The World in Balance Sheet Recession: What Post-2008 U.S., Europe and China Can Learn from Japan 1990-2005
Richard C. Koo Chief Economist Nomura Research Institute Tokyo November 2011 Exhibit 1. US Housing Prices Are Moving along the Japanese Experience
(US: Jan. 2000=100, Japan: Dec. 1985=100) Futures 260
240 US: 10 Cities Composite Home Price Index
220 Japan: Tokyo Area Condo Price1 Composite Index Futures 200
180
160
140 Japan: Osaka Area Condo Price1 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 13 14 US 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 Japan Note: per m2, 5-month moving average Sources: Bloomberg, Real Estate Economic Institute, Japan, S&P, S&P/Case-Shiller® Home Price Indices, as of Oct. 28, 2011
1 Exhibit 2. Drastic Liquidity Injection Failed to Increase Money Supply (I): US
320 (Aug. 2008 =100, Seasonally Adjusted) 300 Monetary Base 280 Money Supply (M2) 260 Loans and Leases in Bank Credit 240 220 200 180 160 Down 140 25% 120 100 80 3.0 (%, yoy) Consumer Spending 2.5 Deflator (core) 2.0 1.5 1.0 0.5 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
Sources: Board of Governors of the Federal Reserve System, US Department of Commerce Note: Commercial bank loans and leases, adjustments for discontinuities made by Nomura Research Institute.
2 Exhibit 3. Drastic Liquidity Injection Failed to Increase Money Supply (II): EU
150 (Aug. 2008 =100, Seasonally Adjusted) Base Money 140 Money Supply (M3) Credit to Euro Area Residents 130
120
110
100
90
2.2 (%, yoy) 2.0 CPI core 1.8 1.6 1.4 1.2 1.0 0.8 0.6 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 Sources: ECB, Eurostat Note: Base money's figures are seasonally adjusted by Nomura Research Institute.
3 Exhibit 4. Drastic Liquidity Injection Failed to Increase Money Supply (III): UK
280 (Aug. 2008 =100, Seasonally Adjusted) 265 1 Reserve Balances + Notes & Coin 250 235 Money Supply (M4) 220 Bank Lending (M4) 205 190 175 Aug. 08' 160 145 130 Down 115 17% 100 85 70
6 (%, yoy) 5 CPI (ex. Indirect Taxes) 4 3 2 1 0 07/1 07/4 07/7 07/10 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 Sources: Bank of England, Office for National Statisics, UK Notes: 1. Reserve Balances data are seasonally unadjusted. 2. Money supply and bank lending data exclude intermmediate financial institutions.
4 Exhibit 5. Drastic Liquidity Injection Failed to Produce Drastic Increase in Money Supply (IV): Japan
260 (Oct. 97 = 100, Seasonally Adjusted) 240 Quantitative Earthquake Easing 220 Monetary Base
200 Money Supply (M2)
180 Bank Lending
160
140 Oct. 97 120 Down 37% 100
80
60
3.0 (y/y, %) 2.0 CPI Core 1.0 0.0 -1.0 -2.0 -3.0 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Note: Bank lending are seasonally adjusted by Nomura Research Institute. Source: Bank of Japan
5 Exhibit 6. Japan’s De-leveraging with Zero Interest Rates Lasted for 10 Years
Funds Raised by Non-Financial Corporate Sector (% Nominal GDP, 4Q Moving Average) (%) 25 10 CD 3M rate 20 (right scale) 8
Borrowings from Financial Institutions (left scale) 15 6 Funds raised in Securities Markets (left scale)
10 4
5 2
0 0
-5 Debt-financed Balance sheet -2 bubble recession (4 years) (16 years) -10 -4
-15 -6 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 Sources: Bank of Japan, Cabinet Office, Japan
6 Exhibit 7. Japan’s GDP Grew in spite of Massive Loss of Wealth and Private Sector De-leveraging
(Tril.yen, Seasonally Adjusted) (Mar. 2000=100) 600 Nominal GDP 800 550 (Left Scale) Real GDP 700 (Left Scale) 500 Cumulative 600 90-05 GDP Supported by 450 500 Government Action: Likely GDP Path 400 ~ ¥2000 trillion w/o Government Action 400
350 300
300 200 Cumulative Last seen in 1973 down 87% Loss of Wealth on 250 100 Land Price Index in Six Major Cities Shares and (Commercial, Right Scale) Real Estate 200 0 ~ ¥1500 trillion 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
Sources: Cabinet Office, Japan Real Estate Institute
7 Exhibit 8. Japanese Government Borrowed and Spent the Unborrowed Savings of the Private Sector to Sustain GDP
(Tril. yen) 110 Government spending 100
90
80 cumulative cyclical deficit 70 90-05 ¥315 trillion 60 overall 50 deficit ¥460 trillion 40 Bubble Collapse 30 Tax revenue
20 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 Source: Ministry of Finance, Japan Note: FY 2011 includes 2nd supplementary budget.
