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

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

Futures

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

260

US: 10 Cities Composite Home Price Index

240

Composite
Index
Futures

Japan: Tokyo Area Condo Price1

220
200
180
160
140
120
100
80

Japan: Osaka Area Condo Price1

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

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

US
Japan

Note: per m 2, 5-month moving average

Sources: Bloomberg, Real Estate Economic Institute, Japan, S&P, S&P/Case-Shiller Home Price Indices, as of Jul. 26, 2012

Exhibit 2. House Prices in Europe also Experienced Bubble

(end of 1995 = 100)
550

514

525
500

Ireland

475
450

Greece

425

Spain

400

Germany

375

342

350

Greece
271
Ireland
262

325
300
275

303

250

Spain
238

225
200
175
150
125

90

Germany
100

100
75
91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

Notes: Ireland's f igures bef ore 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.

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

or House Prices
(%)
8

Australia
7

UK
6

EU

US
2

Japan
1

0
2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

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

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

(2007=100, Seasonally adjusted)

(%, Seasonally adjusted, inverted)

103

3.5
4.0

Unemployment Rate
(right scale)

101

4.5

99

5.0
5.5

Last
seen
in 2006

Industrial Production
(left scale)

97

6.0

95

6.5
7.0

93
7.5
91

8.0

Last seen in 1983

8.5
89
9.0
87

9.5
10.0

85
10.5

Last seen in 1997

83

11.0
98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

Sources: US Department of Labor, FRB

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

(Seasonally adjusted, 2005=100)

(%, Seasonally adjusted, inverted)

115

7.0
7.5

Unemployment Rate
(right scale)

110

8.0
105

8.5
9.0

100

Last seen
in 2005

9.5

95

10.0
10.5

90

Industrial Production
(left scale)
85
1998

11.0

Worst on record*

11.5
1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

*No data bef ore 1995

Source: Eurostat

Exhibit 6. Except in Germany, Industrial Production in Europe

Is still Weak
(2005 = 100, Seasonally Adjusted)

Level last
seen in

120

Spain

115

France

110

2007: Germany

Italy
105

Germany

100
95

1997: France
90
85

1987: Italy

80

1994: Spain
75
70
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. Japans Industrial Production Fell to the Level of 1987

after the Earthquake
(Seasonally adjusted)

(Seasonally adjusted, 2005=100)

1.2

115

forecast
Industrial production (right scale)

110

1.1

105
1.0
100
0.9

95

Last seen in 2002

Last seen
in 2004

0.8

0.7

90
85

Job offers to applicants ratio

(left scale)

Last seen
in 1987

80

0.6
75

Last seen in 1983

0.5

70

Lowest on record
0.4
2000

65
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 Welf are

Exhibit 8. Drastic Liquidity Injection

Failed to Increase Money Supply (I): US
340
320
300
280
260
240
220
200
180
160
140
120
100
80
3.0
2.5

(Aug. 2008 =100, Seasonally Adjusted)

Monetary Base
Money Supply (M2)
Loans and Leases in Bank Credit

311

Down
25%
129
96
(%, yoy)

Consumer Spending
Deflator (core)

2.0

+1.82%

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 12/1 12/4
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.

Exhibit 9. Drastic Liquidity Injection

Failed to Increase Money Supply (II): EU
200

(Aug. 2008 =100, Seasonally Adjusted)

190

Base Money

180

Money Supply (M3)

170

Credit to Euro Area Residents

194

160
150
140
130
120
110

108

100

104

90
2.2
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6

(%, yoy)

CPI core

+1.6%

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 11/10 12/1 12/4 12/7

Sources: ECB, Eurostat

Note: Base money's figures are seasonally adjusted by Nomura Research Institute.

Exhibit 10. Drastic Liquidity Injection

Failed to Increase Money Supply (III): UK
370

369

(Aug. 2008 =100, Seasonally Adjusted)

1

340

Reserve Balances + Notes & Coin

Money Supply (M4)
Bank Lending (M4)

310
280
250
220

Aug. 08'

190
160

Down
19%

130

106
85

100
70
6
5
4
3
2
1
0

(%, yoy)

CPI (ex. Indirect Taxes)

+2.4%

07/1

07/7

08/1

08/7

09/1

09/7

10/1

10/7

11/1

11/7

12/1

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.

