M4)Bank Lending (M4)

Aug. 08'

(Aug. 2008 =100, Seasonally Adjusted)1

0123456

07/1 07/7 08/1 08/7 09/1 09/7 10/1 10/7 11/1 11/7 12/1

CPI (ex. Indirect Taxes)(%, yoy)

Down 19%

Sources: Bank of England, Office for National Statisics, UKNotes: 1. Reserve Balances data are seasonally unadjusted. 2. Money supply and bank lending data exclude intermmediate financial institutions.

369

10685

+2.4%

Exhibit 11. Drastic Liquidity Injection Failed to Produce Drastic Increase in Money Supply (IV): Japan

11

50

100

150

200

250

300

350

Monetary Base

Money Supply (M2)

Bank Lending

QuantitativeEasing

1990/1Q

(1990/1Q = 100, Seasonally Adjusted)

Textbook Economics

(Monetary PolicyEf fective)

Balance SheetRecession(Monetary Policy NOT Ef fective)

-3-2-101234

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

(y/y, %) CPI Core(ex. fresh food)

Down 41%

Note: Bank lending are seasonally adjusted by Nomura Research Institute.Source: Bank of Japan

Earthquake329

175

-0.2%

102

Exhibit 12. Japan’s De-leveraging with Zero Interest Rates Lasted for 10 Years

12

-6

-4

-2

0

2

4

6

8

10

-15

-10

-5

0

5

10

15

20

25

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Borrowings from Financial Institutions (left scale)

Funds raised in Securities Markets (left scale)

CD 3M rate (right scale)

(% Nominal GDP, 4Q Moving Average) (%)

Sources: Bank of Japan, Cabinet Of f ice, Japan

Debt-financedbubble

(4 years)

Balance sheetrecession(16 years)

Funds Raised by Non-Financial Corporate Sector

Exhibit 13. Japan’s GDP Grew in spite of Massive Loss of Wealth and Private Sector De-leveraging

13

down87%

25

40

55

70

85

100

115

130

0

20

40

60

80

100

120

140

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 09 10 11 12

(Sep.1990=100, Seasonally Adjusted)

Real GDP(Right Scale)

Land Price Index in Six Major Cities(Commercial, Left Scale)

(Sep. 1990=100)

Sources: Cabinet Of f ice, Japan Real Estate Institute

Nominal GDP (Right Scale)

Likely GDP Path w/o Government Action

Last seen in 1973

Cumulative 90-05 GDP

Supported by Government

Action: ~ ¥2000 trillion

Cumulative Loss of

Wealth on Shares and Real Estate

~ ¥1500 trillion

Exhibit 14. Japanese Government Borrowed and Spent the Unborrowed Savings of the Private Sector to Sustain GDP

14

overall deficit ¥460

trillion

20

30

40

50

60

70

80

90

100

110

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 09 10 11 12

Source: Ministry of Finance, JapanNote: FY 2011 includes 4th supplementary budget and FY2012 is initial budget.

Government spending

Tax revenueBubble Collapse

(Tril. yen)

cumulativecyclical deficit 90-05

¥315 trillion

Exhibit 15. Premature Fiscal Reforms in 1997 and 2001 Weakened Economy, Reduced Tax Revenue and Increased Deficit

15

0

10

20

30

40

50

60

70

80

0

10

20

30

40

50

60

70

80

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Tax RevenueBudget Deficit

Hashimotofiscal

reform Koizumi

fiscal reform

(Yen tril.) (Yen tril.)

(FY)

Global Financial

Crisis

*

Obuchi-Morifiscal

stimulus

Earthquake

Source: Ministry of Finance, JapanNotes: Latest f igures(*) are estimated by MOF. From FY2011, f igures includes reconstruction taxes and bonds.

unnecessaryincrease in

deficit:¥103.3 tril.