8 Exhibit 9. Premature Fiscal Reforms in 1997 and 2001 Weakened Economy, Reduced Tax Revenue and Increased Deficit
(Yen tril.) (Yen tril.) 70 70 Tax Revenue Hashimoto Global Obuchi-Mori Koizumi Budget Deficit fiscal fiscal Financial reform fiscal Crisis 60 stimulus reform 60
50 50 * unnecessary 40 40 increase in deficit: ¥103.3 tril. 30 30
20 20
10 10
0 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 (FY) Source: Ministry of Finance, Japan *: estimated by MOF
9 Exhibit 10. Monetary Easing No Substitute for Fiscal Stimulus (I):
Japan’s Money Supply Has Been Kept Up by Government Borrowings Balance Sheets of Banks in Japan
December 1998 December 2007 Assets Liabilities Assets Liabilities
Credit Extended to the Private Credit Sector Money Supply Extended to ¥501.8 tril. Money Supply the Private (M2+CD) (-99.8) (M2+CD) Sector ¥621.5 tril. ¥744.4 tril. ¥601.6 tril. (+122.9)
Credit Extended to the Credit Extended to the Public Public Sector Sector ¥247.2 tril. (+106.8) ¥140.4 tril. Other Liabilities (net) Foreign assets Foreign Assets Other Liabilities ¥153.2 tril. (net) (net) (net) ¥74.1 tril. ¥32.7 tril. ¥78.7 tril. (+41.4) (-74.5) Total Assets ¥774.7 tril. Total Assets ¥823.1 tril. (+48.4)
Source: Bank of Japan "Monetary Survey"
10 Exhibit 11. Monetary Easing No Substitute for Fiscal Stimulus (II): Post-1933 US Money Supply Growth Made Possible by Government Borrowings
Balance Sheets of All Member Banks
June 1929 June 1936 Assets Liabilities Assets Liabilities
Credit Extended to the Deposits Private Credit $32.18 bil. June 1933 Sector Deposits Extended to Assets Liabilities $15.71 bil. $34.10 bil. the Private Credit (-0.09) (+10.74) Sector Deposits Extended to (= Money Supply) $29.63 bil. the Private $23.36 bil. Sector (-8.82) Credit $15.80 bil. Extended (-13.83) to the Public Credit Sector Extended $16.30 bil. Credit to the (+7.67) Extended to Public the Public Sector Other Other Sector $8.63 bil. Other Other Liabilities Assets $5.45 bil. (+3.18) Liabilities Liabilities $6.93 bil. $8.91 bil. $4.84 bil. $7.19 bil. Other (+2.54) (-2.09) (+2.35) Other Assets Assets $8.02 bil. $6.37 bil. Reserves (-1.65) Capital Capital $5.61 bil. Capital Reserves $4.84 bil. $5.24 bil. (+3.37) Reserves $6.35 bil. $2.24 bil. (-1.51) (+0.40) $2.36 bil. (-0.12) Total Assets $45.46 bil. Total Assets $33.04 bil. (-12.42) Total Assets $46.53 bil. (+13.49)
Source: Board of Governors of the Federal Reserve System (1976) Banking and Monetary Statistics 1914-1941 pp.72-79
11 Exhibit 12. US in Balance Sheet Recession: US Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector (as a ratio to nominal GDP, %, quarterly) 8 Households (Financial Surplus) 6 Shift from Rest of the World 4Q 2006 in 4 private sector: 9.30% of GDP Corporate: 1.40% 2 Households: 8.22% 0
-2
-4 Shift from -6 4Q 2006 in General public sector: -8 Government 5.80% of GDP Corporate Sector (Non-Financial Sector + -10 Financial Sector) IT Bubble Housing Bubble (Financial Deficit) -12 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
Note: For the latest figures, 4 quarter averages ending with 2Q/11' are used. Sources: FRB, US Department of Commerce
