Economic Recovery in the Asia Pacific: Is It Sustainable?
Mr. Richard Koo
Senior Economist
Nomura Research Institute
The previous speaker spoke thirty-five minutes, so I have to speak at the machine-gun speed so that you have some question, that you can ask at the end.
In order not to repeat what Dr. Courtis said, let me start out by saying I think he's reasonably correct on Asia, dead wrong on Japan.
Let me start with the conclusion first. I think Japan's recovery is sustainable, but it's not a self-sustaining one; and Asian recoveries I believe is real and sustainable.
Let me start with the Japan first. A lot of people in Japan and outside Japan talks about the need for reform, but I believe that the real problem the Japanese economy contracted - the disease that the Japanese economy contracted in the nineties is simply put, "balance sheet recession." And it's a very special type of recession, doesn't happen very often - only happened in the United States in the 1930's - where a lot of people chased the wrong asset prices.
In the late eighties a lot of Japanese chased asset prices, borrowing money, and then in the nineties we all know what happened to the Japanese asset prices -- they collapsed -- but the liabilities, those debts that they contracted, are still there - the liabilities are here. They thought the asset prices would be somewhere up here, but now they are down here. And millions and millions of dollars changed in Japan are now underwater.
What happens when you are in that situation? But first you try to tell yourself, "Well, these kinds of things can happen in the market, but of course in a few years time the prices will go back up and everything will be fine" But you wait a few years and then you realize that that's not happening, but that the situation is getting worse. Then you realize that maybe you were chasing wrong asset prices all along - that the Imperial Palace Gardens in the middle of Tokyo is not worth the State of California after all. Then, once you realize that you have your balance sheet problems, you try to repair it.
Well, how do you repair balance sheet problems? You pay down your debt. How do you pay down your debt? You refrain from consuming; you refrain form investing; and that's how you enter balance sheet recession.
Everybody in Japan is trying to clean up their balance sheets. The are doing the right things, you don't want them to be doing anything else, but in the process, they cut down consumption, they cut down investment and the economy contracts further. Now this a very difficult recession to tackle because for one thing the monetary policy loses its effectiveness completely.
Well why does monetary policy lose its effectiveness in a balance sheet recession? Well, for monetary policy to work when central bank lowers interest rates someone in the private sector has to respond to that interest rate, go to the bank, borrow money and spend it. Well if everybody is trying to pay down debt, none of this is will ever happen, and that's the key problem with all these suggestions from outside. People like Paul Krudman and MIT asking Bank of Japan just to print money. Just print and flood the place with money and everything will fine.
But it's very difficult to do that in this kind of situation because people are not borrowing money for a very good reason. They want to clean up their balance sheets and you don't want them to be doing otherwise. So even if Bank of Japan and Krudman hand in hand goes to the borrower and says, "Hey, why don't you just borrow money. Forget about your past mistakes. Forget that your balance sheet is under water. Just borrow money and spend it, everything will be fine" Well, I don't know how many people in Japan will listen to that because they will say, "Oh, that is a great idea, but let me clean up my balance sheet first."
And the same thing happens with the bankers. You know, unless the bankers provide the money, the money won't move...
At the moment with the lowest interest rate in the history of mankind why are people not borrowing? Because they have something more urgent business to take care of. So the bankers go to those borrowers and say "Hey, forget that you're underwater. Forget that you're technically bankrupt, or really bankrupt. Just borrow money and spend it and everything will be fine." You know that's not going to happen.
And the bankers are under tremendous pressure under the... by the government to clean up their act, to reduce their... problems, and so forth. So both on the borrower's side as well as on the lender's side, nothing can move forward through the monetary side.
And the real problem here is that everybody is doing the right things, you don't want them to be doing otherwise, but since everybody is doing all at the same time, you have a fallacy of composition. And it's in these circumstances you need the fiscal stimulus, the government spending, to fill the gap because in a balance sheet recession there is an absolute lack of demand.
In ordinary circumstances, if you have a let's say, an income of a thousand dollars. You spend eight hundred yourself as a consumption, two-hundred you... save as a savings. You give it to the bank, then the bank lends that two-hundred to someone else to spend, so as a result, you have a thousand dollars income, a thousand dollars spending.
But in the balance sheet recession, the persons spends only seven-hundred dollars and adding the hundred, plus the two-hundred before to pay down the debt. The three-hundred goes down to the financial institutions, but the financial institutions cannot find the borrowers for the three-hundred. That's the balance sheet recession. And if you leave this to its own devices, the net result is called "The Great Depression." And Japan barely managed to avoid that scenario in spite of the fact that millions of Japanese balance sheets are underwater precisely with fiscal spending.
And even though OECD, IMF, these people who know nothing about Japan (nothing about most things, I suppose) tried to tell Japan to reduce the budget deficit. The result was the economic collapse of 1997-1998. You need fiscal spending to keep the vicious cycle from starting. And of course now, both OECD and IMF are saying Japan needs fiscal stimulus, and Omichiko government understands that and that's why there is so much fiscal stimulus going on at the moment. Well how long could this continue?
Well, I believe that Japan has entered the second stage of balance sheet recession. The first stage of balance sheet recession (because I made this all up -- it's not in any textbooks) is when asset prices are falling. When it's falling, people can never really plan ahead, because everything is collapsing all around you. Even people with clean balance sheets cannot get ahead when asset prices are falling. You really don't know where you are.
I mean, people ask about the size of the... problem in Japanese banks. These things are meaningless because the asset prices are collapsing...
Last year and this year, I think asset prices are finally stabilizing because they have fallen enough tht the stock market has recovered fifty-percent, golf club memberships, important for some Japanese, are beginning to recover, from a very low base of course, and even commercial real estate prices in some areas are beginning to recover. That means for the first time in ten years Japanese people know where they are financially. They know that maybe this is the bottom and they know this is the situation they are faced.
