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

Richard C. KooChi f E i tChief Economist

Nomura Research InstituteT kTokyo

April 2012

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

220

240

260

US: 10 Cities Composite Home Price Index

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

Composite Index

Japan: Tokyo Area Condo Price1

Futures

160

180

200Futures

80

100

120

140

40

60

80

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

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

USJapan

Note: per m2, 5-month moving averageSources: Bloomberg, Real Estate Economic Institute, Japan, S&P, S&P/Case-Shiller® Home Price Indices, as of Mar. 23, 2012

1

(peak = 100)

Exhibit 2. US Commercial Real Estate Prices Also Falling to Japanese Levels

90

100

110(peak = 100)

US: Commercial Property Price Index

70

80 Down42.0%

from Peak

40

50

60

"Pretend & Extend"

20

30

01 02 03 04 05 06 07 08 09 10 11

84 85 86 87 88 89 90 91 92 93 94

Japan: Commercial Land Price Index in Six Major Cities

Extend

USJapan

Note: Peak of US Prices: Oct. 2007, Peak of Japanese Prices: Sep. 1990.Source: Nomura Research Institute, based on Moody's/Real Estate Analytics and Japan Real Estate Institute

p

2

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

7

8(%)

Australia

UK

4

5

6

2

3

4

EU

US

0

1

2

Japan

3

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Sources: BOJ, FRB, ECB, BOE and RMB Australia. As of Mar. 23, 2012.

Exhibit 4. US Economy Is still a Long Way from Previous Peak3.5

4.0

4.5

5.099

101

103(%, Seasonally adjusted, inverted)

Unemployment Rate(right scale)

(2007=100, Seasonally adjusted)

5.5

6.0

6.5

7.0

95

97Last seen

in 2005

Industrial Production(left scale)

7.0

7.5

8.0

8.5

9.089

91

93

Unemployment rate:Last seen in 1983

9.0

9.5

10.0

10.5

11.083

85

87

Industrial Production:Last seen in 199711.083

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

Sources: US Department of Labor, FRB

4

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

7.0

7.5110

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

Unemployment Rate(right scale)

8.0

8.5105

9.0

9.595

100 Last seenin 2005

10.0

10.5

11 085

90 Industrial Production(left scale) Last seen in 1997

5

11.0851998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Sources: Eurostat

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

110

115

120

Spain

France

(2005 = 100, Seasonally Adjusted) Level last seen in

2007: Germany

100

105

110Italy

Germany

y

85

90

951997: France

1987-88: Italy

70

75

801996: Spain

6

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

Source: Eurostat

Exhibit 7. Drastic Liquidity Injection Failed to Increase Money Supply (I): US(Aug 2008 =100 Seasonally Adjusted)

240260 280 300 320 340

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

(Aug. 2008 =100, Seasonally Adjusted)

140160 180 200 220 240

Down 25%

80 100 120 140 25%

2.53.0 (%, yoy) Consumer Spending

Deflator (core)

0.5 1.0 1.5 2.0 2.5

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 12/1

( )

7

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

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.

Exhibit 8. Drastic Liquidity Injection Failed to Increase Money Supply (II): EUThe image cannot be displayed. Your computer may not have enough memory to open the image, or the image may have been corrupted. Restart your computer, and then open the file again. If the red x still appears, you may have to delete the image and then insert it again.

8

Exhibit 9. Drastic Liquidity Injection Failed to Increase Money Supply (III): UK

250

280

310

340

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

(Aug. 2008 =100, Seasonally Adjusted)1

130

160

190

220 Aug. 08'

Down 16%

70

100

56

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

01234

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

9

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.

