Rebuilding of the European and US Economy and Japan

Richard C. Koo Chief Economist Nomura Research Institute Tokyo January 2012

Exhibit 1. US Housing Prices Are Moving along the Japanese Experience

(US: Jan. 2000=100, Japan: Dec. 1985=100) 260 240 220 200 180 160 140 120 100 80

Futures

US: 10 Cities Composite Home Price Index Japan: Tokyo Area Condo Price1 Composite Index Futures

Japan: Osaka Area Condo Price1

60 40 92 77 93 78 94 79 95 80 96 81 97 82 98 83 99 84 00 85 01 86 02 87 03 88 04 89 05 90 06 91 07 92 08 93 09 94 10 95 11 96 12 97 13 98 14 99

US Japan

Note: per m 2, 5-month moving average Sources: Bloomberg, Real Estate Economic Institute, Japan, S&P, S&P/Case-Shiller Home Price Indices, as of Jan. 11, 2012

Exhibit 2. US Commercial Real Estate Prices Also Falling to Japanese Levels

(peak = 100) 110

100

US: Commercial Property Price Index

90

80

70

Down 42.0% from Peak

60

50

40

"Pretend & Extend" Japan: Commercial Land Price Index in Six Major Cities
01 84 02 85 03 86 04 87 05 88 06 89 07 90 08 91 09 92 10 93 11 94

30

20

US Japan

Note: Peak of US Prices: Oct. 2007, Peak of Japanese Prices: Sep. 1990. Source: Nomura Research Institute, based on Moody's/Real Estate Analytics and Japan Real Estate Institute

Exhibit 3. Drastic Rate Cuts Have Done Little to Revive Employment or House Prices
(%) 8

Australia
7

UK
6

EU US

Japan
1

0 2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Sources: BOJ, FRB, ECB, BOE and RMB Australia. As of Jan. 11, 2012.

Exhibit 4. US Economy Is still a Long Way from Previous Peak

(2007=100, Seasonally adjusted) 103 101 99 97 95 93 7.5 91 89 87 85 8.0 (%, Seasonally adjusted, inverted) 3.5 4.0 4.5 5.0

Unemployment Rate (right scale)

Industrial Production (left scale) Last seen in 2005

5.5 6.0 6.5 7.0

Unemployment rate: Last seen in 1983

8.5 9.0 9.5 10.0

Industrial Production:Last seen in 1997

83 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Sources: US Department of Labor, FRB

10.5 11.0

Exhibit 5. Euro-Zone Economy Is still a Long Way from Previous Peak

(Seasonally adjusted, 2005=100) 115 (%, Seasonally adjusted, inverted) 7.0

110

Unemployment Rate (right scale)

7.5

8.0 105 8.5

100

Last seen in 2005

9.0 95 9.5

90

Industrial Production (left scale) Last seen in 1998

10.0

85 1998

10.5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Sources: Eurostat

Exhibit 6. Except in Germany, Industrial Production in Europe Is still Weak

(2005 = 100, Seasonally Adjusted) 120 115 110 105 100 95

Level last seen in

Spain France Italy Germany 2007: Germany

1997: France
90 85 80 75 70 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Source: Eurostat

1993: Italy 1996: Spain

Exhibit 7. Drastic Liquidity Injection Failed to Increase Money Supply (I): US

320 300 280 260 240 220 200 180 160 140 120 100 80 3.0 2.5 2.0 1.5 1.0 0.5 08/1 08/4 08/7 08/10 09/1 09/4 09/7 09/10 10/1 10/4 10/7 10/10 11/1 11/4 11/7 11/10
Sources: Board of Governors of the Federal Reserve System, US Department of Commerce Note: Commercial bank loans and leases, adjustments for discontinuities made by Nomura Research Institute.