Of course, a lot of them don't like where they are, but compared to ten years ago... Ten years ago you were in the dinghy and the waves are ten feet high, the sky is under... there's a storm going on, you don't know where you are facing, you're just keep trying to keep yourself afloat... that was the last ten years.
Last year and this year finally the waves have come down, you can see blue skies, and you look over there, "Ah! That's Mount Fuji!" So you know exactly where you are. For some people it might take three years to swing back. Others might take five. But for companies with clean balance sheets, strong balance sheets -- and there are a few of those, Sony, Toyota, those companies -- they are going to find a lifetime opportunity to beat the competitors; because now these companies can borrow money at the lowest rate in the history of mankind -- and the competitors cannot follow you because they are still underwater. They are going to be on a debt repayment mode for the next two or three years. So you can go out and catch the market share that the competitors cannot come back and try to catch back.
So that's the situation from this stage onward. That we are now in the second stage and the prices are more or less stable, although some are in the recovery mode, then those people with the clean balance sheets can start moving forward. And that will put tremendous pressure on all the other companies still on the backward-looking mode to look forward as well. And my guess is that it might take maybe another two or three years before the Japanese economy will truly be on the self-sustaining recovery mode. And I hope that during that process, the fiscal stimulus will be in place because if the fiscal stimulus is removed, we will fall into that viscous cycle all over again. So that's Japan. It's still very sick, but it's now heading in the right direction.
How about Asia? Well Asia viewed from Japan is slightly different from the way it's often portrayed in publications from New York or Washington. In that, as Ken mentioned earlier, in my view the "Asian Miracle" - the one that existed before 1997 - was a strong yen miracle. And from the Plaza Accord of 1985 exchange rate of yen-dollar removed from two-hundred-forty (240) all the way to hundred-twenty (120) and that forced for the first time in the history of Japan thousands, literally millions of companies to move south. And Thailand, Indonesia, Malaysia got most of the factories, and South Korea was competing directly with the Japanese so they benefited as well.
Starting with April 1995 on the other hand, as Ken mentioned, the exchange rate got reversed. The yen became the weakest of major currencies, the dollar became the strongest, and these Asian countries who were all pegged to the dollar were losing international competitiveness left and right. And as Ken mentioned, the currencies in current account were deteriorating, external balances were deteriorating, and so forth. But at that time, there was a so-called "Asian Fever" among portfolio investors -- people in my industry I'm afraid, who thought investing in Asia you can never go wrong. People have high savings rate, well-educated, hard-working, entrepreneurial. It's everything plus entrepreneurial spirit - everything in Japan, plus the entrepreneurial spirit, "How can you go wrong in Asia?" So all these people brought money to Asia and that kept the currency going even though Asians external competitiveness was deteriorating very, very rapidly. In fact by middle of 1996, a lot of Japanese retailers was saying, "We have nothing to buy from Thailand. We have no reason to invest in Thailand. It's too expensive." But of course, the 'bubble economy' continued with all the investors around the world going crazy about Asia.
But even those crazy investors realized in July of 1997 that things could still go wrong in Asia, where the external accounts were deteriorating so bad and international competitive was totally lost. So that's how the crisis began in my view. And the collapse of Asian currencies were very rapid, going well beyond the yen. Now I produced a hand-out. So some of you lucky enough to have the hand-out have the chart in there that shows what happened to Asian currencies vies-a-vies the yen. But I was told that there was only hundred and fifty hand-outs; there are fifteen-hundred of you here, so I'm not going to refer to the charts, but for those of you who have the charts, you can see what happened.
Today, after that crisis, after the panic, all those currencies are back to where the yen is, or slightly below the yen. What that means is that these people now realize that, you know, we started off the bread the butter is on, but you have to stay with the yen when the yen is weak. So for Asian countries, you have to stay with the dollar when the yen is strong, but you have to stay with the yen when the yen is weak. That's basically what they have to do to stay afloat in this difficult environment.
Now many of you might ask, "Well how about all these structural reforms? Would the reform effort stop?" as some people was mentioning earlier. Well, I think structure issues are not absolute. I mean, in some cases they are absolute, like in the North Korean case. I think it's a pretty absolute structure problem there; but most other cases, structure problems have its own price. And the key price here is the … the key issue here is, in view of the structure problems, 'Is the prices correct?' and the price here means the exchange rate. Because after all, why are people investing in developing countries? -- because people invest in developing countries because you want above-average return. You can only get above-average return when there is some structural problems in the economy. If everything is perfect you get only the average return, right? So why people go to developing countries? -- because you want the above-average return and you seek above-average return because there is some imperfections there that you want to exploit.
So the real issue is, given the problems they have, 'Is the exchange rate correct?' And I must say that Asian economies today, given the exchange rate, are extremely competitive, as Ken mentioned, and given that exchange rate, given the yen-dollar rate and the Asian currencies vis-à-vis the yen stays where they are or remain in the reasonable vicinity, I believe that Asian economies can grow very strongly.
And so the Asia recovery is real and sustainable. Now of course Japan wanted to emulate that if it had the option, but unfortunately Japan is running the largest trade surplus in the world and yet they should know push on exports will get people like Charlene Barshefsky very, very angry and that's likely to push the yen higher. So unfortunately, Japan does not have the option to export its way out and that's why it has to use the fiscal stimulus, but Asia does have the option and they are using it.
So altogether, I believe Japan is in the recovery mode, but its not a self-sustaining one until the balance sheet problems are behind us and that will probably take about one or two more years of fiscal stimulus, and the Asian economic recoveries I believe is real and sustainable. Thank you very much.