10

Exhibit 11. Drastic Liquidity Injection Failed to

Produce Drastic Increase in Money Supply (IV): Japan
350

(1990/1Q = 100, Seasonally Adjusted)

Quantitative
Easing

Earthquake
329

Monetary Base

300

Money Supply (M2)

Bank Lending

250

1990/1Q
200

150

Textbook
Economics

Balance Sheet
Recession

(Monetary Policy
Ef f ective)

(Monetary Policy
NOT Ef f ective)

175
Down
41%

102

100

50
4
3
2
1
0
-1
-2
-3

(y/y, %)

CPI Core
(ex. fresh food)

-0.2%

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

11

Exhibit 12. Japans 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
(right scale)

20

Borrowings from Financial Institutions (left scale)

15

Funds raised in Securities Markets (left scale)

10

-5

Debt-financed
bubble
(4 years)

Balance sheet
recession
(16 years)

-10

-2

-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 11

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

12

Exhibit 13. Japans GDP Grew in spite of Massive Loss of Wealth

and Private Sector De-leveraging
(Sep. 1990=100)

(Sep.1990=100, Seasonally Adjusted)

140

130

Nominal GDP (Right Scale)

120

Real GDP
(Right Scale)

115

100

Cumulative
90-05 GDP
Supported by
Government
Action:
~ 2000 trillion

100

Likely GDP Path

w/o Government Action
80

85

60

70

40

55

Last seen in 1973

20

40

Land Price Index in Six Major Cities

(Commercial, Left Scale)
0

25

down
87%

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 12
Sources: Cabinet Of f ice, Japan Real Estate Institute

13

Exhibit 14. Japanese Government Borrowed and Spent

the Unborrowed Savings of the Private Sector to Sustain GDP
(Tril. yen)
110

Government spending
100
90

cumulative
cyclical
deficit
90-05
315 trillion

80
70
60

overall
deficit
460
trillion

50
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 12
Source: Ministry of Finance, Japan
Note: FY 2011 includes 4th supplementary budget and FY2012 is initial budget.

14

Exhibit 15. Premature Fiscal Reforms in 1997 and 2001 Weakened

Economy, Reduced Tax Revenue and Increased Deficit
(Yen tril.)

(Yen tril.)
80

70

60

80

Tax Revenue
Budget Deficit

Hashimoto
fiscal
Obuchi-Mori
reform
fiscal
stimulus

Earthquake
Koizumi
fiscal
reform

70

Global
Financial
Crisis

60

50

50

*
40

unnecessary
increase in
deficit:
40
103.3 tril.

30

30

20

20

10

10

0
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.

15

Exhibit 16. 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)
10

Households
8

(Financial Surplus)
Rest of the World

Private
Sector
Savings:
7.33%
of GDP

6
4
2
0
-2
-4
-6
-8
-10

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

IT Bubble
(Financial Deficit)

Housing
Bubble

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

16

Exhibit 17. 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
6

(Financial Surplus)
Rest of the World

Private
Sector
Savings:
7.54%
of GDP

-3

-6

-9

General
Government

Corporate Sector
(Non-Financial Sector +
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 12
Note: For the latest f igures, 4 quarter averages ending with 1Q/12' are used.
Source: Of f ice f or National Statistics, UK

17

Exhibit 18. Global Bond Yields* Nearing Japanese Levels

(%)
6

UK
US
Sweden
Switzerland
Japan

bond yield
first seen
in Japan
in 1998

3%
2

0.7%
1

0
2007

2008

2009

2010

2011

2012

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

Source: Bloomberg

18

Exhibit 19. Euro-Zone Bond Yields Are Diverging Sharply

(%)
40

35

Greece
Ireland

30

Portugal
Spain

25

Italy
France

20

Germany

15

10

0
2007

2008

2009

2010

2011

2012

Note: As of Jul 26, 2012.