Exhibit 10. Drastic Liquidity Injection Failed to Produce Drastic Increase in Money Supply (IV): Japany pp y ( ) p

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10

Exhibit 11. Japan’s De-leveraging with Zero Interest Rates Lasted for 10 Years

8

10

20

25

CD 3M rate (right scale)

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

Funds Raised by Non-Financial Corporate Sector

4

6

10

15Borrowings from Financial Institutions (left scale)

Funds raised in Securities Markets (left scale)

0

2

0

5

-6

-4

-2

-15

-10

-5 Debt-financedbubble

(4 years)

Balance sheetrecession(16 years)

11

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: Bank of Japan, Cabinet Of f ice, Japan

Exhibit 12. Japan’s GDP Grew in spite of Massive Loss of Wealth and Private Sector De-leveraging

115

130

120

140(Sep.1990=100, Seasonally Adjusted)

Real GDP(Right Scale)

(Sep. 1990=100)

Nominal GDP (Right Scale)

g g

85

100

80

100

Likely GDP Path w/o Government Action

Cumulative 90-05 GDP

Supported by Government

Action: ¥2000 trillion

55

70

40

60

~ ¥2000 trillion

C l tidown87%

25

40

0

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

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

Last seen in 1973 Cumulative Loss of

Wealth on Shares and Real Estate

~ ¥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 Of f ice, Japan Real Estate Institute

12

Exhibit 13. Japanese Government Borrowed and Spent the Unborrowed Savings of the Private Sector to Sustain GDP

90

100

110

Government spending

(Tril. yen)

g

70

80

90

cumulativecyclical deficit 90-05

¥315 t illi

overall deficit ¥460

trillion40

50

60¥315 trillion

20

30

40

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

Tax revenueBubble Collapse

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

13

Exhibit 14. Premature Fiscal Reforms in 1997 and 2001 Weakened Economy, Reduced Tax Revenue and Increased Deficit

70

80

70

80

Tax RevenueBudget Deficit

Hashimotofiscal

reform Koizumi

fiscal f

(Yen tril.) (Yen tril.)

Global Financial

Obuchi-Morifiscal

stimulus

Earthquake

50

60

50

60reform Financial

Crisis

*

stimulus

unnecessaryincrease in

deficit:

20

30

40

20

30

40 deficit:¥103.3 tril.

0

10

0

10

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

14

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12(FY)Source: Ministry of Finance, Japan

Notes: Latest f igures(*) are estimated by MOF. From FY2011, f igures includes reconstruction taxes and bonds.

Exhibit 15. US in Balance Sheet Recession: US Private Sector Increased Savings Massively after the Bubble

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15

Exhibit 16. UK in Balance Sheet Recession: UK Private Sector Increased Savings Massively after the Bubbley

6

9(as a ratio to nominal GDP, %)

(Financial Surplus)

Rest of the World

Households

Financial Surplus or Deficit by Sector

Shift from 1Q 2007 in

private sector:6.77% of GDPCorporate: 0.88%

Households: 5.90%

0

3

6 Rest of the World

Shift from 1Q 2007 in-6

-3

0

public sector:6.45% of GDP

-12

-9

(Financial Deficit)

General Government

Corporate Sector(Non-Financial Sector +

Financial Sector)

16

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 f igures, 4 quarter averages ending with 3Q/11' are used.Source: Of f ice for National Statistics, UK

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Exhibit 17. Global Bond Yields* Nearing Japanese Levels

Japanese Bond Yield

in 1997

17

Exhibit 18. Euro-Zone Bond Yields Are Diverging SharplyThe image cannot be displayed. Your computer may not have enough memory to open the image, or the image may have been corrupted. Restart your computer, and then open the file again. If the red x still appears, you may have to delete the image and then insert it again.

18

Exhibit 19. Euro-zone in Balance Sheet Recession: Euro-zone Private Sector Increased Savings Massively after the Bubbleg y

4

6(as a ratio to nominal GDP, %)

Households(Financial Surplus)

Financial Surplus or Deficit by Sector

Shift from 3Q 2008 i

0

2

4

Rest of the World

3Q 2008 in private sector:3.66% of GDP

Corporate: 3.12%Households: 0.54%

-4

-2

0

G l

Shift from 3Q 2008 in

public sector:3.12% of GDP

-8

-6

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

(Financial Deficit)

Corporate Sector(Non-Financial Sector + Financial Sector)

General Government

19

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

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: ECB

Exhibit 20. Spain in Balance Sheet Recession: Spanish Private Sector Increased Savings Massively after the Bubble

