Radio Nippon presents, “Sugahara Akiko’s EDGE TALK”
Guest is Mr. Richard Koo

S:Today we're visiting Nomura Research Institute to interview Mr. Richard Koo.

Your book 'The two waves threatening Japan's economy.' which you wrote almost a year a go was very easy for me to understand and furthermore, I think looking at Japan thinking about those waves is indeed important both for Japan and the world. Judging from the nature of those waves, you mentioned in your book that Japan still has some energy left. However the average yearly GDP in Japan decreased around 15% which has made me concerned about the future of Japan and I'd like to ask for your opinion on this.

K:Well, Japan is not the epicentre of the global financial trouble, however our situation has perhaps got worse than what can be seen in the epicentre that is America. I think the lessons that Japan has learned as to how to climb out of a recession or minimize the damage caused throughout a recession can be applied in the same way as they are to any market at present in the world. The fact that Japan has to undertake a religious and intellectual leadership has never been doubted. Let me tell you why the financial damage Japan has suffered was larger than anywhere else. In the Lehman Brothers case last autumn, America made a number of mistakes that were unbelievable, which caused stock-market plunges both in the States and elsewhere in the world, thereby consumers all over the world started thinking they just shouldn't be spending money at the present time. However even if you're determined not to spend any money, you need to eat and thus have inevitable expenses. However durable consumer goods like cars can last for as long as they work, so people as a result started not to replace their old cars like before. Japan has always been dependant on exports most of which are durable goods and hardly any of them are non-durable goods like clothes. Mostly durable goods.
S: Yeah.

K:And they're of excellent quality and last so long that buyers don't need to rush to buy a new one. So when those who would normally replace goods after five or six years decide to wait for another three or four years as the product still works fine, the damage Japan suffers due to the loss in consumption gets bigger than other countries since such durable consumer goods is what Japan specializes in.

S:You're saying Japan's heavy dependance on exports has been a main cause of damage, am I right ?

K:Yes. By saying dependance on exports, I mean since Mr. Koizumi won power, the word 'domestic demand expansion' itself became a dead word and local businesses were forgotten and domestic-demand expansion policies have always been put on hold for a long time. At that time, every country was enjoying a boom and foreign demand was holding up weak domestic demand so things looked good. However being in a recession, consumers in foreign countries started to realise there were better things to buy than cars and this kind of mindset eventually accelerated the rapid decrease in exports from Japan as there was no domestic demand that could make up for this. (S:Domestic demand wasn't developed enough then.) Japan's lack of domestic demand has been notable for a long time, especially over the past few years.

S:One thing I'd like to note here is that Japanese people overall handled this very well because very few Japanese people were interested in buying those subprime loans. Is that right?

K:It is only the Japanese financial market including the short-run market and the long-run market that has been up and running since the crisis of subprime lending, whereas in the States and Europe, since the end of the year before last, the financial market itself stopped functioning. Therefore, when applying for a home mortgage, people got offered ridiculous deals. American university tuition fees generally cost so much that students including myself usually had to go and arrange students loans but there was no money to be borrowed. In this way, the financial damage did exist in a tangible form amongst the citizens. However in Japan, those problems were long solved in Japanese banks whose debts were already paid back therefore we weren't influenced by the crisis of subprime loans as financial dysfunction didn't take place in the Japanese market.

S:According to what you're telling me, it seems like we're blessed to have at least a financial market running.

K:It's fantastic. It was only the Japanese market that was open so I saw a lot of foreign banks come to the Japanese market during the end of last year or the year before last.

S: So What has become of the mess seen in America and Europe that you mentioned earlier? Those banks that stopped functioning, the unavailability of student loans and people not being able to buy things? Have things been getting better at all since then?