(Aug. 2008 =100, Seasonally Adjusted)

Monetary Base Money Supply (M2) Loans and Leases in Bank Credit

Down 25%

(%, yoy)

Consumer Spending Deflator (core)

Exhibit 8. Drastic Liquidity Injection Failed to Increase Money Supply (II): EU

150 (Aug. 2008 =100, Seasonally Adjusted)

Base Money
140

Money Supply (M3) Credit to Euro Area Residents

130

120

110

100

90 2.2 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 (%, yoy)

CPI core

08/1

08/4

08/7

08/10

09/1

09/4

09/7

09/10

10/1

10/4

10/7

10/10

11/1

11/4

11/7

11/10

Sources: ECB, Eurostat Note: Base money's figures are seasonally adjusted by Nomura Research Institute.

Exhibit 9. Drastic Liquidity Injection Failed to Increase Money Supply (III): UK

310 280 250 220 190 160 130 100 70 6 5 4 3 2 1 0 (%, yoy) (Aug. 2008 =100, Seasonally Adjusted)

Reserve Balances + Notes & Coin Money Supply (M4) Bank Lending (M4)

Aug. 08' Down 17%

CPI (ex. Indirect Taxes)

07/1

07/7

08/1

08/7

09/1

09/7

10/1

10/7

11/1

11/7

Sources: Bank of England, Office for National Statisics, UK Notes: 1. Reserve Balances data are seasonally unadjusted. 2. Money supply and bank lending data exclude intermmediate financial institutions.

Exhibit 10. Drastic Liquidity Injection Failed to Produce Drastic Increase in Money Supply (IV): Japan
350 (1990/1Q = 100, Seasonally Adjusted)

300

Monetary Base Money Supply (M2) Bank Lending

Quantitative Easing

Earthquake

250

1990/1Q
200

Textbook Economics
(Monetary Policy Ef f ective)

Balance Sheet Recession

(Monetary Policy NOT Ef f ective)

150

Down 41%

100

50 4 3 2 1 0 -1 -2 -3 (y/y, %)

CPI Core

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Note: Bank lending are seasonally adjusted by Nomura Research Institute. Source: Bank of Japan

10

Exhibit 11. Japans De-leveraging with Zero Interest Rates Lasted for 10 Years
Funds Raised by Non-Financial Corporate Sector
(% Nominal GDP, 4Q Moving Average) 25 (%) 10

20

CD 3M rate (right scale) Borrowings from Financial Institutions (left scale)

15

Funds raised in Securities Markets (left scale)

10 4

0 Debt-financed bubble (4 years)

-5

Balance sheet recession (16 years)

-2

-10

-4

-15 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Sources: Bank of Japan, Cabinet Of f ice, Japan

-6

11

Exhibit 12. Japans GDP Grew in spite of Massive Loss of Wealth and Private Sector De-leveraging
(Sep. 1990=100) (Sep.1990=100, Seasonally Adjusted)

140

130

Nominal GDP (Right Scale)

120

Real GDP (Right Scale)

115

100

100

Likely GDP Path w/o Government Action

80 85

Cumulative 90-05 GDP Supported by Government Action: ~ 2000 trillion

60

70

40

55

Last seen in 1973

20 40

down 87%

Land Price Index in Six Major Cities (Commercial, Left Scale)

0 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Sources: Cabinet Of f ice, Japan Real Estate Institute 25

Cumulative Loss of Wealth on Shares and Real Estate ~ 1500 trillion

12

Exhibit 13. Japanese Government Borrowed and Spent the Unborrowed Savings of the Private Sector to Sustain GDP
(Tril. yen) 110

Government spending
100 90 80 70 60 50 40

cumulative cyclical deficit 90-05 315 trillion overall deficit 460 trillion Bubble Collapse

30 20

Tax revenue

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Source: Ministry of Finance, Japan Note: FY 2011 includes 4th supplementary budget and FY2012 is initial budget.

13

Exhibit 14. Premature Fiscal Reforms in 1997 and 2001 Weakened Economy, Reduced Tax Revenue and Increased Deficit
(Yen tril.) 80 (Yen tril.) 80 Earthquake Koizumi fiscal reform Global Financial Crisis 70

70

Tax Revenue Budget Deficit

Hashimoto fiscal Obuchi-Mori reform fiscal stimulus

60

60

50

50

*
40

unnecessary increase in deficit: 40 103.3 tril.

