Over the past few days, I delved into a book titled “The Great Recession,” authored by Gu Chao Ming, who is the Chief Economist at Nomura Securities, Japan’s largest brokerage firm. Gu also boasts an impressive tenure at the Federal Reserve Bank of New York, providing him with a profound understanding of economic dynamics. This article aims to share insights from his book, which examines the operational logic of modern economies, explores why monetary policy failed in Japan, and deciphers the economic implications of such phenomena.
The book begins by highlighting a distinctive feature of the Japanese economy leading up to the 1990s: Japanese companies had accumulated more debt than their Western counterparts to fuel expansion. This high leverage contributed to their growth rates but also made them vulnerable to economic downturns. The immediate response of these companies to an economic slowdown was to deleverage. Between 1991 and 1994, the share of private corporate investment in Japan’s GDP, previously on a rising trend, took a sharp downturn. Gu proposes that the pursuit of minimizing debt, triggered by a collapse in asset prices, fundamentally altered the logic of economic operation during boom times.
In a thriving economy, consumer spending is a primary driver of economic activity. For instance, if an individual earns 1000 units of currency, they might spend 900 and save the remaining 100 in a bank. This spending becomes income for others, who in turn spend and save, perpetuating economic activity. Banks lend out savings to businesses in need of funds, thus facilitating further economic benefits. However, when companies become reluctant to borrow, even if banks lower interest rates to encourage lending, it can lead to economic stagnation. Gu’s research indicates that rather than taking on new debt, Japanese companies were repaying existing debts at a rate of several billion yen annually, despite their rapid growth. This collective move towards debt reduction led to a national decline in asset prices.
An intriguing shift occurred by 1988, with some Japanese companies becoming net savers, a trend that continued until corporate savings surpassed personal savings by 2000. This was highly unusual, as businesses are typically the primary borrowers in a healthy economy. From 1990 to 2003, the reduction in corporate demand contributed to a loss equivalent to 20% of Japan’s GDP. The book challenges the conventional academic belief that external shocks are irrelevant, arguing instead that specific shocks can fundamentally change the goals of businesses and individuals. When asset prices nationwide fall, companies prioritize debt reduction over profit maximization to repair their balance sheets.
Gu asserts that despite Japan’s economic bubble and subsequent struggles, the country’s GDP remained stable due to two primary factors. First, fiscal policy, rather than monetary policy, played a crucial supportive role. With Japanese businesses losing the desire to borrow, the effectiveness of monetary policy was undermined. The Japanese government’s issuance of bonds and investment in public infrastructure projects helped maintain money supply levels. Second, a reduction in the savings rate among residents provided fundamental economic support. Despite high investment in housing and education, Japanese people had to draw on their savings to cover expenses as companies cut bonuses and benefits.
In summary, the book presents a compelling case for the shift from profit maximization to debt minimization during economic downturns. It credits Japan’s choice of fiscal policy over monetary policy as a wise decision, highlighting the challenge of finding stimulating and profitable fiscal projects in reality. Despite any criticisms of the author’s views, the book offers valuable perspectives worth considering, especially in light of current economic conditions. It serves as a reminder that the essence of history remains unchanged, awaiting new arrangements for future prosperity.