Exhibit 16. US in Balance Sheet Recession: US Private Sector Increased Savings Massively after the Bubble

16

PrivateSector

Savings:7.33% of GDP

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Housing Bubble

IT Bubble

(Financial Surplus)

(Financial Deficit)

(as a ratio to nominal GDP, %, quarterly)

Rest of the World

Households

General Government

Corporate Sector(Non-Financial Sector +

Financial Sector)

Financial Surplus or Deficit by Sector

Note: For the latest f igures, 4 quarter averages ending with 1Q/12' are used.Sources: FRB, US Department of Commerce

Exhibit 17. UK in Balance Sheet Recession: UK Private Sector Increased Savings Massively after the Bubble

17

PrivateSector


-12

-9

-6

-3

0

3

6

9

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Note: For the latest f igures, 4 quarter averages ending with 1Q/12' are used.Source: Of f ice for National Statistics, UK

(as a ratio to nominal GDP, %)

(Financial Surplus)

(Financial Deficit)

Rest of the World

Households

General Government


Financial Sector)


0

1

2

3

4

5

6

2007 2008 2009 2010 2011 2012

UKUSSwedenSwitzerlandJapan

(%)

*Note: Excluding Eurozone. As of Jul 26, 2012.Source: Bloomberg

3%

0.7%

Exhibit 18. Global Bond Yields* Nearing Japanese Levels

18

bond yield first seen in Japan in 1998

Exhibit 19. Euro-Zone Bond Yields Are Diverging Sharply

19

0

5

10

15

20

25

30

35

40

2007 2008 2009 2010 2011 2012

Greece

Ireland

Portugal

Spain

Italy

France

Germany

(%)

Note: As of Jul 26, 2012.Source: Bloomberg

Exhibit 20. Euro-zone in Balance Sheet Recession: Euro-zone Private Sector Increased Savings Massively after the Bubble

20

-8

-6

-4

-2

0

2

4

6

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Rest of the World


Households

(Financial Surplus)

(Financial Deficit)

Corporate Sector(Non-Financial Sector + Financial Sector)

General Government

Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Source: ECB


PrivateSector


Exhibit 21. Spain in Balance Sheet Recession: Spanish Private Sector Increased Savings Massively after the Bubble

21

PrivateSector


-12

-9

-6

-3

0

3

6

9

12

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Note: For the latest f igures, 4 quarter averages ending with 1Q/12' are used.Source: Banco de España


(Financial Surplus)

(Financial Deficit)

Rest of the World

Corporate Sector(Non-Financial Sector + Financial Sector)General

Government

Households


Exhibit 22. Ireland in Balance Sheet Recession: Irish Private Sector Increased Savings Massively after the Bubble

22

PrivateSector


-30

-25

-20

-15

-10

-5

0

5

10

15

20

03 04 05 06 07 08 09 10 11

Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Sources: The Central Bank of Ireland and Central Statistics Of f ice, Ireland


Financial Sector)Rest of the World

HouseholdsGeneral

Government

(Financial Surplus)

(Financial Deficit)



Exhibit 23. Portugal in Balance Sheet Recession: Portuguese Private Sector Increased Savings Massively after the Bubble

23

-12

-9

-6

-3

0

3

6

9

12

99 00 01 02 03 04 05 06 07 08 09 10 11 12

Note: For the latest f igures, 4 quarter averages ending with 1Q/12' are used.Source: Banco de Portugal

Rest of the World

(Financial Surplus)

Households

Corporate Sector(Non-Financial Sector + Financial Sector)

(Financial Deficit)

General Government



PrivateSector

Savings:4.03%

of GDP

Exhibit 24. Two Structural Deficiencies of Eurozone

24

Maastricht Treaty and Fiscal Compact Never Considered the Risk of Balance Sheet

Recessions

Procyclical and Destabilizing Capital Flows between Gov.

Bond Markets of Member Countries

Excessively Low Gov. Bond Yields during Bubbles

Excessively High Gov. Bond Yields during Balance Sheet

Recessions

Countries Are Forced into Deflationary Spirals because They Are

Prohibited by the Treaty and Prevented by the Market

from Using Fiscal Stimulus to Fight Balance Sheet

Recessions

(1) (2)

Result

Exhibit 25. German Private Sector Refused to Borrow Money after 1999-2000 Telecom Bubble

25

-10

-8

-6

-4

-2

0

2

4

6

8

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Balance Sheet Recession

(Financial Surplus)

(Financial Deficit)


General Government

Households

Sources: Deutsche Bundesbank, Federal Statistical Of f ice GermanyNote: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted.

