Latest Developments of The World Economy Daisuke Kotegawa Research Director, Canon Institute for Global Studies June 18, 2013 National Research University Higher School of Economics

22  The financial crisis in Japan can be divided into 4 phases Financial Crisis in Japan – 4 phases Lost Decade Phase1 ( ) Phase2 (1995) Phase3 ( ) Phase4 ( )

33 Financial Crisis in Japan – Phase 3 ( ) 1. What happened?  On November 4, due to the bankruptcy of Sanyo Securities, the first default of financial debt in the short-term money market occurred, rendering the money market dysfunctional  Scandals among bureaucrats in Ministry of Finance - cozy relationships between traditional bureaucracy and banks November 3, Sanyo Securities (7 th largest) went bankrupt November15, Hokkaido-Takushoku Bank went bankrupt November 24, Yamaichi Securities (4 th largest) announced its liquidation (Nov.24) November 26, Tokuyo-City Bank went bankrupt  The resulting credit crunch caused by the banks had a negative impact on the economy. GDP recorded negative growth (-0.1%) in 1997, first time since WWII.  The stormy Financial System Parliament – debated a lot of important financial system related laws  Consecutive bankruptcies of the financial institutions, including large banks and securities in a short time (so called “Black November” in 1997) I was the director in charge in MOF Bear Sterns (7 th largest) Lehman Bros.(4 th largest)

4 Top executives of four major entities which either collapsed or nationalized ( i.e. Hokkaido- Takushoku, Yamaichi, Long Term Credit Bank and Nippon Credit Bank ) were arrested for the allegations of illegal conducts, including window dressing settlement of their BS. After several years of court proceedings, those of LTCB were found innocent by the Supreme Court. Those of NCB are under review by the Supreme Court. Others served time in jail. Arrest of top executives—Necessary sacrifice?

BRICs:1/3% the world (2008:1/2) Recently: about 3%of the world Japan of which:1/3 EU China:25% of the world 1980s: about 10% of the world of which:50% USAAdvanced countries:1/3 Contribution to world economic growth ( ) Overview of Global Economy How this gap can be filled? Total :25% of world growth 1980s: USA and EU: about 35% of the world Not recover until 2014 Not recover until 2018 Emerging countries:1/3 BRIC ｓ other than China: about10%of the world

66 Set of Measures 1. The measures to protect financial sector from further adverse developments in the ongoing crisis, ( Safety Net ) i.e., the package of three measures,  recapitalizations,  the disposal of non-performing loans.  guarantees on inter-bank lending and 2. The implementation of these measures. This includes actual injection of public money and the disposal of non-performing loans. 3. The measures to be taken to avoid a vicious cycle between problems in financial sector and those of real economy. ( Fiscal Stimulus ) 4. The lessons learned from the ongoing crisis and the measures to be taken in order to avoid the repetition of the crisis in the future. This include, among other things,  strengthening transparency and accountability  enhancing sound regulation  promoting integrity in financial markets  reinforcing international cooperation, and  reforming international financial institutions. 5. The architecture of future global financial systems. Established among advanced countries Work-in Process Not yet completed Work-in Process Done Urgent Necessary Not Urgent

7 In the financial crisis in Japan, US urged a hard landing with three principles;  No bail-out of banks,  To maintain short-selling scheme, and  Observe mark-to-market accounting. All of these principles were breached in the ongoing crisis US vs Japan

88 Corporate Household Net Export Asset Balance Sheet Adjustment Government Repayments Over-borrowing GNP GNP Shrinks without Stimulus Liability Asset Over-borrowing With stimulus GNP not shrink

How long attack from market continue? Effectively Insolvent Excess Liquidity Investment banks western countries Deficit countries Short sales ＣＤＳ Short- term high return Escape from insolvency ＩＭＦ，ＥＵ Fiscal austerity Vicious Circle

Recovery of housing prices has been delayed Keys to recovery are disposal of non performing loans of financial institutions and recovery of real economy Current stability of financial system is pretentious thanks to relaxation of accounting rules Are the improvement in unemployment rate and favorable consumption figures good sign to recovery? Job creation by fiscal stimulus is essential Country of key currency does not have to worry about trade deficit US economy No ！！ Those who gave up job search Part-timer

11 UK, USA vs Continental Europe Introduction of financial transaction tax １． Expansion of ＥＳＦＳ to 2 Trillion Euro By way of regular tax revenue difficult Europe - What is happening under the table since last fall? Adverse effect on the City and Wall Street Concentration of risk on ECB Consequent additions of equities by ECB member countries ２． Purchase of Government bonds by ECB

12 Spain - NPLs of bank, Debt ratio of government Injection of capital to banks in Spain by ＥＣＢ Injection of capital to banks in Japan(1998,1999) Needs 100 billion About 93 billion GNP of Japan=4 times of GNP Spain Greece - Debt ratio of government Italy - Debt ratio of government Relaxation of Loan condition by IMF & EU Government bonds can be sold in the market? Issues in European economy September 12 Constitutional Court of Germany

13 Reinstatement of Glass Steagal Act Subscription for Europe Biggest Issue in presidential election Socialist parties in Germany & France JPMorgan Problem ＝ loss of US$ 2billion 2. Offense LIBOR manipulation Victims – Local communities of US Money Laundering HSBC, Standard Chartered Part of UK & Sandy Weil Destroy Investment banks

Loans Investments Deposits Other Liab Equity Essence of Banking Liabilitie s Asset － 10 ＝ 90 Credit Creation

15 Problem of Cyprus Scheme I When a bank fails, shareholders first take loss, then creditors. Depositors are always asked to take loss last. Banks can create credits based upon depositors’ confidence Investment banks gamble and lose money In order to maintain confidence, governments usually put priority on protecting deposits by way of deposits insurance Banks operate by deposits (=other people’s money) In the financial crisis in Japan, all amount of deposits were protected. Ceiling on the deposits eligible for protection was put only after crisis was over

16 Problem of Cyprus Scheme II Deposits in US and UK banks would not be protected. Lack of protection on deposits over certain amount in Cyprus triggered capital flight from Spain There is a joint paper by the FDIC and the Bank of England in December 2012 Capital flight from endangered European countries to USA. Dutch finance minister said “Cyprus scheme will be a template” Title II of Dodd-Frank Act Losses of any financial company placed into receivership will not be borne by taxpayers, but by common (depositors) and ----other unsecured creditors Is this a right move? No!