Question 1:    You are the Chief Economist of Nomura Research Institute, the research division of Nomura Securities, the leading securities house in Japan.  You are a trained economist, a visiting professor of Waseda University and recipient of the Abramson Award by the National Association of Business Economics.  In the past you worked with the U.S. Federal Reserve where you dealt with syndicated loans to Latin America and were a Doctoral Fellow of the Federal Reserve Bank of New York.  I know from the book that you also are a U.S. citizen and the son of Chinese immigrants.  Obviously you are a man who knows Asia, international business and finance and the World.  You also are the author of many other books.  Why did you decide to write this book and what are you hoping that its publishing will achieve?

  First, there are just too much misunderstanding outside Japan as to the real driver of recession in the country. I also found that once I explain the concept of balance sheet recession, most people are surprisingly willing to listen. They must have felt that the conventional "structural reform or bust"arguments are not sufficiently convincing to explain what has happened to Japan.
After all, those structural problems had been around for a long time, but  they did not keep the Japanese economy from becoming the second largest economy in the world.  Second, as for the banking crisis, so much of the key information on this issue has never been reported in the English press, resulting in a massive perception gap between the policy makers in Japan and those making noise abroad.  Third, I noticed that after the collapse of the IT bubble and the corporate accounting mess, the US economy is beginning to display the symptoms of a balance sheet recession. As a US citizen, I wanted to warn my people that this disease is different from the usual recessions and that  proper care should be put in place quickly. In particular, I did not want them to waste time relying on monetary policy when the only effective cure available is fiscal stimulus.

Question 2:    In your new book Balance Sheet Recession which has just been published by J. Wiley & Sons, you state that “the root cause of Japans economic weakness during the last decade has had more to do with Company balance sheet problems than with Japan’s overall lack of structural reform.”  Exactly what is a balance sheet recession, are they common and is the fact that Japan is currently in the midst on one recognized by the current Japanese government?
Answer:  Balance sheet recessions are highly uncommon and happen following the bursting of a nation-wide asset price bubble. Balance sheet recessions are as rare as a nation-wide asset price bubble which happens perhaps once every two generations. This type of recession is unlike other recessions in that the inventory cycle is not the key driver. The key driver in this recession is the corporate effort to repair their balance sheets by postponing investments and instead, paying down debt. When a large number of companies move away from the usual goal of profit maximization to debt minimization all at the same time in their effort to regain their financial health, the balance sheet recession starts.
Although a large number of policy makers in Japan are becoming aware of the concept of balance sheet recession (largely because of my frequent TV appearances with key policy makers), it is still an extremely new concept in the economics profession not just in Japan but in the world. The current Koizumi government, unfortunately, does not understand the concept or the proper remedy. In spite of many one-to-one nationally televised debates I have had with Minister Takenaka, he refuses to understand it either. And that is why the Japanese economy is going nowhere.
Question 3:  In your book at page 7 you show a chart (Exhibit 1.2 Falling asset prices forced companies to move away from profit maximization to debt minimization).  Could you explain what this chart demonstrates and how it relates to a balance sheet recession and the points you were making above?

Answer:  I just noticed while trying to answer your question that a horizontal line at zero mentioned in page 6 is missing from 1.2. I guess I have to get back to the publisher for this horrible mistake.  (It is corrected on the graphic above.) The point of this chart is that households in Japan really did not change their behavior since the beginning of 1990, supplying 5 to 8 percent of the GDP equivalent of savings to the economy each year. But the corporate sector did change its behavior, from a net taker of funds to a net supplier funds to the economy. This shift resulted in a loss of aggregate demand equivalent to 14 percent of GDP.
Question 4:  In the next chapter, you show another graphic (Exhibition 2.4
Net wealth ratio of Japanese companies
) and note that Japan has experienced a greater loss of wealth than the loss experienced by the U.S. in the Great Depression.  I don’t think this point is common knowledge or if it is, it isn't commonly discussed.  Could you clarify this point and also explain how Japan’s economic performance since the late 1980s should be viewed in light of this?

