richard koo - abenomics and the escape from balance sheet recession

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Any authors named on this report are research analysts unless

otherwise indicated.

A Country-by-Country Evaluation

Abenomics and the Escape

from Balance Sheet Recession

May 2013

Richard C. Koo, Chief EconomistNomura Research Institute, [email protected]

Monetary Base as a Percentage of Nominal GDP2

Exhibit 1. BOJ’s Kuroda Is Trying to Double Japan’s already

substantial Monetary Base

0

10

20

30

40

50

60

2006 2007 2008 2009 2010 2011 2012 2013 2014

Japan

Japan: estimate

U.S.

Eurozone

U.K.

(%)

Notes: 1. Estimates are based on the assumption that Japan's nominal GDP will increase by 2.7% a year, which is the GDP growth outlook of the Japanese Government for FY2013.

2. All f igures, including the BOJ's monetary base target for the end of 2013 and 2014, are seasonally adjusted byNomura Research Institute.

Sources: Nomura Research Institute, based on BOJ, Cabinet Of f ice, Japan, FRB, US Department of Commerce, ECB, Eurostat,BOE and ONS data

1, 2

Bank Reserves as Multiples of Required Reserves

Exhibit 2. But in terms of Potential Growth of Money Supply, Kuroda

BOJ Is in the Process of Catching up with the Fed and BOE

0

5

10

15

20

25

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Japan

Japan: estimate

U.S.

Eurozone

U.K.

(x)

Bank reserves ÷ statutory reserves

16.0x

4.9x

3.3x

Notes: 1. Estimates are based on the assumption that required reserves will increase by 3% a year and bank reserves constitute88.8% of f inancial institution's current deposit holdings with the BOJ.

2. The BOE has suspended reserve requirement in March 2009. The post-March 2009 f igures are based on the assumptionthat the original reserve requirement is still applicable.

Sources: Nomura Research Institute, based on BOJ, FRB, ECB and BOE data

11.8x

18.7x

21.6x

9.7x

1

2

Exhibit 3. Drastic Liquidity Injections Resulted in minimal

Increases in Money Supply and Credit (I): US

80 100 120 140 160 180 200 220 240 260 280 300 320 340 360

Monetary Base

Money Supply (M2)

Loans and Leases in Bank Credit

(Aug. 2008 =100, Seasonally Adjusted)

0.5

1.0

1.5

2.0

2.5

3.0

07/1 07/7 08/1 08/7 09/1 09/7 10/1 10/7 11/1 11/7 12/1 12/7 13/1

(%, 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.

359

136

99

+1.13%


Increases in Money Supply and Credit (II): Eurozone

80

90

100

110

120

130

140

150

160

170

180

190

200

Base Money

Money 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

07/1 07/7 08/1 08/7 09/1 09/7 10/1 10/7 11/1 11/7 12/1 12/7 13/1

(%, yoy)

CPI core

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

150

107

101

+1.0%


Increases in Money Supply and Credit (III): UK

50

100

150

200

250

300

350

400

450

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 12/7 13/1

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

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

435

11086

+2.9%


Increases in Money Supply and Credit (IV): Japan

50

100

150

200

250

300

350

400

Monetary Base

Money Supply (M2)

Bank Lending

QuantitativeEasing

(1990/1Q = 100, Seasonally Adjusted)

Bubble Burst

-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 13

(y/y, %)

CPI Core(ex. fresh food)

Note: Figures of bank lending and BOJ's targets are seasonally adjusted by Nomura Research Institute.Source: Bank of Japan

Earthquake

380

180

-0.5%

104

US House Prices Have Been Following the Japanese Experience

Exhibit 7. Cause of Breakdown in Monetary Transmission:

Bursting of Debt-Financed Bubbles

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 Apr. 29, 2013

Composite Index

FuturesJapan: 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

Japan falls of f its f iscal clif f(Apr. 1997)

USJapan

Futures

Exhibit 8. Europe also Experienced House Price Bubbles,

except Germany

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.

Sources: Nomura Research Institute, calculated f rom BIS data.

90

303

342

514

an origin of Eurozone crisis

Ireland259

Greece241

Spain221

Germany103

Exhibit 9. Japan’s De-leveraging with Zero Interest Rates

Lasted for 10 Years

-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 12

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 Off ice, Japan

Debt-financedbubble

(4 years)

Balance sheetrecession(16 years)

Funds Raised by Non-Financial Corporate Sector

Exhibit 10. Japan’s GDP Grew despite major Loss of Wealth and

Private Sector De-leveraging

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 Off 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 11. Japanese Government Borrowed and Spent

Unborrowed Savings of Private Sector to Sustain GDP

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 13

Source: Ministry of Finance, JapanNote: FY2013 is initial budget and FY2012 is supplementary budget.

