Political Economy of Japan

POL 384

Political Economy of Japan

Financial Crisis

Origins of the Financial Crisis in Japan

Plaza Agreement

BOJ/MOF – cushion adjustment via easy money

Huge increases in debt to buy domestic and foreign assets

Very highly leveraged assets

Effects of the Bubble burst

Collapse of asset prices

Huge rise in non-performing loans

Banks respond with credit strike

Economic downturn – move to zero growth not severe depression

Continuing fiscal stimulus via government deficit spending – brakes but does not revive the economy

Weaknesses of the Japanese Economy

Dual Economy

Rigid Labor Market

Limited innovation capacity

Hollowing Out

Financial systems

·  Investment – stocks, bonds, real estate, derivatives (options)

·  Banking – loans for business operations

·  Banking – loans for consumer purchases

·  Home finance – mortgage banking

Exotic finance

·  International Lending

·  Foreign exchange operations

·  Derivatives – hedge funds

Why are certain financial systems inherently unstable and prone to booms and busts?

·  All financial markets are driven by hope, greed and fear

·  Where there are large numbers of investors have different levels of knowledge and information

·  Where the value of the investment is uncertain and variable

·  Where large gains are contingent on trading success – search for investment outlets

·  Limited regulation

·  Such systems have strong herd effects – any pattern of success is followed by others who engage in herd buying – success feeds on itself (greed)

·  Evidence of failure leads to herd sellers (fear)

·  Systems overshoot “correct” price – both up and down

·  When easy money occurs this adds gas on a fire – leverage produces a magnified effect

In such systems bubbles are common:

1979-1982 – Financial crisis in lending to developing nations – sovereign nations won’t default

1987 – 25% decline in Dow in one day

1994 – financial crisis in Mexico

1997 – Asian financial crisis

1999 – Argentina financial crisis

2000 – Dot com bubble bursts NASDAQ loses 80%

2008-09 – Global financial crisis

Global Financial Crisis

Globalization creates huge profits for financial firms – 41% of US profits in finance in 2007

1999 – Congress prevents regulation of hedge funds and derivatives – too much money to be made

Low interest rates and loose money after 9/11/01

Money to lend meets borrowers for homes

Creation of subprime mortgages

Creation of derivatives of subprime mortgages

Explosion of lending, borrowing, home purchases

Many underfinanced borrowers use debt as income supplement

Highly leveraged system based on very shaky base of home mortgages

For a detailed and somewhat sophisticated video on derivatives:

Merton on derivatives and financial crisis

http://mitworld.mit.edu/video/659

How did we get to 2008? The origins of American-GFC

1945-1973 Postwar Economic Boom

Based on manufacturing and selling to home markets and some exports

Growth Rates PCGDP

1962-1966  4.6%

1967-1970  1.5%

1971-1973  4.3%

1974-1983  1.3%

1984-2000  2/6%

2001-2008  1.7%

Measuring income distribution in the US

http://en.wikipedia.org/wiki/List_of_countries_by_income_equality

GINI Coefficient (2004-2006)

US .45

Austria .26

Australia .35

Canada .32

Denmark .24

France .28

Germany .28

Italy .33

Japan .38

Korea (South) .35

Norway .28

Sweden .23

China .47

India .36

Indonesia .36

Malaysia .46

Mexico .46

Russia .41

Vietnam .37

Uganda .47

Brazil .57

Paraguay .58

Rwanda .47

South Africa .58

Zimbabwe .57

GINI over time

US economic weaknesses

Education

Savings and investment

Debt

Work ethic

Anti government sentiment

Dependence on foreign oil/energy