Nomura’s Richard Koo has been banging on about the similarities between Japan’s balance sheet recession and the current financial malaise for a long while.
His main point has always been that the financial system won’t recover unless corporates and households complete their deleveraging journey.
On Wednesday he provides some charts to help illustrate the journey’s progress thus far.
Let’s start with Japan’s corporate sector:
As he explains, when the white bar, indicating financial assets, is above the centre line, it implies that financial assets increased during the given period; when it is below the centreline it means financial assets shrank.
The grey bars, indicating financial liabilities, are on an inverse scale, so a bar below the center line signifies an increase in liabilities while a bar above the centre line signals a decrease in liabilities.
Thus what we can see here is that up until the Japan’s bubble collapsed in 1990, the country’s corporate sector was growing at rapid pace with liabilities growing faster than assets. Or as he puts it “businesses were borrowing large sums of money to purchase financial assets and real assets.”
After the bubble burst, that growth in financial liabilities slowed sharply, even turning negative in 1997 — indicating that corporates had actually started to pay down debt. This deleveraging continued until 2004, even though interest rates were at zero, indicating “just how desperate corporates were to repair their balance sheets”.
The paying down of debt only stopped in 2005. But instead of taking on new liabilties they moved to restore the pool of financial assets that had been depleted during the difficult years.
A similar story can be observed in Japan’s household sector, despite the fact that financial asset growth far outpaced the growth of financial liabilities.
As Koo explains:
As Figure 2 shows, financial asset growth in Japanese households greatly exceeded the growth in financial liabilities through the first half of the 1990s, reflecting a history of high savings rates. But growth in financial assets (savings) fell steadily after the bubble burst and had dipped nearly to zero by 2003. This was attributable more to sluggish incomes than to aging demographics, in my view. It was during this period that employment and wage adjustments began and “restructuring” became a buzzword, pushing many households into a tight financial corner. Financial assets did not resume growing until 2004, when improvements in the job market enabled households to start saving again.
Growth in financial assets slumped again as the global financial crisis depressed incomes, but picked up sharply last year following the March earthquake and tsunami. The disaster—and the subsequent problems at the nuclear plants—fueled widespread concerns about the future, prompting people to cut consumption and increase savings.
Growth in household financial liabilities fell sharply after the bubble burst, and from 1998 onward households not only stopped borrowing money but in most years were paying down existing debt. I attribute this largely to sluggish demand for home mortgage loans as land prices fell. The combined private savings surplus for Japan’s household and corporate sectors is now running at 9.5% of GDP. At a time when the strong yen and overseas economic weakness prevent Japan from boosting its exports, these savings could easily shrink GDP by 9.5% a year if the government did not step in to borrow and spend the surplus.
So how does this story compare to the US?
Well, Koo provides the following charts. First, we have an illustration of the deleveraging journey of US nonfinancial companies:
As Koo notes, it’s clear that corporate deleveraging in the US has been much more cyclical. Nevertheless there are still many factors in the journey that echo those of Japan:
Next I would like to take a look at financial assets and liabilities at US companies. As Figure 3 shows, the last thirty years have been characterized by periods of substantial growth in both financial assets and liabilities followed by periods of little or no increase. Growth in financial liabilities and assets saw especially sharp declines in 1990, when the mini-bubble in commercial real estate collapsed, and in 2001, when the IT bubble burst.
Still, the US corporate sector experienced a pronounced savings surplus in only one year—1993. But after Lehman Brothers failed in 2008, corporate fund procurement (i.e., financial liabilities) fell sharply and businesses were forced to drawn down financial assets, most likely because the credit crunch made it very difficult for companies to obtain funding. In 2009 US companies began accumulating financial assets and paying down debt in spite of zero interest rates, probably as a defensive response to the financial crisis and credit crunch of 2008.
Over the last two years some firms have been procuring funds (i.e, increasing financial liabilities), but that was outstripped in aggregate by an increase in corporate sector savings (i.e., an increase in financial assets). The fact that US corporate balance sheets were not particularly weak to begin with probably made it possible for some firms to obtain funding.
But there’s also the point that there was never really the same corporate issue in the US, as there was in Japan.
Hence it’s the following chart, depicting the US household deleveraging journey, which is perhaps much more pertinent to the comparison:
Indeed, the similarities strike us as much more evident.
As Koo himself notes:
Let us now look at the situation at US households with their damaged balance sheets. As Figure 4 shows, their behavior since 2008 has mirrored that of Japanese households and companies over the last decade and a half: they are both reducing financial liabilities (paying down debt) and increasing financial assets (savings) in spite of zero interest rates. Together, the household and corporate sectors are now net savers to the tune of 5.8% of GDP. That this surplus of private savings is occurring at a time when interest rates are at zero is a clear indication the US is in a balance sheet recession triggered by the first crash in house prices in seven decades.
All of which supports the idea that lessons from Japan’s Great Depression should be respected, we would say.