Shift from 9

12(as a ratio to nominal GDP, %)

(Financial Surplus)

Rest of the World

Households

Financial Surplus or Deficit by Sectorg y

3Q 2007 in private sector:17.65% of GDPCorporate: 12.24%Households: 5.41%

3

6

Rest of the World

Shift from 3Q 2007 in

public sector:11 62% f GDP6

-3

0

11.62% of GDP

-12

-9

-6

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

(Financial Deficit)

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

Government

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

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Banco de España

20

Exhibit 21. Ireland in Balance Sheet Recession: Irish Private Sector Increased Savings Massively after the Bubbleg y

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21

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

9

12

Rest of the World

(Financial Surplus)

(as a ratio to nominal GDP, %)

Financial Surplus or Deficit by Sectorg y

3

6 Households

Shift from 2Q 2008 in

private sector:8.65% of GDPCorporate: 5.20%

Households: 3.34%

-6

-3

0

General Government

Shift from 2Q 2008 inbli t

-12

-9

-6

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

Corporate Sector(Non-Financial Sector + Financial Sector)

(Financial Deficit)

public sector:5.40% of GDP

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Banco de Portugal

22

Exhibit 23. Sustaining Fiscal Stimulus in Democracy during Peacetime Is Difficultg

Authoritarian Democracies

No opposition "Bond market might rebel"pp g

(if any, quickly suppressed) "Big Government is BAD Government"

"Monetary Policy should work better"

"Aging Population""Aging Population"

"Should not use grand-children's credit card"

"Structual Reform is what is needed"

"Maastricht Treaty and Fiscal Compact"

"Must Avoid Greece's Fate"

.

23

...

Exhibit 24. Balance Sheet Correction in France Was Minimal

8

10(as a ratio to nominal GDP, %)

Financial Surplus or Deficit by Sector

Rest of the WorldHouseholds

(Financial Surplus)

2

4

6 Shift from 2006private sector:3.43% of GDPCorporate: 2.85%

Households: 0.57%

-2

0

Shift from 2006

-8

-6

-4

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

General Government

Corporate Sector(Non-Financial Sector + Financial Sector)

(Financial Deficit)

Shift from 2006public sector:4.71% of GDP

24

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

Sources: ECB, Eurostat

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Exhibit 25. Balance Sheet Correction in Italy Was Minimal

25

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Exhibit 26. Italian Corporates Are Back to Normal After 2 Difficult Years

26

Exhibit 27. Italian Households Are Not Affected by Crisis( t f i l GDP) ( t f i l GDP i t d)

-16

-1212

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

Financial Assetsleft scale

-88

-4

00

4

4

8-8

-4

Financial Liabilities right scale

27

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

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Sources: Banca d'Italia, Eurostat

Exhibit 28. Greek Private Sector Is Drawing Down Savings to Survive The image cannot be displayed. Your computer may not have enough memory to open the image, or the image may have been corrupted. Restart your computer, and then open the file again. If the red x still appears, you may have to delete the image and then insert it again.

28

Exhibit 29. Greek Corporates Are Both Drawing Down Savings and Reducing Debt( t f i l GDP)

-15

-1010

15

Financial Assetsleft scale

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

-55

0

5-5

0

10

15-15

-10

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

Financial Liabilities right scale

29

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

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Sources: Bank of Greece, Eurostat

Exhibit 30. Greek Households Are Both Drawing Down Savings and Reducing Debt(as a percentage of nominal GDP) (as a percentage of nominal GDP inverted)

-20

-1515

20

Financial Assetsleft scale

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

-10

-55

10

0

5-5

0

10

15-15

-10Financial Liabilities right scale

30

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

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Sources: Bank of Greece, Eurostat

Exhibit 31. ECB Facing Balance Sheet Recession Can Supply Large Amounts of Liquidity without Igniting Inflation

300

325

350

Eurozone

US

UK

Monetary Base(=Liquidity)

(Aug. 2008 = 100, seasonally adjusted)

US-like monetary

g g

225

250

275 Eurozone

US

UK

Money Supply

monetaryeasing would allow ECB to

supply €945.5 bil. worth of

additional li idit

125

150

175

200

Aug. 2008

liquidity.

estimates

75

100

125

2007 2008 2009 2010 2011 2012

Notes: 1 UK's reserve balances data are seasonally unadjustedNotes: 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.