Government spending

Tax revenueBubble Collapse

(Tril. yen)

(FY)

cumulativecyclical deficit 90-05

¥315 trillion

Exhibit 12. Japan’s Money Supply Has Been Kept Up by

Government Borrowings

CreditExtended tothe Private

Sector¥601.6 tril.

CreditExtended to the

Public 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

Assets

Liabilities

Liabilities

Source: Bank of Japan "Monetary Survey"

Money Supply Is Kept Up by Government Borrowings (II)

Balance Sheets of All Member Banks

Exhibit 13. Post-1933 US Money Supply Growth Made Possible by

NEW DEAL 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

Exhibit 14. Challenge of Abenomics: Get Businesses to Borrow Money

-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)

(as a ratio to nominal GDP, %)

Households

Rest of the World

Corporate Sector(Non-Financial Sector +

Financial Sector)

General Government

Financial Surplus or Deficit by Sector

Balance Sheet Recession Global Financial

Crisis

PrivateSector

Savings:8.76% of GDP

1991-2003 shift = 22% of GDP

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

Exhibit 15. Japan’s Fall from its Fiscal Cliff in 1997 and 2001 Weakened

Economy, Reduced Tax Revenue and Increased Deficit

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 13

Tax Revenue

Budget Deficit

Hashimotofiscal

reform

Koizumifiscal

reform

(Yen tril.) (Yen tril.)

(FY)

Global Financial

Crisis

*

Obuchi-Morifiscal

stimulus

Earthquake

"Abenomics"

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. Factor for a Weaker Yen: Japan’s Non-Energy Related

Trade Surplus Is Shrinking

-3500

-3000

-2500

-2000

-1500

-1000

-500

0

500

1000

1500

2000

2500

3000

3500

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Energy-related trade balance

Non-energy-related trade balance

Overall trade balence

Earthquake

LehmanShock

(Billion Yen, Seasonally adjusted)

Note: Seasonal adjustments by Nomura Research InstituteSource: Nomura Research Institute, based on the data of Ministry of Finance, Japan

Exhibit 17. US in Balance Sheet Recession: US Private Sector

Increased Savings significantly after the Bubble

PrivateSector

Savings:6.95% of GDP

-15

-10

-5

0

5

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


Financial Sector)


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

Exhibit 18. US Households Are Paying down Debt at Zero-Interest Rates

-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 12

(as a ratio to nominal GDP, %, seasonally adjusted) (as a ratio to nominal GDP, %, inverted, seasonally adjusted)

Financial Assets

Financial Liabilities right scale

left scaleFinancial

Surplus/Deficitleft scale

Notes: Latest f igures are for 2012 Q4.Sources: Nomura Research Institute, based on f low of funds data f rom FRB and US Department of Commerce

Exhibit 19. US Non-Financial Corporates Are Accumulating

Financial Assets at Zero-Interest Rates

-20

-15

-10

-5

0

5

10

15

20-20

-15

-10

-5

0

5

10

15

20

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


Financial Assets

Financial Liabilities right scaleleft scale

Financial Surplus/Deficit

left scale

Notes: Latest f igures are for 2012 Q4.Sources: Nomura Research Institute, based on f low of funds data f rom FRB and US Department of Commerce

Exhibit 20. Europe in Balance Sheet Recession: European Private

Sectors Increasing Savings despite record-low Interest Rates

-20

-15

-10

-5

0

5

10

15

20

25

30

03 04 05 06 07 08 09 10 11 12

UK

Spain

Ireland

Portugal

Italy

(as a ratio to nominal GDP, %)

(Financial Surplus)

(Financial Deficit)

* Private Sector = Household Sector + Non-Financial Corporate Sector + Financial SectorNote: All entries are four-quarter moving averages. For the latest f igures, four-quarter averages ending with 4Q/'12 (only Ireland and Italy,

3Q/'12) are used.Sources: Flow of funds data f rom Off ice for National Statistics, UK, Banco de España, National Statistics Institute, Spain, The Central

Bank of Ireland, Central Statistics Off ice Ireland, Banco de Portugal, Banca d'Italia and Italian National Institute of Statistics

Private Sector Savings as %

of GDP

Ireland: 8.58%Spain: 10.39%

Portugal: 7.25%

UK: 3.31%

Italy: 4.39%

Exhibit 21. Peripheral Eurozone Bond Yields Diverged

significantly from the Global Trend

0

2

4

6

8

10

12

14

16

18

20

2007 2008 2009 2010 2011 2012 2013

Japan

UK

US

Spain

Portugal

Italy

(%)

Note: As of Apr. 29, 2013.Source: Bloomberg

3%

Eurozone crisis

1.1%

Exhibit 22. German Private Sector Refused to Borrow Money

after the Dotcom Bubble

-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)

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

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


Dotcom Bubble


Financial Sector)

German Private Sector Savings

9.8% of GDP

Exhibit 23. ECB’s Drastic Rate Cuts to 2% in 2003 Failed to Revive

the German Economy

0

1

2

3

4

5

6

7

8

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

(%)

Sources: BOJ, FRB, ECB, BOE and RMB Australia. As of Apr. 30, 2013.