Source: Bloomberg

19

Exhibit 20. 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
4

Private
Sector
Savings:
3.77%
of GDP

Rest of the World

-2

-4

General
Government
-6

Corporate Sector
(Non-Financial Sector + Financial Sector)

(Financial Deficit)
-8
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

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

20

Exhibit 21. 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

6

Private
Sector
Savings:
5.55%
of GDP

-3

-6

Corporate Sector
-9

(Non-Financial Sector + Financial Sector)

General
Government

(Financial Deficit)

-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 Espaa

21

Exhibit 22. 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, %, quarterly)
20

(Financial Surplus)

Corporate Sector
(Non-Financial Sector +
Financial Sector)

15

Rest of the World

10

Private
Sector
Savings:
7.66%
of GDP

5
0
-5
-10
-15
-20

Households
General
Government

-25

(Financial Deficit)

-30
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

22

Exhibit 23. Portugal in Balance Sheet Recession: Portuguese Private

Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %)
12

(Financial Surplus)
Rest of the World

Households

Private
Sector
Savings:
4.03%
of GDP

General Government
-3

-6

Corporate Sector

-9

(Non-Financial Sector + Financial Sector)

(Financial Deficit)

-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

23

Exhibit 24. Two Structural Deficiencies of Eurozone

(1)

(2)

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

Result
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

Excessively Low Gov. Bond

Yields during Bubbles
Excessively High Gov. Bond
Yields during Balance Sheet
Recessions

24

Exhibit 25. 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
6

(Financial Surplus)

Shift from 2000

to 2005
in private sector:
12.06% of GDP

Telecom Bubble

Corporate: 9.26%
Households: 2.80%

2
0

Rest of the World

-2
-4
-6
-8

Shift from 2000

to 2005
in public sector:
4.62% of GDP

General
Government

Corporate Sector
(Non-Financial Sector +
Financial Sector)

Balance Sheet
Recession
(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 Of f ice Germany

Note: The assumption of Treuhand agency's debt by the Redemption Fund f or Inherited Liabilities in 1995 is adjusted.

25

Exhibit 26. Source of Competitiveness Problem:

Divergence of Eurozone Money Supply Growth
(1999 Q1=100, Seasonally adjusted)
300

250

Eurozone ex. Germany

Lehman Shock

Germany
Greece
200

Paths will cross

in Jun. 2021
150

100

Already crossed
for Greece

50
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
Notes: Growth in M3. Figures f or Germany and Greece seasonally adjusted by Nomura Research Institute. Path of money
supply growth was estimated as 2,167.852 + 9.79354 x trend f or Germany and 7,126.945 + 11.01537 x trend f or other
countries, based on trend f or January 2010 through May 2012.
Source: Nomura Research Institute, based on ECB, Deutsche Bundesbank and Bank of Greece

26

Exhibit 27. Divergence of Eurozone Labor Costs

(2000 = 100)
160

150

Germany

Spain: 154.4

Ireland

Ireland: 151.4

Greece
Spain

France: 144.0

France

140

Italy: 139.5

Italy
Portugal

Portugal: 133.3

130

Greece: 129.8*

Germany: 122.7
120

110

100
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Note: Greek f igure f or 2011 represents average through 2011 Q3.

Source: Eurostat

27

Exhibit 28. Post IT-Bubble Germany Recovered by Increasing

Exports to Eurozone
German Balance of Trade
(mn, seasonally adjusted)
12000

Eurozone
10000

8000

6000

US

4000

2000

-2000

-4000

Asia

-6000
95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

Source: Deutsche Bundesbank

28

Exhibit 29. ECB Facing Balance Sheet Recession Can Supply Large
Amounts of Liquidity without Igniting Inflation
(Aug. 2008 = 100, seasonally adjusted)
400

Eurozone

375

Monetary Base
(=Liquidity)

350

US

US-like
monetary
easing would
allow ECB to
supply
960.3 bil.
worth of
additional
liquidity.

UK

325

Eurozone

300

Money Supply

US

275

UK
250
225
200

Aug. 2008

175
150
125
100
75
2007

2008

2009

2010

2011

2012

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.