31

Exhibit 32. Exit Problem (I): Japanese Corporates Increased Savings Again After Lehman

Shift from12

15(Financial Surplus)

(as a ratio to nominal GDP, %)

Households

Financial Surplus or Deficit by Sector

Shift from 4Q 2008 in

private sector:5.76% of GDP

Corporate: 3.29%Households: 2.47%

0

3

6

9

Rest of the World

Shift from 4Q 2008 inbli t

-9

-6

-3

0

public sector:6.86% of GDP

-18

-15

-12

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

(Financial Deficit)

Corporate Sector(Non-Financial Sector +

Financial Sector)

General Government

Balance Sheet Recession Global Financial

Crisis

Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Of f ice, National Accounts

32

Exhibit 33. Japanese Corporates Are Increasing Savings

-25

-20

-1515

20

25

Financial Assetsleft scale

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

-10

-5

00

5

10

5

10

15-15

-10

-5

20

25

30-30

-25

-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

right scaleFinancial Liabilities

33

Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Of f ice, National Accounts

(FY)

Exhibit 34. Japanese Households Are Both Increasing Savings and Reducing Debt(as a percentage of nominal GDP inverted)(as a percentage of nominal GDP)

-21

-18

-1515

18

21

Financial Assetsleft scale

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

-12

-9

-66

9

12

-3

0

3-3

0

3

6

9

12-12

-9

-6

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

Financial Liabilities right scale

34

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(FY)

Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Of f ice, National Accounts

Exhibit 35. Exit Problem (II): German Private Sector Refused to Borrow Money after 1999-2000 Telecom Bubble

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

(Financial Surplus)

Financial Surplus or Deficit by Sector

Shift from

0

5

10Households Telecom Bubble

Shift from 3Q 2000

to 1Q 2005 in private sector:12.59% of GDPCorporate: 9.98%

Households: 2.60%

-10

-5

0

General Government Balance

Shift from 3Q 2000

-20

-15

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

(Financial Deficit)

Rest of the World

Corporate Sector(Non-Financial Sector +

Financial Sector)

Sheet Recession

3Q 000to 1Q 2005

in public sector:4.91% of GDP

35

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

Notes: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted. For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Deutche Bundesbank

Exhibit 36. German Corporates Are Saving More than Borrowing

-20

-1515

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

Financial Assetsleft scale

-10

-55

10

0

5-5

0

10

15-15

-10

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

Financial Liabilities right scale

36

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

Notes: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted. For thelatest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Deutche Bundesbank

Exhibit 37. German Households Are Refusing to Borrow

-12

-88

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

Financial Assetsleft scale

-8

-44

8

00

4

8-8

-4

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

Financial Liabilities right scale

reason for weak German house prices despite record

low interest rate

37

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

Notes: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted. For thelatest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Deutche Bundesbank

Exhibit 38. Exit Problem (III): U.S. Took 30 Years to Normalize Interest Rate after 1929 Because of Private Sector Aversion to Debt

7

8

9

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)

(%)

5

6

7

Oct '29 NY StockMarket Crash

Jun '50 Korean War

Dec '41 PearlHarbor Attack

'33～New Deal

3

4

0

1

2

38

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

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

Exhibit 39. Japanese Money Supply Kept up by Government Borrowings B l Sh t f B k i JBalance Sheets of Banks in Japan

December 2007December 1998Assets

AssetsLiabilities

Liabilities

CreditExtended to Money Supply

CreditExtended tothe Private

Sector¥501 8 tril Money Supply

the PrivateSector

¥601.6 tril.

Credit

(M2+CD)¥621.5 tril.

¥501.8 tril.(-99.8)

y pp y(M2+CD)

¥744.4 tril.(+122.9)

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.

Other Liabilities(net)

¥78.7 tril.

