Japan’s Bubble and America’s bubble: some implications for China

July 2010Kazuo Ueda

Professor of EconomicsThe University of Tokyo

The current episode resembles Japan in the 1990s

• The world during 2007-2010 resembles Japan in the 1990s-the early 2000s.– Property and other asset price bubbles and their collapse with serious

effects on the financial system.– The bubbles turned on too easy macroeconomic environment and

regulatory failure to reign in excessive speculation.– After the burst of the bubble, monetary policy rates were lowered

aggressively from fairly high levels, reaching eventually near zero levels.

• Central banks in 2007-09 acted more rapidly than in Japan in the early to mid 1990s.

– Policies to address financial system problems were also adopted more quickly in the current episode.

• In Japan, it was possible to hide bad loan problems for a while due to the bank centered nature of the financial system unlike in the current case.

• If the world fails to avoid deflation or a near zero inflation rate, however, it may look like Japan 1999-2006 for years to come.

• The world is also following Japan with regard to the heavy burden on fiscal authorities.

2

3Bloomberg, CEIC

4CEIC (NBS)

5CEIC (Economic Research Institute of China)

6Bloomberg, CEIC

7Bloomberg

8

9

10

Easy monetary policy was the major cause of the bubble.

11

Policy rate during the bubble: The U.S.

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The gap has been very large in China since 2004 except for early 2009.But RRR and WG?

13Datastream

14Datastream

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Japan feared the deflationary effects of stronger currency and eased monetary policy. China has resisted the pressure for appreciation.

BIS

May 2010 for China

16BIS

But in real effective terms, the picture is not that different between the two countries.

17BIS

Fear of deflation led the Fed to adopt ultra easy policy in 2003-04

• a substantial fall in inflation at this stage has the potential to interfere with the ongoing U.S. recovery, and that in conceivable--though remote--circumstances, a serious deflation could do significant economic harm. Thus, avoiding a further substantial fall in inflation should be a priority of monetary policy. (B. Bernanke, July 2003)

• "the Committee believes that policy accommodation can be maintained for a considerable period." …. Today inflation is at the lower end of the range consistent with optimum economic performance, and soft labor markets and excess capacity create a further downward risk to inflation. As a result, I believe that increased economic growth may not elicit the same response from the Fed that it has sometimes elicited in the past. (B. Bernanke, September 2003)

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This time is different psychology

• Japan– Japan as # 1.– 17 of the 25 world’s

largest financial institutions were Japanese as of 1989.

• US– The U.S. economy has

conquered the business cycle. (R. Dornbusch, R. Lucas.)

– The U.S. economy has become very flexible and resilient. (A. Greenspan.)

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Distorted Incentives leading up to the Bubble:regulatory failure

• Japan– Deregulation in the bond

market. – But banks were not allowed

to move into securities businesses, unlike in the US.

– Banks increased property related lending.

• Also, through Jusen.

– Neither banks nor regulators were equipped with risk management techniques to look at the entire bank loan portfolios.

• US– BIS capital regulation, financial

innovation and some deregulation encouraged the formation of the shadow banking system, which was not policed well by regulators.

– BIS regulation on security trading was effectively eased in 1996.

– The SEC policy change toward investment banks in2004.

– SEC policy toward rating agencies.– Derivatives.– Government’s housing policy.– Compensation.

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21Ueda(2000)

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Total assets by sector/household financial assets

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24

25

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AAA ABS 保有割合

0

5

10

15

20

25

30

35

Banks Conduits SIVs Hedge Funds MMF Credit Funds Others

％50 % of super seniors were held directly or indirectly by banks, but in ways to lower BIS capital charges.

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The BOJ & Fed’s monetary policies after the burst of the bubble

• Stock and land prices plummeted, the economy went into a recession and bad loans increased.

• The O/N rate was lowered slowly to 0.5% by mid 1995.– Financial instability

manifested itself very slowly.• Started unconventional policies in

the fall of 1998.

• Prices plummeted in capital markets and stresses developed in the entire financial system.

• The O/N rate was lowered to 0.25% by December 2008, faster than the Taylor rule indicated.– Financial system deteriorated

very rapidly.– May have learned from

Japan’s experience.• Unconventional policies started

in the fall of 2008.