Rest of the World


Telecom Bubble


Financial Sector)

Shift from 2000 to 2005

in private sector:12.06% of GDPCorporate: 9.26%

Households: 2.80%

Shift from 2000 to 2005

in public sector:4.62% of GDP

Exhibit 26. Source of “Competitiveness Problem”: Divergence of Eurozone Money Supply Growth

26

50

100

150

200

250

300

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Eurozone ex. Germany

Germany

Greece

(1999 Q1=100, Seasonally adjusted)

Notes: Growth in M3. Figures for Germany and Greece seasonally adjusted by Nomura Research Institute. Path of money supply growth was estimated as 2,167.852 + 9.79354 x trend for Germany and 7,126.945 + 11.01537 x trend for other countries, based on trend for January 2010 through May 2012.Source: Nomura Research Institute, based on ECB, Deutsche Bundesbank and Bank of Greece

Lehman Shock

Paths will cross in Jun. 2021

Already crossed for Greece

Exhibit 27. Divergence of Eurozone Labor Costs

27

Spain: 154.4

Ireland: 151.4

France: 144.0

Greece: 129.8*

Italy: 139.5

Portugal: 133.3

Germany: 122.7

100

110

120

130

140

150

160

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

GermanyIrelandGreeceSpainFranceItalyPortugal

(2000 = 100)

Note: Greek f igure for 2011 represents average through 2011 Q3.Source: Eurostat

Exhibit 28. Post IT-Bubble Germany Recovered by Increasing Exports to Eurozone

28

-6000

-4000

-2000

0

2000

4000

6000

8000

10000

12000

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Source: Deutsche Bundesbank

(€mn, seasonally adjusted)

Eurozone

Asia

US

German Balance of Trade

Exhibit 29. ECB Facing Balance Sheet Recession Can Supply Large Amounts of Liquidity without Igniting Inflation

29

75

100

125

150

175

200

225

250

275

300

325

350

375

400

2007 2008 2009 2010 2011 2012

Eurozone

US

UK

Eurozone

US

UK

Monetary Base(=Liquidity)

Money Supply

(Aug. 2008 = 100, seasonally adjusted)

Aug. 2008

Notes: 1. UK's reserve balances data are seasonally unadjusted. 2. UK's money supply and bank lending data exclude intermmediate f inancial institutions. 3. Base money's f igures of Eurozone are seasonally adjusted by Nomura Research Institute.

Source: Nomura Research Institute, based on FRB, ECB and Bank of England data.

US-like monetary

easing would allow ECB to

supply € 960.3 bil. worth of

additional liquidity.

Exhibit 30. Balance Sheet Correction in France Was Minimal

30

-10

-8

-6

-4

-2

0

2

4

6

8

00 01 02 03 04 05 06 07 08 09 10 11


Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Sources: ECB and Eurostat


(Financial Surplus)

(Financial Deficit)

Households

Rest of the WorldGeneral

GovernmentCorporate Sector

(Non-Financial Sector + Financial Sector)

PrivateSector

Savings:2.12%

of GDP

Exhibit 31. Balance Sheet Correction in Italy Was Minimal

31

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

General Government


Financial Sector)

Households

Rest of the World


(Financial Surplus)

(Financial Deficit)

Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Sources: Banca d'Italia, Eurostat


PrivateSector

Savings:-1.16% of GDP

Exhibit 32. Greek Private Sector Is Drawing Down Savings to Survive

32

-20

-15

-10

-5

0

5

10

15

20

25

01 02 03 04 05 06 07 08 09 10 11


(Financial Surplus)

(Financial Deficit)

Rest of the World

Households

General Government


Financial Sector)

Note: For the latest f igures, 4 quarter averages ending with 2Q/11' are used.Sources: Bank of Greece, Eurostat