30

30

20

20

10

10

0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

(FY) Source: Ministry of Finance, Japan Notes: Latest f igures(*) are estimated by MOF. From FY2011, f igures includes reconstruction taxes and bonds.

14

Exhibit 15. US in Balance Sheet Recession: US Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %, quarterly) 8

Households
6

(Financial Surplus) Rest of the World Shift from 4Q 2006 in private sector: 9.13% of GDP
Corporate: 1.32% Households: 7.81%

4 2 0 -2 -4 -6 -8 -10 -12 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used. Sources: FRB, US Department of Commerce

General Government Corporate Sector

(Non-Financial Sector + Financial Sector)

Shift from 4Q 2006 in public sector: 7.15% of GDP IT Bubble Housing Bubble

(Financial Deficit)

15

Exhibit 16. UK in Balance Sheet Recession: UK Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %) 9

Households
6

(Financial Surplus) Rest of the World Shift from 1Q 2007 in private sector: 6.77% of GDP
Corporate: 0.88% Households: 5.90%

-3

-6

-9

General Government (Financial Deficit)

Corporate Sector
(Non-Financial Sector + Financial Sector)

Shift from 1Q 2007 in public sector: 6.45% of GDP

-12 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used. Source: Of f ice f or National Statistics, UK

16

Exhibit 17. Global Bond Yields* Nearing Japanese Levels

(%) 6

England US Sweden Switzerland Japan

Japanese Bond Yield in 1997

3%
2

0.9%
1

0 2007

2008

2009

2010

2011

2012

*Note: Excluding Eurozone. As of Jan. 12, 2012. Source: Bloomberg

17

Exhibit 18. Euro-zone in Balance Sheet Recession: Euro-zone Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %) 6

(Financial Surplus) Households

4

Shift from 3Q 2008 in private sector: 4.28% of GDP

Corporate: 2.81% Households: 1.47%

Rest of the World

-2

-4

General Government
-6

Shift from 3Q 2008 in public sector: 3.99% of GDP

Corporate Sector
(Non-Financial Sector + Financial Sector)

(Financial Deficit)
-8 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Note: For the latest f igures, 4 quarter averages ending with 2Q/11' are used. Source: ECB

18

Exhibit 19. Euro-Zone Bond Yields Are Diverging Sharply

(%) 40

35

Greece Ireland

30

Portugal Spain

25

Italy France

20

Germany

15

10

0 2007 Note: As of Jan. 12, 2012. Source: Bloomberg

2008

2009

2010

2011

2012

19

Exhibit 20. Spain in Balance Sheet Recession: Spanish Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %) 12

(Financial Surplus) Households

9

Rest of the World

6

Shift from 3Q 2007 in private sector: 17.95% of GDP

Corporate: 12.54% Households: 5.41%

-3

-6

Shift from 3Q 2007 in public sector: 11.93% of GDP Corporate Sector General Government
96 97 98 99 00
(Non-Financial Sector + Financial Sector)

-9

-12 01

(Financial Deficit)
02 03 04 05 06 07 08 09 10 11

Note: For the latest f igures, 4 quarter averages ending with 2Q/11' are used. Source: Banco de Espaa

20

Exhibit 21. Ireland in Balance Sheet Recession: Irish Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %) 20 15 10 5 0 -5 -10 -15 -20 -25 -30 -35 2002 2003 2004

Corporate Sector

(Financial Surplus)
Rest of the World Shift from 2007 in private sector: 29.60% of GDP
Corporate: 14.99% Households: 14.61%

(Non-Financial Sector + Financial Sector)

Households

General Government

Shift from 2007 in public sector: 31.20% of GDP

(Financial Deficit)
2005 2006 2007 2008 2009 2010

Sources: Eurostat, Central Statistics Of f ice, Ireland

21

Exhibit 22. Portugal in Balance Sheet Recession: Portuguese Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %) 12

(Financial Surplus) Rest of the World Shift from 2Q 2008 in private sector: 8.65% of GDP
Corporate: 4.70% Households: 3.95%

Households

General Government
-3

-6

Shift from 2Q 2008 in public sector: 6.21% of GDP Corporate Sector

(Non-Financial Sector + Financial Sector)