29

Exhibit 30. Balance Sheet Correction in France Was Minimal

Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %)
8

(Financial Surplus)

Households

Private
Sector
Savings:
2.12%
of GDP

-2

-4

-6

Rest of the World

Corporate Sector
-8

General
Government

(Non-Financial Sector + Financial Sector)

(Financial Deficit)

-10
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

30

Exhibit 31. Balance Sheet Correction in Italy Was Minimal

Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %, quarterly)
12

(Financial Surplus)

10

Households

8
6
4

Rest of the World

Private
Sector
Savings:
-1.16%
of GDP

0
-2
-4
-6
-8

Corporate Sector
(Non-Financial Sector +
Financial Sector)

General
Government

-10

(Financial Deficit)

-12
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 4Q/11' are used.
Sources: Banca d'Italia, Eurostat

31

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

Financial Surplus or Deficit by Sector
25

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

(Financial Surplus)
20

Rest of the World

Households

15

10

Private
Sector
Savings:
-7.04%
of GDP

-5

-10

Corporate Sector

-15

(Non-Financial Sector +
Financial Sector)

(Financial Deficit)

General
Government

05

08

-20
01

02

03

04

06

07

09

10

11

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

32

Exhibit 33. Greek Corporates Are Both Drawing Down Savings and
Reducing Debt
(as a percentage of nominal GDP)

(as a percentage of nominal GDP, inverted)

15

-15
left scale

Financial Assets

10

-10

-5

-5

-10

10

Financial Liabilities right scale

-15

15
00

01

02

03

04

05

06

07

08

09

10

11

Sources: Bank of Greece, Eurostat

33

Exhibit 34. Greek Households Are Both Drawing Down Savings and
Reducing Debt
(as a percentage of nominal GDP, inverted)

(as a percentage of nominal GDP)

20

-20
left scale

Financial Assets

15

-15

10

-10

-5

-5

-10

10

Financial Liabilities right scale

-15

15
00

01

02

03

04

05

06

07

08

09

10

11

Sources: Bank of Greece, Eurostat

34

Exhibit 35. Japanese Corporates Increased Savings again after Lehman

Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %)
15

(Financial Surplus)
12

Households

9
6

Private
Sector
Savings:
10.1%
of GDP

Rest of
the World

3
0
-3

1991-2003 shift
= 22% of GDP

-6
-9

Corporate Sector
-12
-15

(Non-Financial Sector +
Financial Sector)

General Government

Balance Sheet Recession

(Financial Deficit)

-18

Global
Financial
Crisis

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
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

35

Exhibit 36. Australian Household Savings Are Large while

Corporate Borrowings Are Modest
Financial Surplus or Deficit by Sector
8

(Financial Surplus)
Households
Rest of the World

Private
Sector
Savings:
1.75%
of GDP

-2

-4

-6

Corporate Sector
-8

(Non-Financial Sector
+ Financial Sector)

General
Government

(Financial Deficit)

-10
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

36

Exhibit 37. U.S. Took 30 Years to Normalize Interest Rate after 1929
because of Private Sector Aversion to Debt
(%)
9
8

US government bond yields

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

7
6
5

Oct '29 NY Stock

Market Crash

Dec '41 Pearl

Harbor Attack

Jun '50 Korean

War

'33
New Deal

4
3
2

1
0
19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 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

37

Exhibit 38. Monetary Easing No Substitute for Fiscal Stimulus (I):

Japans Money Supply Has Been Kept Up by Government Borrowings
Balance Sheets of Banks in Japan
December 2007

December 1998

Assets
Assets

Credit
Extended to
the Private
Sector

Credit
Extended to
the Private
Sector

Money Supply
(M2+CD)

501.8 tril.
(-99.8)

621.5 tril.

Credit
Extended to the
Public Sector

Credit Extended
to the Public
Sector

Foreign Assets
(net)

Money Supply
(M2+CD)

744.4 tril.
(+122.9)

601.6 tril.

140.4 tril.

Liabilities

Liabilities

Other Liabilities
(net)

153.2 tril.

