The US Economic Crisis: Impact on Northeast Asia, Lessons from Japan

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1 The US Economic Crisis: Impact on Northeast Asia, Lessons from Japan Richard Katz The Oriental Economist Report Japan Watchers LLC. All rights reserved. Do not reproduce or redistribute without permission. Shorenstein Asia-Pacific Research Center November 19,

2 Impact on Northeast Asia Korea, Japan and China all very vulnerable Decoupling theory is wrong In this decade, Japan, Korea and China have all depended excessively on a rising trade surplus to drive growth Japan and Korea s exports to China hinge on Chinese exports to the US US imports slowing No Obama protectionism 2

3 Japan 3

4 Forecast for Two Consecutive Years of Negative Growth 4

5 Demand Ultra-Dependent On Investment and Trade Surplus 60% Share of GDP 55% Share of GDP Growth 02-I to 07-IV 50% 40% 30% 20% 10% Share of GDP Grow th 16% 36% 4.3% 41% 33% 0% Invest. Trade Surplus Household Consum. 5

6 Now Capex and Trade Surplus Detracting From Growth 2.0% 1.5% Contribution to GDP Growth 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% Capex Trade Surplus 2008-I 2008-II 2008-III 6

7 Wage Share of GDP Plunges Compensation % of real GDP, 2-qtr MA 57% average 56% 55% 54% 53% 52% 51% 50% 49% 48% % 56% 55% 54% 53% 52% 51% 50% 49% 48% 7

8 Income is Deficit-Financed Real Disp. Income as % of GDP 74% 73% 72% 71% 70% 69% 68% 67% 66% 65% 64% 63% 62% 61% 60% 59% 58% Total net disposable incom e Private incom e Govt tax cuts and transfer paym ents % 73% 72% 71% 70% 69% 68% 67% 66% 65% 64% 63% 62% 61% 60% 59% 58% 8

9 Household Savings Rate Drops Savings rate (% of disposable income) 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%

10 Trade Surplus Hit Record % of GDP (before pulling back) Trade Surplus (% of Real GDP) 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5%

11 Decoupling theory is wrong 11

12 Nikkei 225 Echoes S&P 500 Nikkei ,000 21,000 20,000 19,000 18,000 17,000 16,000 15,000 14,000 13,000 12,000 11,000 10,000 9,000 Nikkei 225 8,000 S&P 500 7,000 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1, S&P

13 13 Nikkei Echoes Yen/$ Jan- 05 Apr- 05 Jul- 05 Oct- 05 Jan- 06 Apr- 06 Jul- 06 Oct- 06 Jan- 07 Apr- 07 Jul- 07 Oct- 07 Jan- 08 Apr- 08 Jul- 08 Oct- 08 Yen/$ 7,000 9,000 11,000 13,000 15,000 17,000 19,000 21,000 Nikkei 225 Yen/$ Nikkei 225

14 This Decade: 70% Correlation Between US and Japanese GDP 6% 5% US (left scale) Japan (right scale) 5% 4% US Yr-on-Yr GDP growth 4% 3% 2% 1% 0% Japanese exports tum ble 3% 2% 1% 0% -1% Japan Yr-on-Yr GDP growth -1% % 14

15 Japanese Global Exports Mirror US Global Imports 20% Japanese exports 15% Yr-on-yr % growth 10% 5% 0% -5% US imports -10% -15%

16 Japanese Exports to China Mirror Chinese Exports to US 50% 40% Yr-on-Yr growth 30% 20% 10% 0% Anti-Japan boycott in China -10% -20% Japan exports to China China exports to US

17 Japanese Exports to Asia Mirror Asian Exports to US 30% 20% Yr-on-Yr growth 10% 0% -10% -20% -30% Asian economic crisis Japan exports to Asia Asia exports to US

18 Japanese Exports to Asia Mirror Chinese Exports to US Yr-on-Yr growth 30% 20% 10% 0% -10% 50% 40% 30% 20% 10% 0% -20% -30% Japan exports to Asia Asia exports to China % -20% -30% 18