-9

-12 99 00 01 02 03

(Financial Deficit)
04 05 06 07 08 09 10 11

Note: For the latest f igures, 4 quarter averages ending with 2Q/11' are used. Source: Banco de Portugal

22

Exhibit 23. Balance Sheet Correction in France Was Minimal

Financial Surplus or Deficit by Sector
10 8 6 4 2 0 -2 -4 -6 -8 99 00 01 02 03 04 05 06 07 08 09 10 (as a ratio to nominal GDP, %)

(Financial Surplus)
Households Rest of the World

Shift from 2006 private sector: 3.43% of GDP

Corporate: 2.85% Households: 0.57%

General Government

Corporate Sector
(Non-Financial Sector + Financial Sector)

Shift from 2006 public sector: 4.71% of GDP

(Financial Deficit)

Sources: ECB, Eurostat

23

Exhibit 24. Balance Sheet Correction in Italy Was Minimal

Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %, quarterly) 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 96 97 98 99 00 01 02 03 04 05

(Financial Surplus) Households Shift from 3Q 2008 in private sector: 3.49% of GDP Rest of the World
Corporate: 4.53% Households: -1.04%

Shift from 3Q 2008 in public sector: 1.90% of GDP General Government Corporate Sector (Financial Deficit)
(Non-Financial Sector + Financial Sector)

06

07

08

09

10

11

Note: For the latest f igures, 4 quarter averages ending with 2Q/11' are used. Sources: Banca d'Italia, Eurostat

24

Exhibit 25. Balance Sheet Correction in Greece Was Minimal

Financial Surplus or Deficit by Sector
25 (as a ratio to nominal GDP, %, quarterly)

(Financial Surplus)
20

Rest of the World

Households Shift from 2Q 2008 in private sector: 1.18% of GDP

Corporate: 4.27% Households: -3.09%

15

10

-5

-10

Shift from 3Q 2008 in public sector: 1.82% of GDP Corporate Sector

(Non-Financial Sector + Financial Sector)

-15

(Financial Deficit)
05 06 07

General Government
08 09 10 11

-20 01 02 03 04

Note: For the latest f igures, 4 quarter averages ending with 2Q/11' are used. Sources: Bank of Greece, Eurostat

25

Exhibit 26. ECB Facing Balance Sheet Recession Can Supply Large Amounts of Liquidity without Igniting Inflation
(Aug. 2008 = 100, seasonally adjusted) 350 325 300 275 250 225 200 175 150 125 100 75 2007 2008 2009 2010 2011 Notes: 1. UK's reserve balances data are seasonally unadjusted. 2. UK's money supply and bank lending data exclude intermmediate f inancial institutions. 3. Base money's f igures of Eurozone are seasonally adjusted by Nomura Research Institute. Source: Nomura Research Institute, based on FRB, ECB and Bank of England data.

Eurozone Monetary Base (=Liquidity) US UK Eurozone Money Supply US UK

Aug. 2008

US-like monetary easing would allow ECB to supply 1.3 tril. worth of additional liquidity.

26

Exhibit 27. European Banks Are Already on Credit-Crunch Mode

(D.I.) 50 more banks tightning credit standards compared to 3 months ago 40 0 30 more banks easing credit standards compared to 3 months ago

Lending Attitudes of Euro-zone Banks

large sized firms

20

10

-10

small and medium-sized firms

-20 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: Nomura Research Institute, based on ECB, The Euro Area Bank Lending Survey. Note: D.I. are calculated f rom the answers to the question, "Over the past three months, how have your bank's credit standards as applied to the approval of loans or credit lines to enterprises changed?" D.I. = ("Tightened considerably" + "Tightened somewhat"0.5) - ("Eased somewhat"0.5 + "Eased considerably")

27

Exhibit 28. Sustaining Fiscal Stimulus in Democracy during Peacetime Is Difficult

Authoritarian
No opposition (if any, quickly suppressed)

Democracies
"Bond market might rebel" "Big Government is BAD Government" "Wasteful spending" "Monetary Policy should work better" "Aging Population" "Should not use grand-children's credit card" "Structual Reform is what is needed" "Republicans, Tea Party types and Blue Dog Democrats (U.S.)" "Need to beg Chinese to buy more Treasuries (U.S.)"