247.2 tril.
(+106.8)
Foreign assets
(net)

Other Liabilities
(net)

74.1 tril.
(+41.4)

32.7 tril.

Total Assets 774.7 tril.

Total Assets 823.1 tril. (+48.4)

78.7 tril.
(-74.5)

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
Balance Sheets of All Member Banks
June 1936

June 1929
Assets

Credit
Extended to
the Private
Sector
$29.63 bil.

Assets

Liabilities

Deposits
$32.18 bil.

June 1933
Assets

Credit
Extended to
the Private
Sector
$15.80 bil.
(-13.83)
Credit
Extended
to the
Public
Sector
Other
$8.63 bil.
Liabilities
(+3.18)
$6.93 bil.
Other
Assets
$6.37 bil.
(-1.65)
Capital Reserves
$6.35 bil. $2.24 bil.

Credit
Extended to
the Public
Sector
$5.45 bil.
Other Assets
$8.02 bil.

Reserves
$2.36 bil.

Credit
Extended
to the
Private
Sector
$15.71 bil.
(-0.09)

Liabilities

Deposits
$23.36 bil.
(-8.82)
Credit
Extended
to the
Public
Sector
$16.30 bil.
(+7.67)

Liabilities

Deposits
$34.10 bil.
(+10.74)
(= Money Supply)

Other
Other
Assets
Liabilities
$8.91 bil.
$4.84 bil.
(+2.54)
(-2.09)

Other
Liabilities
$7.19 bil.
(+2.35)

Reserves
Capital
$5.61 bil.
$4.84 bil.
(+3.37)
(-1.51)

$5.24 bil.
(+0.40)

Capital

(-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

39

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

wages

A
S

Fast growth
Stable prices
Widening
income
inequality
Strong
investment

B
Capital's
profit

Labor supply
curve

Industrialization

Inflation

Labor demand
curve

(i)

Investment

H
G

China Today

D1

Weak
consumption

D2

(ii)
Consumption E

China until now

(capital-accumulation phase)

Narrowing
income
inequality

D3

D
Worker's
income

Slower growth

Slower
investment
Stronger
consumption

number of
workers

China in the future

(normalization of domestic
demand phase)

Source: Nomura Research Institute

40

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

Yin (=Shadow)

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

US
Spain
UK

Yang (=Light)

Bubble

(9) Overconfident private sector triggers a bubble.

(2) Collapse in asset prices leaves private sector

with excess liabilities,
forcing it into debt minimization mode.
The economy falls into a balance sheet recession.

(8) With the economy healthy,

the private sector regains its vigour,
and confidence returns.

(3) With everybody paying down debt,

monetary policy stops working.
Fiscal policy becomes the main economic tool
to maintain demand.

(7) Monetary policy becomes the main

economic tool, while deficit reduction
becomes the top fiscal priority.

(4) Eventually private sector finishes its debt repayments,

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.

(6) Private sector fund demand recovers,

and monetary policy starts working again.
Fiscal policy begins to crowd out private investment.

Japan
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 Japans Great Recession , John Wiley & Sons, Singapore, April 2008 p.160.

41

Exhibit 42. Contrast Between Yin and Yang Phases of Cycle

Yang

Yin

1) Phenomenon

Textbook economy

Balance sheet recession

2) Fundamental driver

Adam Smith's "invisible hand"

Fallacy of composition

3) Corporate financial condition

Assets > Liabilities

Assets < Liabilities

4) Behavioral principle

Profit maximization

Debt minimization

5) Outcome

Greatest good for greatest number

Depression if left unattended

6) Monetary policy

Effective

Ineffective (liquidity trap)

7) Fiscal policy

Counterproductive (crowding-out)

Effective

8) Prices

Inflationary

Deflationary

9) Interest rates

Normal

Very low

10) Savings

Virtue

Vice (paradox of thrift)

a) Localized

Quick NPL disposal

Pursue accountability

Normal NPL disposal

Pursue accountability

b) Systemic

Slow NPL disposal

Fat spread

Slow NPL disposal

Gov. capital injection

11) Remedy for

Banking Crisis

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

42