Strategy 1,2 Strategy 1,2

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Nontraditional moves

Monetary policy options during an economic/financial crisis

• Lowering the policy rate aggressively.• Non-traditional moves:

– (Strategy 1) Expectations management– (Strategy 2) Purchases of non-traditional assets– (Strategy 3) Quantitative easing

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The BOJ’s Non-Traditional Operations during 1998-2006

Strategy 1 Zero rate until deflationary concerns disappear (April 1999- August 2000)

“zero rate” until CPI inflation becomes stably positive (March 2001-March 2006)

Strategy 2 CP repo

Unusually long-dated fund supplying operations

Purchases of equities from banks

Purchases of ABCP/ABS

Strategy 3 Target for private banks’ current account balances at the BOJ (March 2001-March 2006)

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Examples of Non-Traditional Policies during 2007-2009

Strategy 1

“The O/N rate can be expected to remain the same until 2010QII.” (Bank of Canada)

“economic conditions are likely to warrant low levels of the FFrate.” (FRB)

Strategy 2

Purchases of nontraditional assets: corporate bonds (BOJ,BOE), CP & equity (BOJ), covered bonds (ECB), Agency Bonds, MBS, Treasury Bonds (FRB)

Fixed rate full allotment fund supply (ECB, BOJ)

Swap between government securities and other non-liquid collateral (FRB, BOE)

US dollar repo (most central banks)

Strategy 3

BOE’s asset purchase FacilityThe BOE hopes to see easing effects through expansion of the money supply

Non-sterilization of strategy 2 (most central banks) 31

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Overnight Rates: Comparison with the Taylor Rule

0

1

2

3

4

5

6

7

8

9

start 1 yr 2 yrs 3 yrs 4 yrs 5 yrs

J - actual

US- actual

J - Taylor

US- Taylor

The Fed was more aggressive than the Taylor rule.

Capital injection into banks also came faster in the U.S.

• Japan 1994-2005– Total cost of bad loan

resolution = 113 trillion yen, of which

• Banks bore 93.6 trillion• Deposit Insurance, 8.3• Government 10.4

– Capital injection= 12.4 trillion (1998-2006)

• Of which 9.2 trillion has been recovered

• The U.S. 2007-– Estimate of total cost = 1

trillion dollars (IMF, GFSR)

– Capital injection =0.2 trillion (2008-09)

• Other financial assistance under TARP = 0.25

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Capital injection (US)

Capital injection (JPN)

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But in a sense the U.S. did not learn from Japan’s mistake

• Forbearance lending in the absence of M-to-M accounting (1991-96).

• Capital injection to Tokyo-Kyoudo Bank (1994).

• The bankruptcy of Sanyo securities & a resultant crisis in the financial system (1997-98) .

– Contagion through the money market & the stock market.

• Government’s capital injection, protection of all bank debt & the BOJ’s ZIRP stabilize the system (1999).

• M-to-M leads to sharp fall in asset prices across the financial system (2007-).

• De facto capital injection to the Bear Stearns bailout scheme (March 2008).

• The bankruptcy of Lehman Brothers and a resultant crisis in the financial system (Sept. 2008).

– Contagion through the money and capital markets & through MMF and the repo market.

• TARP, protection of senior bank debt & the Fed’s credit easing, but financial stresses remain. (2008-09).

Money Market Rates in Tokyo

0

0.2

0.4

0.6

0.8

1

1.2

% TIBOR3MCALLRO/ N

SanyoBankruptcy

HokkaidoTakushokuBankruptcy

Yamaichi Bankuruptcy

Tokuyo City Bankruptcy

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Financial Market Report, BOJ, March 2009

40Flow of Funds, FRB

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ABCP1 FFR月物ー

- 1

0

1

2

3

4

5

620

07

2008

2009

2010

Bloomberg

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LIBOR- OIS(3Month)

0

0.5

1

1.5

2

2.5

3

2007 1年 月 2007 7年 月 2008 1年 月 2008 7年 月 2009 1年 月 2009 7年 月 2010 1年 月

LIBOR ー OIS spread （ 3M ）

Bloomberg

Lessons• Ultra easy--say, easier than the Taylor rule--monetary policy sometimes

generates major financial imbalances.– In both Japan and China the ultra easy monetary policy came from the fear of

deflationary effects of stronger currency.

• Financial imbalances are exacerbated when financial regulation does not catch up with financial innovation or when pace of deregulation is uneven across sectors.

• Bubbles lead to systemic events if financial intermediaries are at the heart of their formation.

• People learn from others’ mistakes, but not always.• The world is not out of the woods yet.

– Large budget deficits and buildup of government debt– Disinflation is continuing.

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Leverage Ratio By Sector: J apan

0

5

10

15

20

25

30

HouseholdNon-FinancialFinancialGeneral Gov.

National Accounts, the Cabinet Office

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Growth of Nominal Government Spending on Goods & Services

-2

0

2

4

6

8

10

1991 1993 1995 1997 1999 2001 2003 2005 2007

46

47Cabinet Office

Japan’s net national debt/GDP quickly rose from zero to 100%.

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3日米の短期実質金利（ヶ月物）

- 2

- 1

0

1

2

3

4

5

6

7

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

％

USJ apan

LIBOR (3 month) – Core CPI Inflation

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