Richard Koo: Lessons from Japan's Decline
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
A video of this interview is available here.
Richard Koo is the Chief Economist of Nomura Research Institute, the research arm of Nomura Securities, Tokyo. Before joining Nomura in 1984, Mr. Koo, a US citizen, was an economist with the Federal Reserve Bank of New York (1981-84). Prior to that, he was a Doctoral Fellow of the Board of Governors of the Federal Reserve System (1979-81). In addition to conducting financial market research, he has been appointed by several different Japanese prime ministers to a number of key committee positions to study the future of the Japanese economy. He has been named the top analyst of the Japanese economy and has spearheaded the national debate in Japan on how best to save the country’s ailing banking system.
Dan Richards interviewed Koo at the CFA conference in Boston in May.
Let's start by talking about some of the lessons from the problems that Japan had in the last 20 years. Can you quickly summarize the two or three conditions that led to Japan’s economic woes starting roughly in 1989?
We didn't realize that we had contracted a different disease. We thought it was the typical cyclical downturn where we fell into recession, but it was a very different type of disease altogether. The disease was caused by a massive nationwide asset price bubble that was financed with debt.
Real estate in particular?
Real estate, the stock market, and everything else. When that bubble collapsed, asset prices fell, but the liabilities remained. Balance sheets all over Japan in the private sector were underwater. Although they were bankrupt, the cash flow of many of these companies was still very good. Japan continued to run one of the largest trade surpluses in the world. So companies had the cash flow, but balance sheets were underwater.
If you put anyone in that situation, what would they do? They will use the cash flow to pay down debt, because shareholders don't want to be told that their shares were just a piece of paper. Bankers don't want to be told that their loans are all nonperforming. Workers don't want to be told that there are no more jobs tomorrow. For all the stakeholders involved, the right thing to do was to use the cash flow to repair their balance sheets.
The problem is, when everybody does that all at the same time, what happens to the national economy? If someone is saving money or paying down debt, you better have someone on the other side borrowing and spending money. In the usual world, we have the financial sector in the middle taking the money from this side and giving it to people on that side. If there are too many people who want to borrow money, interest rates rise; if there are too few, you bring interest rates down, and the money circulates in the economy.
But what we discovered when our bubble burst was that even with zero interest rates, no one was borrowing money. Everybody was paying down debt, because their balance sheets were all underwater. No one wanted to borrow money.