PrivateSector

Savings:-7.04% of GDP

Exhibit 33. Greek Corporates Are Both Drawing Down Savings and Reducing Debt

33

-15

-10

-5

0

5

10

15-15

-10

-5

0

5

10

15

00 01 02 03 04 05 06 07 08 09 10 11

Sources: Bank of Greece, Eurostat

Financial Assets

Financial Liabilities

left scale

right scale

(as a percentage of nominal GDP) (as a percentage of nominal GDP, inverted)

Exhibit 34. Greek Households Are Both Drawing Down Savings and Reducing Debt

34

-20

-15

-10

-5

0

5

10

15-15

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11

Sources: Bank of Greece, Eurostat

Financial Assets

Financial Liabilities

left scale

right scale

(as a percentage of nominal GDP) (as a percentage of nominal GDP, inverted)

Exhibit 35. Japanese Corporates Increased Savings again after Lehman

35

-18

-15

-12

-9

-6

-3

0

3

6

9

12

15

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 09 10 11 12

(Financial Deficit)

(Financial Surplus)


Households

Rest of the World


Financial Sector)

General Government


Note: For the latest f igures, 4 quarter averages ending with 1Q/12' are used.Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Of f ice, National Accounts

Balance Sheet Recession Global Financial

Crisis

PrivateSector


1991-2003 shift = 22% of GDP

-10

-8

-6

-4

-2

0

2

4

6

8

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Note: For the latest f igures, 4 quarter averages ending with 1Q/12' are used.Source: Australian Bureau of Statistics

(Financial Surplus)

Rest of the WorldHouseholds

Corporate Sector(Non-Financial Sector

+ Financial Sector)

(Financial Deficit)General

Government


PrivateSector


Exhibit 36. Australian Household Savings Are Large while Corporate Borrowings Are Modest

36

Exhibit 37. U.S. Took 30 Years to Normalize Interest Rate after 1929 because of Private Sector Aversion to Debt

0

1

2

3

4

5

6

7

8

9

1920 21 2223 24 2526 27 2829 30 3132 33 3435 36 3738 39 4041 42 4344 45 4647 48 4950 51 5253 54 5556 57 5859 60

US government bond yieldsPrime BA, 90daysUS government bond yields 1920-29 average (4.09%, June 1959)Prime BA, 90days 1920-29 average (4.13%, September 1959)

Oct '29 NY StockMarket Crash

Jun '50 Korean War

Dec '41 PearlHarbor Attack

(%)

'33～New Deal

Source: FRB, Banking and Monetary Statistics 1914-1970 Vol.1, pp.450-451 and 468-471, Vol.2, pp.674-676 and 720-727

37

Exhibit 38. Monetary Easing No Substitute for Fiscal Stimulus (I): Japan’s Money Supply Has Been Kept Up by Government Borrowings

CreditExtended tothe Private

Sector¥601.6 tril.

CreditExtended to thePublic Sector¥247.2 tril.

(+106.8)

Foreign assets(net)

¥74.1 tril.(+41.4)

Foreign Assets(net)

¥32.7 tril.

Credit Extendedto the Public

Sector¥140.4 tril.

Money Supply(M2+CD)

¥621.5 tril.


Sector¥501.8 tril.

(-99.8)

Other Liabilities(net)

¥78.7 tril.(-74.5)

Other Liabilities(net)

¥153.2 tril.

Money Supply(M2+CD)

¥744.4 tril.(+122.9)

Balance Sheets of Banks in Japan

December 2007

Total Assets ¥823.1 tril. (+48.4)Total Assets ¥774.7 tril.

December 1998Assets

AssetsLiabilities

Liabilities

Source: Bank of Japan "Monetary Survey"

38

Exhibit 39. Monetary Easing No Substitute for Fiscal Stimulus (II): Post-1933 US Money Supply Growth Made Possible by Government Borrowings


Sector$29.63 bil.

Deposits$32.18 bil.

CreditExtended tothe Public

Sector$5.45 bil.

Other Assets$8.02 bil.

Reserves$2.36 bil.

Capital$6.35 bil.

OtherLiabilities$6.93 bil.

June 1929 Assets Liabilities

Total Assets $45.46 bil. Total Assets $33.04 bil. (-12.42) Total Assets $46.53 bil. (+13.49)

CreditExtended

to thePrivateSector

$15.71 bil.(-0.09)Credit

Extended tothe Private

Sector$15.80 bil.