12 Exhibit 13. UK in Balance Sheet Recession: UK Private Sector Increased Savings Massively after the Bubble Financial Surplus or Deficit by Sector (as a ratio to nominal GDP, %) 9 Households (Financial Surplus)
6 Rest of the World Shift from 1Q 2007 in private sector: 3 8.23% of GDP Corporate: 2.19% Households: 6.04% 0
-3
Shift from -6 1Q 2007 in public sector: General Corporate Sector 7.11% of GDP (Non-Financial Sector + -9 Government Financial Sector)
(Financial Deficit) -12 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Note: For the latest figures, 4 quarter averages ending with 2Q/11' are used. Source: Office for National Statistics, UK
13 Exhibit 14. Global Bond Yields* Nearing Japanese Levels
(%) 6 England US 5 Sweden Switzerland Japan Japanese 4 Bond Yield in 1997
3
3%
2
1.3%
1
0 2007 2008 2009 2010 2011
*Note: Excluding Eurozone. As of Oct. 28, 2011. Source: Bloomberg
14 Exhibit 15. Euro-Zone Bond Yields Are Diverging Sharply
(%) 26
24 Greece 22 Ireland 20 Portugal 18 Spain 16 Italy
14 France
12 Germany
10
8
6
4
2
0 2007 2008 2009 2010 2011
Note: As of Oct. 28, 2011. Source: Bloomberg
15 Exhibit 16. Euro-zone in Balance Sheet Recession: Euro-zone Private Sector Increased Savings Massively after the Bubble Financial Surplus or Deficit by Sector (as a ratio to nominal GDP, %) 6 (Financial Surplus) Households Shift from 4 3Q 2008 in private sector: 4.09% of GDP Corporate: 2.62% 2 Rest of the World Households: 1.47%
0
-2 Shift from 3Q 2008 in public sector: -4 4.03% of GDP General Government Corporate Sector -6 (Non-Financial Sector + Financial Sector)
(Financial Deficit) -8 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Note: For the latest figures, 4 quarter averages ending with 1Q/11' are used. Source: ECB
16 Exhibit 17. Spain in Balance Sheet Recession: Spanish Private Sector Increased Savings Massively after the Bubble Financial Surplus or Deficit by Sector (as a ratio to nominal GDP, %) 12 (Financial Surplus) Households 9 Rest of the World Shift from 3Q 2007 in private sector: 6 17.95% of GDP Corporate: 12.54% Households: 5.41% 3
0
-3 Shift from 3Q 2007 in public sector: -6 11.93% of GDP Corporate Sector (Non-Financial Sector + Financial Sector) -9 General Government (Financial Deficit) -12 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Note: For the latest figures, 4 quarter averages ending with 2Q/11' are used. Source: Banco de España
17 Exhibit 18. Ireland in Balance Sheet Recession: Irish Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector (as a ratio to nominal GDP, %) 15 Corporate Sector (Financial Surplus) (Non-Financial Sector + Financial Sector) 10 Shift from 2006 Rest of the World in private sector: 21.55% of GDP 5 Corporate: 7.29% Households: 14.26%
0
General Shift from 2006 -5 Government in public sector: 16.78% of GDP
-10 Households
(Financial Deficit) -15 2002 2003 2004 2005 2006 2007 2008 2009
Sources: Eurostat, Central Statistics Office, Ireland
18 Exhibit 19. Exit Problem (II): German Private Sector Refused to Borrow Money after 1999-2000 Telecom Bubble
Financial Surplus or Deficit by Sector (as a ratio to nominal GDP, %) 8 Households (Financial Surplus) Shift from 2000 6 to 2005 Telecom Bubble in private sector: 4 12.06% of GDP Corporate: 9.26% Households: 2.80% 2
0 Rest of the World -2