19 Capex Mirrors Exports Quarter Earlier 20% 20% 15% 15% Yr-on-Yr growth, Exports 10% 5% 0% -5% 10% 5% 0% -5% -10% Yr-on-Yr growth, Capex -10% -15% Exports (lagged) Capex % -20% 19

20 Korea 20

21 Consumption Share Falling 64% 62% 60% Consumption % of real GDP 58% 56% 54% 52% 50% 48% 46% 44% 42% 40%

22 Culprit Is Low Personal Income Household disposable income % of real GDP 85% 80% 75% 70% 65% 60% 55% 50% 45% 40% US $ 2005 nom inal w on 85% 80% 75% 70% 65% 60% 55% 50% 45% 40% 35% % The constant dollar measure of disposable income shows a drastic decline, but the nominal won measure also shows a big decline. 22

23 Excess Reliance on Trade Surplus 12% 9% Asian financial crisis Trade surplus as % of real GDP 6% 3% 0% -3% -6% -9% -12%

24 Unbalanced Growth % of GDP and of GDP growth, % 50% 40% 30% 20% 10% 0% % of GDP % of Grow th Consum ption Capex Gov't Trade Surplus Black column shows the percentage of GDP; grey chart shows the % of GDP growth during

25 Korean Exports to China Hinge on Chinese Exports to US 70% 60% 50% 40% 30% 20% 10% 0% -10% ROK exports to China -20% China exports to US -30% % correlation between ROK exports to China and Chinese exports to US in ; rises to 72% correlation in

26 Much Looser Link Between ROK Exports to China and China s GDP 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% ROK exports to China China GDP Smaller 32% correlation between ROK exports to China and Chinese GDP; falling to negligible 7% correlation in % 13% 12% 11% 10% 9% 8% 7% 6% 26

27 China 27

28 Consumption Drops as % of GDP (due to drop in household income as % of GDP) Figure 2. Household consumption as percent of GDP, Percent Source: National Bureau of Statistics of China, China Statistical Yearbook

29 One of Lowest Consumption Rates (despite rapid rise in absolute terms) 120% 100% Consumption % of GDP 80% 60% 40% 20% China 0% $0 $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 $40,000 Per capita GDP 29

30 Make up Demand Shortfall Via Capex 60% Investment % of GDP 50% 40% 30% 20% China 10% 0% $0 $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 $40,000 Per capita GDP 30

31 Make up Demand Shortfall Via Trade Surplus Figure 4. Net exports of goods and services, F US$ Billion 350 Percent Percent of GDP (RHS) Goods and Services Balance (LHS) F Source: National Bureau of Statistics of China, China Statistical Yearbook 2007; Author's Calculations. 31

32 Renminbi Rises 22% vs. $ Index vis a vis $, July 21, 2005 = Broad index of currencies vs. dollar RMB J-05 O-05 J-06 A-06 J-06 O-06 J-07 A-07 J-07 O-07 J-08 A-08 J-08 O

33 US Locomotive Hits Brake Japan, Korea, China can only run trade surplus of $100 billion or $200 billion or $300 billion if rest of the world combined runs equal deficit For most of this decade rest of the world has mostly meant USA Not anymore 33

34 US Imports Slowing 16% US Real Import growth year-on-year 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% -6% -8%

35 US Trade Deficit Down 45% $700 US Goods and Services Trade Deficit ($ bil.) $600 $500 $400 $300 $200 $100 $

36 Lessons for America From Japan Do Too Much Rather Than Too Little Move Too Soon Rather Than Too Late 36

37 America Is Not Japan: Three Differences Cause of the crisis Size of the crisis Response of Policymakers 37

38 Causes Japan: Deep-Seated Structural Flaws US: Policy Mistakes Driven By Ideology and Interests plus post-lehman/aig Investor Panic Better Parallel is not Japan s Lost Decade But Asia (in causes, not severity) 38