...
28

Exhibit 29. Exit Problem (I): Japanese Corporates Increased Savings Again After Lehman
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %) 15

(Financial Surplus)
12 9 6 3 0 -3 -6 -9

Households Shift from 1Q 2009 in private sector: 6.39% of GDP

Corporate: 4.94% Households: 1.45%

Rest of the World

Corporate Sector
-12 -15 -18 (Non-Financial Sector + Financial Sector)

General Government

Shift from 1Q 2009 in public sector: 5.78% of GDP

Balance Sheet Recession (Financial Deficit)

Global Financial Crisis

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used. Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Of f ice, National Accounts

29

Exhibit 30. Exit Problem (II): German Private Sector Refused to Borrow Money after 1999-2000 Telecom Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %) 8

Households
6 4 2 0

(Financial Surplus)

Telecom Bubble

Shift from 2000 to 2005 in private sector: 12.06% of GDP

Corporate: 9.26% Households: 2.80%

Rest of the World

-2 -4 -6 -8 -10 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Corporate Sector (Non-Financial Sector + Financial Sector)

General Government

Balance Sheet Recession (Financial Deficit)

Shift from 2000 to 2005 in public sector: 4.62% of GDP

Sources: Deutsche Bundesbank, Federal Statistical Of f ice Germany Note: The assumption of Treuhand agency's debt by the Redemption Fund f or Inherited Liabilities in 1995 is adjusted.

30

Exhibit 31. Exit Problem (III): U.S. Took 30 Years to Normalize Interest Rate after 1929 Because of Private Sector Aversion to Debt
(%)
9 8 US government bond yields Prime BA, 90days US government bond yields 1920-29 average (4.09%, June 1959) Prime BA, 90days 1920-29 average (4.13%, September 1959)

7 6 5
Oct '29 NY Stock Market Crash '33 New Deal Dec '41 Pearl Harbor Attack Jun '50 Korean War

4 3 2

1 0 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60
Source: FRB, Banking and Monetary Statistics 1914-1970 Vol.1, pp.450-451 and 468-471, Vol.2, pp.674-676 and 720-727

31

Exhibit 32. Recovery from Lehman Shock Is NOT Recovery from Balance Sheet Recession

Bubble Burst

Lehman Shock

Likely GDP Path without Lehman Shock

Economic weakness from private-sector (A) de-leveraging

Weaker Demand from Private Sector De-leveraging

Economic weakness from policy mistake (B) on Lehman

Actual GDP Path

Stronger Demand from Government's Fiscal Stimulus Current Location

Source: Nomura Research Institute

32

Exhibit 33. Before the Earthquake, Japan Was Running Increasingly Larger Trade Surpluses even with Strong Yen
Japans Trade Balances with Korea, Taiwan and China
( bil. Seasonally adjusted, 3 months moving average) 500

Korea
400

(Surplus)

Taiwan China (including Hong Kong) China (excluding Hong Kong)

300

200

100

-100

-200

Earthquake

-300

(Deficit)
-400 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Source: Nomura Research Institute, based on Ministry of Finance, Japan, Trade Statistics Note: Seasonal adjustments by Nomura Research Institute.

33

Exhibit 34. Industrial Production Fell to the Level of 1987 after the Earthquake
(Seasonally adjusted) 1.2 (Seasonally adjusted, 2005=100) 115

forecast Industrial production (right scale)

1.1 110 105 1.0 100 0.9 95

0.8

Last seen in 2002

90 85

0.7

Job offers to applicants ratio (left scale)

Last seen in 2003

Last seen in 1987

80 75

0.6

0.5

Last seen in 1983

70

Lowest on record
0.4 2000 65 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Note: Forecasts are calculated f rom METI's survey on planned production. Sources: Ministry of Economy, Trade and Industry (METI), and Ministry of Health, Labour and Welf are

34