K:Well, there are things that have been getting better, but at the same time some things have worsened. The thing is, the house price crash hit the States in 2006 and the house prices that Americans believed would never decrease, did. The figures actually hadn't dropped for 70 years, so they truly believed prices wouldn't drop, as it were. However the house prices went down by 30% compared to their peak value so those who had invested in property in the hope of making profits lost a vast amount of their personal assets thus creating a big hole in their balance sheets and in the sense that from now on, they have to make back those losses, then yes, recession will continue. But as I mentioned a little bit earlier, the case of the Lehman Brothers was absolutely needless. When I was working for the Federal Reserve Bank in America, a number of similar cases existed but a financial crisis such as the Lehman Brothers case didn't occur as problems were dealt with properly. This time however, under the Secretary of the Treasury Henry Paulson who had no knowledge of banking administration at all, he only had a passing experience of this. If the person in charge had been someone who had a better understanding, we could have avoided the current situation. In fact,he sadly caused it. The aftermath of the problems was also handled badly and therefore the recession got far worse all over the world than what it would otherwise have been. The root cause of the Lehman Brothers case lies in bad policy-making. If the errors in policy were corrected, things would surely get back on track little by little and we've started doing this by installing countermeasures such as the Federal Reserve Bank supplying an enormous amount of money or the government injecting enormous transfers of funding into banks. All of these measures were taken after the crisis of the Lehman Brothers. Such measures have been carried out using astronomical sums of money as damage control and errors in policy-making after the Lehman Brothers case have been getting better. There were a lot of people who didn't really suffer from the financial breakdown from the Lehman Brothers case but dampened their spending as everyone else around them was warning everyone but some of them have started spending again after realising that their jobs as well as their salaries are secure. However, the big wave since the economic collapse of 2006 will drag on for a long while so you shouldn't let your guard down yet just because things have been settling down a bit.

Radio Nippon presents, “Sugahara Akiko’s EDGE TALK”
Guest is Mr. Richard Koo

S:According to your book, Mr. Bernanke from the FRB in America has repeatedly criticized the Japanese government for not making policies against the recession we've been in since the 90s. In this so-called balance sheet recession, a policy of zero interest rates was implemented in the States and it has had no positive effect on the economy which shocked Mr. Bernanke. It's been reported in the press that he often says all there is left for him to do is flood markets with money. You mentioned in your book that when in a balance sheet recession, the most important thing is people's attitudes to finance, could you give us more detail about this? How should we tackle this problem of attitude?

K:Well, first of all, the kind of recession I've been calling 'a balance sheet recession' is what Japan experienced 15 years ago and has spread around the world only occurs maybe once a century. The reason why it takes place maybe only once a century is that it happens after the bursting of a nationwide economic bubble.

S:It's not even covered in economics textbooks.

K:It's beyond the scope of scholars' experience thus has never been written in any textbooks. The reason it happens is that during the economic bubble period, people are usually in debt when buying a house or stocks as personal assets but when we are not in a bubble, they're only left with debt due to a plunge in stock and property prices. This would mean your debt exceeds the assets but if the person or company or financial institution has cash flowing in, in other words, profits, you'd think of paying back the debt with the profits which would eventually enable you to balance your books and after that, you can go back to your textbooks and move on with a positive attitude toward making money. It's the time when you're in the process of paying back that is a serious problem. During the process of repaying, however much the central bank lowers interest rates, you won't take out a loan as you already are crushed by debt.

S:Free financing is supposed to encourage people to take out loans but if they don't that, there's no point in it.

K:Well in that case it's a swing and a miss. This problem itself is not easy, especially in a situation where there's no one borrowing money even with a zero-interest-rate policy. There has always been people saving up their money however, they no longer use their savings even with the free interest rates, so money in the form of savings gets completely stuck inside the banks which as a result stops the circular flow of cash and makes the economy stagnate creating a deflationary gap. As you might have often heard the word 'deflationary gap', the kind of deflationary gap I'm talking about here is the where money is piled up as savings and left unused for borrowing. What becomes of the economy then? For example, if 900 yen out of your 1000 yen income gets spent with 100 yen being saved, the 900 yen will be going into the economy whilst the 100 yen offers no benefit to the economy if not loaned. If the next receiver of the money decides to save the same 10% of the 900 yen, it would result in no economic stimulus again if not used. This figure can only decrease from 1000 yen to 900 yen, to 810 yen and 730 yen and the economy would shrink accordingly at an incredibly high speed. This is a balance sheet recession. In this kind of recession, even if the government urges the private sector to stop repaying their debts, there's no way they will. If the details of your company's debts appeared in a weekly magazine, you'd be in so much trouble the next day. In the case of cash transactions or suspension of transactions with banks, people in the private sector wouldn't stop clearing their debts and if you just let things go on like that, the economy will shrink down in the way I explained earlier. The only way to stop this is for the government to loan the 100 yen mentioned earlier to use it up. In this way, the total sum of the 1000 yen would be spent which would turn the economy around.
S: That's the most important thing in times of recession and it has taken a while for Japan to realise this, hasn't it?

