Our guest blogger is David Min, Associate Director for Financial Markets Policy at the Center for American Progress Action Fund.
A couple of weeks back, my CAP colleague Matt Yglesias asked whether Treasury might be trying to emulate the Japanese government’s response to its credit downturn, citing Richard Koo’s excellent book on the Japanese banking crisis.
Koo acknowledges that the Japanese response to its banking crisis, which consisted primarily of massive regulatory forbearance (propping up banks and putting off loss recognition) and stimulus packages to promote job creation, led to very little growth over time. But Koo challenges the conventional wisdom that the Japanese response was a failure, arguing in short that the massive devaluation of assets throughout the entire Japanese economy should have created a cataclysmic, Great Depression-like downturn, and that the fact that Japanese growth remained fairly stagnant was in fact a great victory.
Well, John Hempton over at Bronte Capital has just written a brief, but I think highly illuminating comparison of the Japanese experience with the roughly contemporaneous credit downturn in Korea:
Korea had a much worse recession than Japan. Vastly worse. Japan was just low growth for a very long time. By contrast the Korean economy crashed and burned. But it also recovered very fast and at one point (1999-2000) the Korean Stock market was 1932 Great Depression cheap. It bounced. It is my contention that the main difference between the Korean and Japanese crashes (and Korea’s case recoveries) was the funding of the banks. In this view Korea’s was so sharp because the banks simply ran out of money – and that caused massive liquidations across the economy – systemic failures.
One of the keys to the Japanese response to its banking crisis, according to Hempton, was its massive internal savings, which was fueled by a “multigenerational” ethos of saving instilled into “Japanese housewives” from a young age. So even though the Korean Chaebol industrial-bank complex model was similar in many ways to the Japanese Zaibatsu/Keiretsu model, the fact that heavy savings (even at zero percent returns) were not as embedded into Korean society meant that when the credit crisis hit, “the Korean banks — unlike their Japanese counterparts were short funds. Endless funding at zero interest rates was simply not possible.”
So in a nutshell, Korea couldn’t match the Japanese response of regulatory forbearance and the avoidance of loss recognition, because it didn’t have the high internal savings rates necessary to advance such a policy. So Korea went through a process more akin to an accelerated Great Depression, with a rapid plunge and lots of bankrupted companies and pain, but emerging quickly from that period to again achieve high rates of growth and relative prosperity.
Obviously, the U.S. does not have a high internal savings rate either. But because of the reserve currency status of the U.S. dollar, and the preeminence enjoyed by U.S. Treasuries as the “safe” form of investment, we’ve effectively tapped into the surplus of Chinese savings to fund our apparent emulation of Japanese-style forbearance. The Chinese are our Japanese housewives, with one crucial difference: Japanese housewives were culturally indoctrinated to save at Japanese banks; there is no similar binding factor when it comes to the Chinese government.
So can we continue down the path of a Japan-style response to our banking crisis? If John Hempton is right in his analysis, then the answer to that question is entirely contingent on the choices made by China.