39 Stock Market Bust 10% 0% S&P % 0% Stock index, % change from peak -10% -20% -30% -40% -50% -60% -70% Nikkei % -20% -30% -40% -50% -60% -70% -80% -80% -90% Years from the peak Japan since end of 1980s bubble; US since end of dot.com bubble. Data through Nov % 39

40 Stocks Gyrate More Wildly Than GDP Annual Changes 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40% S&P GDP 40

41 Japan real estate bubble dwarfs America's Real Estate Index, cumulative price change 500% 450% 400% 350% 300% 250% 200% 150% 100% 50% 0% -50% Japan commercial land in six big cities US house prices in 20 big cities Estimate and forecast Years before and after peak 41

42 The Debt Load of Corporations Japan USA Debt to Operating Profits Ratio

43 Job Losses Less Than in 2001 Recession % change in jobs since pre-recession peak 0.0% -0.5% -1.0% -1.5% -2.0% -2.5% -3.0% -3.5% -4.0% November forecast by 55 economists Nov onw ard forecast May 1990 onw ard March 2001 onw ard Aug onw ard Months from employment peak 43

44 No Credit Crunch Pre-Lehman (just normal recession deceleration) 18% Quarterly Growth in Debt (inflation-adjusted) 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4%

45 Strong Bank Balance Sheets 12% 11% Ratio of Net Worth to Assets 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%

46 NPLs Like Typical Recession Delinquency rate (one month past due) 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% All loans Mortgages on single-fam ily hom es

47 Banks Are Still Lending 20% 18% Year-on-year growth (4-week MA) 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% real estate non-real estate -6% Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Data through Nov. 5 47

48 Mortgage Foreclosures Mostly Subprime (2008-II) % of Outstanding % of Total foreclosure Loans Foreclosures rate Prime Fixed 65% 19% 0.7% Prime ARM 15% 23% 3.5% Subprime Fixed 6% 11% 4.5% Subprime ARM 6% 39% 17.1% FHA & VA 8% 7% 2.2% Total foreclosure rate: 2.47% ARM = Adjustable rate mortgage FHA & VA = loans financed by Federal Housing Authority and Veterans Agency 48

49 Household Wealth Still Strong average Ratio of net worth to income H Data for end of period; data through June

50 Corporate Net Worth Strong 1.4 Ratio of net worth to financial liabilities H 50

51 Post-Lehman Panic in Commercial Paper Total CP outstanding ($ mil.) 2,300,000 2,200,000 2,100,000 2,000,000 1,900,000 1,800,000 1,700,000 1,600,000 1,500,000 1,400,000 Lehman collapse 1,300,000 J-07 A-07 J-07 O-07 J-08 A-08 J-08 O-08 51

52 Post-Lehman Panic in Bond Market 10% Baa bond Aaa bond 10-year Treasury 9% 8% Interest Rate Spread 7% 6% 5% 4% 3% Lehm an bankruptcy 2% J-00 J-01 J-02 J-03 J-04 J-05 J-06 J-07 J-08 52

53 Policy Response Japan: Years of Cover-up, Denial, Support of Zombies, Mismanaged Macroeconomic Policy US: Fiscal and monetary stimulus, rapid write-down of assets, allowing big institutions to fail, government bailout, correcting deregulatory excess, new efforts when some efforts prove insufficient or ineffective 53

54 Outcome? Depends on Policy: Republicans Like Feldstein and Democrats Like Summers Urging Big Fiscal Stimulus (2% of GDP for 2-3 years) and Some Kind of Mortgage Refinance to stop foreclosure-price cycle Probably recession not quite as bad as when US suffered zero growth for three years and unemployment hit 11% 54

From Recession to Recovery

From Recession to Recovery Monday, April 26, 2010 8:00 AM - 9:15 AM Moderator Michael Klowden, President and CEO, Milken Institute Speakers Mohamed El-Erian, CEO and Co-Chief Investment Officer, Pacific