Australia

Eurozone

US

UK

Japan

Exhibit 24. German Households Stopped Borrowing altogether

after the Dotcom bubble

-12

-10

-8

-6

-4

-2

0

2

4

6

8-8

-6

-4

-2

0

2

4

6

8

10

12

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

right scale

left scale left scaleFinancial Assets Financial Surplus/Deficit

Financial Liabilities

(as a ratio to nominal GDP, %, seasonally adjusted)

Note: Seasonal adjustments by Nomura Research Institute. Latest f igures are for 2012 Q3.Sources: Nomura Research Institute, based on f low of funds data f rom Bundesbank and Eurostat

(as a ratio to nominal GDP, %, inverted, seasonally adjusted)

Collapse of the Dotcom

Bubble

Exhibit 25. Spanish Households Increased Borrowings after the Dotcom

Bubble in Response to ECB’s record-low Interest Rates

-16

-12

-8

-4

0

4

8

12

16-16

-12

-8

-4

0

4

8

12

16

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

Notes: Seasonal adjustments by Nomura Research Institute. Latest f igures are for 2012 Q4.Sources: Nomura Research Institute, based on f low of funds data f rom Banco de España and National Statistics Institute, Spain

right scale




Collapse of theDotcom Bubble

Exhibit 26. Portuguese Households Continued to Borrow Money

after the Dotcom Bubble

-20

-15

-10

-5

0

5

10

15

20-20

-15

-10

-5

0

5

10

15

20

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

right scale

left scaleleft scale

Financial Assets Financial Surplus/Deficit


(as a ratio to nominal GDP, %, seasonally adjusted)

Notes: Seasonal adjustments by Nomura Research Institute. Latest f igures are for 2012 Q4.Source: Nomura Research Institute, based on f low of funds data f rom Banco de Portugal

(as a ratio to nominal GDP, %, inverted seasonally adjusted)


Exhibit 27. Irish Households Increased Borrowings after the Dotcom

Bubble in Response to ECB’s record-low Interest Rates

-20

-15

-10

-5

0

5

10

15

20

25-25

-20

-15

-10

-5

0

5

10

15

20

02 03 04 05 06 07 08 09 10 11 12

right scale




Notes: Seasonal adjustments by Nomura Research Institute. Latest f igures are for 2012 Q3.Sources: Nomura Research Institute, based on f low of funds data f rom Central Bank of Ireland and Central Statistics Of f ice, Ireland


Exhibit 28. German-Eurozone (ex. Germany) Competitiveness Gap

Has Macro (50.2%) and Micro (49.8%) Factors

90

100

110

120

130

140

150

160

170

180

190

200

210

220

230

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

Eurozone ULC (ex. Germany) based on German M3 Growth*

Eurozone ULC (ex. Germany)

129.9

German ULCGerman M3

115.2

156.0

100.6

(1Q 2000 = 100, Seasonally Adjusted)

50.2%: Macro-Monetary Effect

49.8%: German Labor Reform Effect

(ULC = Unit Labor Cost)

Eurozone M3 (ex. Germany)

217.0

MonetarySource of

Competitiveness Gap

Note: * Parameters obtained f rom the regression result on Eurozone ULC (ex. Germany) on Eurozone M3 (ex. Germany),log(Eurozone ULC (ex.Germany)) = 3.155506 + log(Eurozone M3 (ex.Germany)) x 0.318227, applied to German M3data indexed to 1Q 2000 = 100.

Sources: Nomura Research Institute, based on ECB, Eurostat and Deutsche Bundesbank data

Exhibit 29. Germany Recovered from Post-Dotcom Balance Sheet

Recession by Exporting to other Eurozone Countries

-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 13

Source: Deutsche Bundesbank

(€mn, seasonally adjusted)

Eurozone

Asia

US

German Balance of Trade

driven by Eurozone housing bubble

driven by weaker Euro

Exhibit 30. Two Structural Deficiencies of Eurozone

Maastricht Treaty restricted fiscal stimulus needed to fight

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

Unable to use fiscal stimulus, those economies suffering

from balance sheet recessions fall into

deflationary spirals, while excessive easing by the ECB

end up creating bubbles elsewhere

(1) (2)

Exhibit 31. Industrialization of Chinese (or any Agrarian) Economy

Source: Nomura Research Institute

L

S

D3

A

B

C

D

EF I J M

H K

D2

D1

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

Higher Inflation

Narrowing income

inequality

Slower investment

Stronger consumption