(-13.83)



Deposits$23.36 bil.

(-8.82)

Deposits$34.10 bil.(+10.74)

CreditExtended

to thePublicSector

$8.63 bil.(+3.18)

CreditExtended

to thePublicSector

$16.30 bil.(+7.67)

OtherAssets

$6.37 bil.(-1.65)

OtherAssets

$8.91 bil.(+2.54)

Reserves$2.24 bil.

(-0.12)

Reserves$5.61 bil.(+3.37)

OtherLiabilities$4.84 bil.

(-2.09)

OtherLiabilities$7.19 bil.(+2.35)

Capital$4.84 bil.

(-1.51)

Capital$5.24 bil.(+0.40)

(= Money Supply)

Source: Board of Governors of the Federal Reserve System (1976) Banking and Monetary Statistics 1914-1941 pp.72-79

Balance Sheets of All Member Banks

39

Exhibit 40. Industrialization of Chinese (or any Agrarian) Economy

40

Source: Nomura Research Institute

L

S

D3

A

B

C

D

EF I J M

H K

D2D1

China in the future(normalization of domestic

demand phase)

China until now(capital-accumulation phase)

Worker'sincome

Capital'sprofit

wages

number of workers

(i)

(ii)

G

Investment

Consumption

Labor supply curve

Labor demand curve

Industrialization

China Today

Fast growth

Stable prices

Wideningincome

inequality

Strong investment

Weak consumption

Slower growth

Inflation

Narrowing income

inequality

Slower investment

Strongerconsumption

Exhibit 41. Yin Yang Cycle of Bubbles and Balance Sheet Recessions

Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession , John Wiley & Sons, Singapore, April 2008 p.160.

(1) Monetary policy is tightened, leading the bubble to collapse.

(5) Private sector phobia towards borrowing gradually disappears,and it takes a more bullish stance towards fund raising.

(8) With the economy healthy,the private sector regains its vigour,

and confidence returns.

(9) Overconfident private sector triggers a bubble.

(7) Monetary policy becomes the maineconomic tool, while deficit reduction

becomes the top fiscal priority.

(6) Private sector fund demand recovers,and monetary policy starts working again.

Fiscal policy begins to crowd out private investment.

(4) Eventually private sector finishes its debt repayments,ending the balance sheet recession.

But it still has a phobia about borrowing which keepsinterest rates low, and the economy less than fully vibrant.

Economy prone to mini-bubbles.

(3) With everybody paying down debt,monetary policy stops working.

Fiscal policy becomes the main economic toolto maintain demand.

(2) Collapse in asset prices leaves private sectorwith excess liabilities,

forcing it into debt minimization mode.The economy falls into a balance sheet recession.

BubbleYin (=Shadow) Yang (=Light)

US

Spain

UK

Germany

Japan

41

Exhibit 42. Contrast Between Yin and Yang Phases of Cycle

42

Yang YinTextbook economy Balance sheet recession

Adam Smith's "invisible hand" Fallacy of composition

Assets > Liabilities Assets < Liabilities

Profit maximization Debt minimization

Greatest good for greatest number Depression if left unattended

Effective Ineffective (liquidity trap)

Counterproductive (crowding-out) Effective

Inflationary Deflationary

Normal Very low

Virtue Vice (paradox of thrift)

a) LocalizedQuick NPL disposal

Pursue accountabilityNormal NPL disposalPursue accountability

b) SystemicSlow NPL disposal

Fat spreadSlow NPL disposal

Gov. capital injection

Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession , John Wiley & Sons, Singapore, 2008

1) Phenomenon

2) Fundamental driver

3) Corporate financial condition

4) Behavioral principle

8) Prices

9) Interest rates

10) Savings

11) Remedy forBanking Crisis

5) Outcome

6) Monetary policy

7) Fiscal policy

Documents

The World in Balance Sheet Recession: What Post-2008 ......The World in Balance Sheet Recession: What Post-2008 West Can Learn from Japan 1990-2005 Richard C. Koo Chief Economist Nomura