K: There are still quite a lot of people who haven't realised this yet though.

S:Yeah I think so, too. Still now, despite your efforts, the government has still got a long way to go until they realise they need to do something in order to make the economy run efficiently.

Radio Nippon presents, “Sugahara Akiko’s EDGE TALK”
Guest is Mr. Richard Koo

K: There's almost 70 years' worth of economic history since the Great Depression and it has always been assumed that everything would be alright thanks to the help of the public sector as the people in it always have a positive attitude. However their attitude is in fact very negative, they always put all their energy into paying back their debts. In circumstances like this, what happens to the economy? This kind of discussion had never been had up until now.

S: At the moment, America is trying to respond to this situation by attempting to boost employment and creating more jobs. Does it look promising so far?

K: Well...

S: We have 2 million of job losses and Green...

K: They have a policy costing 787 billion dollars and they have suffered 3.5 million job losses. At the present time, there are 500,000 or 600,000 people losing their jobs every month which means in 10 months, up to 5 million people become jobless and the present economic measures came into effect in February of this year, they were trying to promote public work projects which do help the sluggish economy, but it takes at least 10 months to choose and plan a project and then select construction companies through open bidding.

S: In which case, there would be another 5 million job losses.

K: Exactly. Even if the project provided 3.5 million of people with jobs, it'd still be one step behind.

S: In Japan, the emergency-funding bill has been arranged. Do you think Japan is better off?

K: As for the Japanese case, for good or bad, the administration of Koizumi pushed the Trinity Reform which reduced the promised subsidies from central government for public work projects. On the other hand, before the Koizumi cabinet when Obuchi was in office, people were encouraged to work on public projects because subsidies were promised. So what's happening now is that there are a variety of projects on hold due to a lack of funding even though environmental assessments and public votes have already been carried out. So if these projects, selected by the public, got subsidized, things would soon get moving much quicker than they would in the States. So it's important to just get working on projects that have public support to get things moving. These projects should be subsidized in order to prevent employment conditions getting worse. For example, while the government is working like that, if a promising project comes up then we should shift our focus onto that. Having these projects all ready to receive funding anytime is a good thing I think.

S:When we compare the States and Japan, America has a trade deficit and they've been issuing national bonds in order to boost the capital input but here I wonder whether or not this would lead them to hyperinflation. I believe your book said the reason why Japan didn't have this problem was that Japan didn't have any foreign debt which enabled our GDP to grow steadily. However that's not the case in America so wouldn't an injection of money trigger economic inflation?

K: Well, I don't recall writing that far to be honest but in the case of a balance sheet recession in which people prioritize paying back debts over maximizing profits, there's no need to worry about inflation nor funding at all. That is to say, even for America who is said to have very little savings, they should be able to do the same as we did. The way to do it is to simply borrow money. If the government says they want to take up a loan, banks would be more than happy to negotiate with them because no one else is asking them for loans. Furthermore in this type of recession in which asset prices drop in value, most financial institutions suffer as their assets start losing value, like we have seen in the case of the bad loans that Japanese banks had. At some point down the line, they would lose their equity capital which would stop them lending money to people. Even if they did want to, it wouldn't be allowed. Under the current rules, banks must have core capital to offer loans to people, however, they don't have to have their own capital to lend to the government. Basically the risk they're taking by lending money to the government is a lot lower and therefore it's allowed. That's why banks are more than welcome to offer their services to the government. For these two reasons, America, Australia and the U.K., all of which have low saving rates and trade deficits, I think there is enough financial power left for government expenditure to maintain GDP rates.

S: Then they should be borrowing money from the public instead of issuing the new deficit-covering national bonds and what not.

K: That's exactly what I was about to say. Issue national bonds to borrow money from the public. It'd be a problem if people wanted to use the money themselves but in this case, they don't and thus there is a lot of money left unused.

S: In short, it's about creating a wave by moving the money around, is it?

K: Yeah, it is and Japan has always dealt with things in this way.

S: I feel as though I've been studying so far rather than interviewing you as you've made everything so easy to understand for me. Anyway, I look forward to our next talk next week, thank you very much.


Translation by Yuka Yamashita