Other Liabilities(net)

¥153.2 tril.

39

(+41.4) (-74.5)Total Assets ¥823.1 tril. (+48.4)Total Assets ¥774.7 tril.

Source: Bank of Japan "Monetary Survey"

Exhibit 40. US Money Supply Increased after 1933 because of Government Borrowingsg

June 1929 Assets Liabilities

CreditExtended

June 1936 Assets Liabilities

Balance Sheets of All Member Banks

CreditExtended tothe Private

Sector$29.63 bil.

Deposits$32.18 bil.

Extendedto the

PrivateSector

$15.71 bil.(-0.09)Credit

Extended tothe Private

Sector$15 80 bil

June 1933 Assets Liabilities

Deposits$23.36 bil.

(-8.82)

Deposits$34.10 bil.(+10.74)

Credit

(= Money Supply)

CreditExtended tothe Public

Sector Other

$15.80 bil.(-13.83)

CreditExtended

to thePublicSector

$8 63 bil

Extendedto thePublicSector

$16.30 bil.(+7.67)

OtherOth OtherSector

$5.45 bil.

Other Assets$8.02 bil.

Reserves$2 36 bil

Capital$6.35 bil.

Liabilities$6.93 bil.

$8.63 bil.(+3.18)

OtherAssets

$6.37 bil.(-1.65)

Assets$8.91 bil.(+2.54)

Reserves$2.24 bil.

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)

40

$2.36 bil.

Total Assets $45.46 bil. Total Assets $33.04 bil. (-12.42) Total Assets $46.53 bil. (+13.49)(-0.12)

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

Exhibit 41. Recovery from Lehman Shock Is NOT Recovery from Balance Sheet Recession

Lehman Shock Likely GDP Pathwithout Lehman Shock

BubbleBurst

Weaker Demand from Private Sector

De-leveragingEconomic weakness f i

?

g g(A)from private-sector

de-leveraging

Actual GDP Path Current Location

Stronger Demand from Government's

Fiscal Stimulus

(B)Economic weakness from policy mistake

on Lehman

41

Source: Nomura Research Institute

Current Location Fiscal Stimulus

Exhibit 42. Yin Yang Cycle of Bubbles and Balance Sheet Recessions

(1) Monetary policy is tightened, leading the bubble to collapse. (9) Overconfident private sector triggers a bubble.

BubbleYin (=Shadow) Yang (=Light)

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

and confidence returns.

(3) With everybody paying down debt

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

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

USSpainUK

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

becomes the top fiscal priority.

(6) Private sector fund demand recovers,(4) Eventually private sector finishes its debt repayments,

ending the balance sheet recession

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

Fiscal policy becomes the main economic toolto maintain demand.

(5) Private sector phobia towards borrowing gradually disappears,

( ) ,and monetary policy starts working again.

Fiscal policy begins to crowd out private investment.

ending the balance sheet recession.But it still has a phobia about borrowing which keeps

interest rates low, and the economy less than fully vibrant.Economy prone to mini-bubbles.

GermanyJapan

42

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

and it takes a more bullish stance towards fund raising.

Exhibit 43. Contrast Between Yin and Yang Phases of Cycle

Yang YinTextbook economy Balance sheet recession

Adam Smith's "invisible hand" Fallacy of composition

1) Phenomenon

2) Fundamental driver

Assets > Liabilities Assets < Liabilities

Profit maximization Debt minimization

Greatest good for greatest number Depression if left unattended

Effective Ineffective (liquidity trap)

5) Outcome

6) Monetary policy

3) Corporate financial condition

4) Behavioral principle

Effective Ineffective (liquidity trap)

Counterproductive (crowding-out) Effective

Inflationary Deflationary

Normal Very low

6) Monetary policy

7) Fiscal policy

8) Prices

9) Interest rates

Virtue Vice (paradox of thrift)

a) Localized Quick NPL disposalPursue accountability

Normal NPL disposalPursue accountability

b) Systemic Slow NPL disposalFat spread

Slow NPL disposalCapital injection

10) Savings

11) Remedy forBanking Crisis

43

Fat spread Capital injection

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