Answer: Exhibit 2.4 does not show that the wealth lost in Japan during the last decade is more than the wealth lost in the US during the depression. It only shows that the corporate asset and liability position improved dramatically during the bubble and deteriorated equally quickly afterward.   Secondly, because the Japanese economy managed to muddle through in spite of such horrendous loss of wealth, most people are not aware of how much wealth was actually lost in the country. It is for this reason that the current recession is called the "bankers' and managers' recession", since only
those two groups of people are aware of the actual state of the balance sheets in the country, the true driver of this recession.  It is truly miraculous that the economy managed to stay afloat for so long in spite of so much losses in national wealth. It is for this reason that I believe Japan's fiscal policy during the last ten years has been one of the most successful fiscal stimuluses in history.
Question 5:   The current Japanese government has followed a policy called “quantitative easing”.  Why specifically do you feel that this policy and monetary policy in general will be ineffective in helping the economy to begin to truly grow again?

Answer:  Monetary policy is ineffective because nobody is borrowing money. There has to be borrowers out there, either pubic or private, who are willing to borrow money for the money supply to increase. With the corporate sector now a net supplier of funds to the economy to the tune of 20 trillion yen a year, all the high-powered money supplied by the Bank of Japan (BOJ) through quantitative easing is stuck within the banking system.

Question 6:  Adam Smith in his writings on capitalism argued that the “invisible hand” will work to bring prosperity and growth by businesses seeking profit maximization.  Was Adam Smith wrong and why isn’t the invisible hand working for Japan at this time?

Answer: He was right, but Japanese businesses are not meeting his fundamental  assumption that they maximize profits. Instead they are minimizing debt. Such a world is not covered by Adam Smith or by the economics profession for that matter, and that is why we need an entirely new macro economic theory (balance sheet recession) for such occasions
Question 7:  Also in your book in Chapter 9 you discuss the real challenges facing Asian economies.  You discuss about the Asian Financial Crisis and its aftermath and note that balance sheet recessions are not only a problem in Japan.  Many observers have pointed the finger at structural issues, crony capitalism, foreign exploitation of exchange rates, weak banking regulation or greed as causing the crisis.  Do you agree or disagree and if so why or why not?

Answer: There is no smoke where there is no fire. All the structural issues mentioned in your question certainly contributed to the severity of the crisis. However, they are not the key driver of the Asian currency crisis. This is because if the lenders of funds did their homework, they would have noticed all of those factors and would have priced them into their lending to the region. If the international lenders did that, it is highly unlikely that there would be a bubble in the Asian asset markets in the first place.  It takes two to tango, and in this case, the lack of due diligence on the part of international investors was more to blame for the crisis because due diligence by the bankers could have and should have prepared them for these factors which had been around for decades prior to the crisis.
Question 8:   In 1999 and thereafter many parts of Southeast Asia regained their competitiveness.  Is this likely to continue and how does China as a competitor play into the equation?  Also are there things that you would advise the countries of Southeast Asia to focus on to improve their competitive position vis-à-vis China?

Answer:  China poses a very serious challenge to the economies of S.E. Asia for all the reasons mentioned in the book. In addition, what the Chinese challenge indicates is that relying on foreign capital for economic development is viable only if the country is the lowest cost producer. Once that distinction is lost to somebody else, inflow of foreign capital could fall off rapidly. In other words, reliance on foreign capital for growth is an easy-come easy-go process. For long-term sustained growth, countries in South East Asia must cultivate and nurture their own technological and other strengths (such as their possessing a strong legal framework). Such an effort to create and nurture a domestic value-added base, however, may run counter in the short run to the principles of market opening and free flow of goods and services.
Question 9:  Based on your study of Balance Sheet Recessions and the current situation in Japan, you also note that Japan’s situation may have lessons for the U.S.  Could you discuss what these lessons are and whether you feel that the lessons have been noted and are being acted upon?