-4 Shift from 2000 to 2005 -6 General in public sector: Corporate Sector Government 4.62% of GDP -8 (Non-Financial Sector + Financial Sector) (Financial Deficit) -10 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Sources: Deutsche Bundesbank, Federal Statistical Office Germany Note: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted.
19 Exhibit 20. Recovery from Lehman Shock Is NOT Recovery from Balance Sheet Recession
Lehman Shock Bubble Likely GDP Path Burst without Lehman Shock
Weaker Demand from Private Sector Economic weakness De-leveraging from private-sector (A) de-leveraging ?
Economic weakness from policy mistake (B) on Lehman Stronger Demand Actual GDP from Government's Path Current Location Fiscal Stimulus
Source: Nomura Research Institute
20 Exhibit 21. Multi-Decade Cycle of Bubbles and Balance Sheet Recessions
Yin (=Balance Sheet Recession) Bubble Yang (=Textbook Economy)
(1) Monetary policy is tightened, leading the bubble to collapse. (9) Overconfident private sector triggers a bubble.
(2) Collapse in asset prices leaves private sector US with excess liabilities, (8) With the economy healthy, forcing it into debt minimization mode. the private sector regains its vigour, Entrance The economy falls into a balance sheet recession. and confidence returns. Problem Spain
UK (3) With everybody paying down debt, monetary policy stops working. (7) Monetary policy becomes the main economic Fiscal policy becomes the main economic tool tool, while deficit reduction becomes the top to maintain demand. fiscal priority.
(4) Eventually private sector finishes its debt repayments, ending the balance sheet recession. (6) Private sector fund demand recovers, But it still has a phobia about borrowing which keeps and monetary policy starts working again. interest rates low, and the economy less than fully vibrant. Fiscal policy begins to crowd out private investment. Exit Japan Economy prone to mini-bubbles. Problem Germany
(5) Private sector phobia towards borrowing gradually disappears, and it takes a more bullish stance towards fund raising.
Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession , John Wiley & Sons, Singapore, April 2008 p.160.
21 Exhibit 22. Euro-Zone Banks Need Low-Cost Unconditional Capital Injection to Avoid Credit Crunch Contrast Between Yin and Yang Phases of Cycle
Yang Yin Behavioral principle = Profit maximization = Debt minimization
1) Phenomenon Textbook economy Balance sheet recession
2) Private sector financial condition Assets > Liabilities Assets < Liabilities
3) Outcome Greatest good for greatest number Depression if left unattended
4) Monetary policy Effective Ineffective (liquidity trap)
5) Fiscal policy Counterproductive (crowding-out) Effective
6) Prices Inflationary Deflationary
7) Interest rates Normal Very low
8) Savings Virtue Vice (paradox of thrift) Quick NPL disposal Normal NPL disposal a) Localized 9) Remedy for Pursue accountability Pursue accountability Banking Crisis Slow NPL disposal Slow NPL disposal b) Systemic Fat spread Capital injection by government
Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession , John Wiley & Sons, Singapore, 2008
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