Answer:  The key lesson is that the US should not wait hoping that monetary policy easing will turn the economy around. If the US has contracted this disease called balance sheet recession, it will have to mobilize its fiscal policies in a timely and pro-active fashion in order to keep the damage from the recession to an absolute minimum.( I know that former White House Advisor on Economic Policy Larry Lindsey was fully aware of the danger of a balance sheet recession.)  Now that he is gone, I am not sure whether the new economic team in Washington understands the danger of balance sheet recession.
Question 10:  The U.S. stock market has been weak of late even in spite of positive news with the completion of the War in Iraq.  President Bush’s tax cut seems to be in some trouble in Congress.  The U.S. budget has gone back into deficit largely to fund the War on Terrorism and the War on Iraq.  How do you see the U.S. economy progressing over the next year and is a Balance Sheet Recession, Double Dip Recession or even a Depression a possibility and if so why or why not?

Answer: The US is likely to muddle through just like the Japanese economy muddled through during the last ten years.  This is because the large deficit brought about by the war and the automatic stabilizer actually represents an important fiscal stimulus needed to keep the economy going in this type of recession.  However, not realizing that this recession is fundamentally different from the usual recession, the US policy makers are not likely to apply the fiscal stimulus in a consistent and pro-active fashion. This will deprive the US from entering a virtuous cycle until policy makers realize that this recession is fundamentally different from the rest and react accordingly.
Question 11:   In the last Chapter of your book you talk about the real challenges facing Japan – among these you include inefficient use of land, the need to make Japan more attractive for companies to invest, the need to change Japanese public perceptions about saving, the need to improve housing, etc.  Could you speak about some of these points and how progress in solving these issues would help to improve Japan’s overall financial outlook?

Answer:  As I indicated in the book, increasing investment opportunities by changing people's life styles and relaxing land use laws in Japan will help bridge the huge gap between investment and savings inside the country. That, in turn, will reduce the need for fiscal stimulus to keep the economy going. However, as I indicated in the book, changing people's savings behavior is an extremely difficult task. Thus, this must be viewed as a medium-term objective. The progress in this front, however, is pitifully slow because most people do not realize the need for change from a macro-economic perspective. In other words, most people still do not realize that the real problem in Japan is the fact that the household sector is saving but the companies are not borrowing even at zero interest rates.
Question 12:  In summary, are you optimistic about Japan and the World economy say over the next three to five years and if so why or why not?  Also, if not, what actions by the current government or by other actors could help to improve the situation?          

Answer: Given that most people have never even heard of a balance sheet recession, even within the economics profession, I am not that optimistic in the short-run. However, as more and more people begin to realize that such a type of recession can actually happen and that they are actually in the middle of it, I am confident that they will take the kind of actions suggested in this book to rid themselves of the disease. That is the whole purpose of writing this book in English in the first place.


About the author:
Richard C. Koo is the Chief Economist of Nomura Research Institute, the research arm of Nomura Securities, the leading securities house in Japan.  Consistently voted as one of the most reliable economists by Japanese capital and financial market participants for nearly a decade, he has also advised successive prime ministers on how best to deal with Japan's economic and banking problems.  He served as an economist with the Federal Reserve Bank of New York, and was a Doctoral Fellow of the Board of Governors of the Federal Reserve System.  Author of many books and a visiting professor of Waseda University, he was awarded the Abramson Award by the National Association of Business Economics, Washington, D.C. for 2001.

About the Interviewer:   Christopher W. Runckel, a former senior US diplomat who served in many counties in Asia, is a graduate of the University of Oregon and Lewis and Clark Law School.  He served as Deputy General Counsel of President Gerald Ford’s Presidential Clemency Board.

Until April of 1999, Mr. Runckel was Minister-Counselor of the US Embassy in Beijing, China.  Mr. Runckel lived and worked in Thailand for over six years.  He was the first permanently assigned U.S. diplomat to return to Vietnam after the Vietnam War.  In 1997, he was awarded the U.S. Department of States highest award for service, the Distinguished Honor Award, for his contribution to improving U.S.-Vietnam relations.  Mr. Runckel is one of only two non-Ambassadors to receive this award in the 200-year history of the U.S. diplomatic service.

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