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Koo 6.8

Koo 6.8



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Published by: zerohedge on Jun 08, 2010
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8 June 20101 Nomura Research
Richard Koo: a personal view of the macroeconomy
Kan replaces Hatoyama as PM after Futenma imbroglio
It has been several weeks since my last report. During that time the eurozone turmoil sparkedby problems in Greece grew and spread to Hungary. The euro weakened further and goldresumed its rise amid a global equities correction.The US payrolls report for May, released last Friday, was also a disappointment: despite aheadline increase of 430,000 jobs, the private sector generated only slightly more than 40,000 jobs when temporary hirings of census workers are excluded.In Japan, Yukio Hatoyama resigned as prime minister after being driven into a corner on theFutenma air base issue, and the DPJ chose Naoto Kan to succeed him.
* Pragmatism informs Kan’s economic perspective
I would first like to touch on Mr. Kan’s policy skills and vision. As noted in previous reports, hisprimary interest lies in social and not economic issues. He played a particularly important role inobtaining relief for hemophiliacs who contracted AIDS via contaminated blood products.A survey of his past statements and actions reveals a careful observance of the ideals of social justice and democracy. It also leaves the impression that he is less interested in economicmatters, particularly macroeconomic matters.But at the same time, the fact that he is not tied to a single economic theory or set of economicprinciples allows him to adopt a pragmatic and flexible stance on economic matters. I suspectthis characteristic will receive more attention as the market digests the new administration’spolicies.
* Was Kan’s “tolerance” of weaker yen born out of economic pragmatism?
A prominent recent example of this pragmatism can be found in Mr. Kan’s indication soon afterbecoming Minister of Finance that he would be willing to tolerate a weaker yen. In the statementin question, made in January, he did not actually call for a weaker yen—he merely said thatmany companies were in favor of a weaker yen. The markets, however, interpreted thecomment as an attempt to guide the currency lower.The statement hardly came as a surprise, given that the yen has become perhaps the world’sstrongest currency, causing great suffering among Japan’s export-dependent manufacturers.Too, many investors in Japanese equities argue that a weaker yen is the quickest shortcut tohigher share prices in Japan. Against this backdrop, it would hardly be surprising if Mr. Kanenvisioned a scenario in which a weaker yen pushed stock prices higher, thereby contributing toa Japanese economic recovery.
* Aso and Fujii saved global economy from competitive currency devaluations
In contrast, Yasuhisa Fujii—Mr. Kan’s predecessor at the Ministry of Finance—and formerPrime Minister Taro Aso had a deep understanding of both the real economy and economichistory. They were well aware that when the global economy faced a similar crisis in the 1930sand countries tried to export their way out of their problems, the result was a round ofcompetitive currency devaluations that led to protectionist measures and, ultimately, a globaleconomic collapse.Mr. Aso and Mr. Fujii feared that if Japan—a trade surplus nation—were to guide its currencylower, it would provoke a round of competitive devaluations by the US and other trade deficitnations. Consequently, they never suggested that a weaker yen would be preferable or eventolerated, which was understandably quite unpopular within Japan.
Nomura Securities Co Ltd, Tokyo
Economic Research – Flash Report
8 June 2010
(issued in Japanese on 7 June 2010)
R. Koo
Chief economistNomura Research Institute, TokyoNomura research sites:www.nomura.com/researchBloomberg: NMR
Please read the importantdisclosures and disclaimerson pages 8–9.
8 June 2010Nomura Research 2
Inasmuch as Japanese currency intervention to soften the yen could have sent the globaleconomy back to the 1930s, the strong principles of Mr. Aso and Mr. Fujii and their refusal totake the easy way out by devaluing the yen helped save the world economy.In that sense, it was extremely fortunate—both for Japan and the global economy—that thesetwo men, with their extensive knowledge of economics and economic history, were at thecontrols at this pivotal moment in economic history following the Lehman collapse.
* Kan’s decision saved Japanese economy in 1998
On the other hand, we should not overlook the fact that Mr. Kan’s pragmatic flexibility and hisdesire to do the right thing for the people—and not just for his party—once saved the Japaneseeconomy and its financial system.In 1998 the Japanese economy was in serious trouble and faced a growing number of problemsin the banking sector. Local banks were forced to pay a “Japan premium” to borrow oninternational capital markets, and Long-Term Credit Bank of Japan and Nippon Credit Bankwent under.Meanwhile, the Hashimoto administration’s fiscal consolidation policies sparked stock marketinvestors to “sell Japan,” which in turn pushed the yen sharply lower. This double weakness inthe yen and Japanese equities served to lower the capital adequacy ratios of Japanese banksas their dollar-denominated assets grew and the unrealized gains on their cross-shareholdingsfell sharply. The result was an unprecedented credit crunch.To address this situation it was essential that the government inject capital into the bankingsystem and get banks lending again. But the opposition parties were violently opposed to thisstrategy—it was simply out of the question, they said, to spend the money of already sufferingtaxpayers to save banks and their high-earning employees.The situation grew steadily worse, and it was thought to be only a matter of time before Japanexperienced large-scale bank runs.The situation was so serious that I was asked to appear on television programs every week toexplain why the banking system needed a capital infusion. The ruling LDP, on the other hand,had just experienced a major defeat in the summer upper house election, draining its strengthand vitality.
* Kan’s idealism saved Japan’s economy
It was at this point that a miracle occurred. Mr. Kan was the leader of the main opposition party,which had been violently opposed to a bailout. Yet he offered to end his opposition to theFinancial Reconstruction Law if the LDP agreed to certain conditions.These conditions were not particularly onerous, and they were accepted as-is by the LDP. As aresult, the Financial Reconstruction Law finally became law, and Japan managed to pull throughits worst postwar financial crisis.If Mr. Kan had not changed his stance, the LDP government might well have collapsed, givingway to a DPJ administration. That, in turn, could have cast Japan’s financial sector into theabyss.But Mr. Kan gave precedence to saving the economy and financial sector and left theopportunity for his party to take power for another day. His decision effectively delayed the birthof a DPJ government by a decade.In my view, this story reflects Mr. Kan’s idealism—specifically, his view that the party’s interestsshould be sacrificed if necessary to save the nation and its people. His decision, on the otherhand, generated a great deal of debate within the DPJ at the time.I remember speaking to a DPJ representative immediately after the Financial Reconstruction
8 June 20103 Nomura Research
Law passed. When I remarked that Mr. Kan had performed a great service by choosing hiscountry over his party, she said the situation within the party had been very difficult.In a subsequent magazine interview, Mr. Kan said Ichiro Ozawa had told him that he didn’tunderstand politics and had made a major mistake by not taking advantage of the party’schance to topple the LDP.
* Kan’s political philosophy likely to lead to more politically driven policy decisions
In the same interview, Mr. Kan said that administrative reform is the goal of a change ingovernment. That belief stems from his deep-seated concern that the concept of “neutrality” and“continuity” so highly valued by the bureaucrats who had traditionally governed Japan wasfundamentally inconsistent with the principles of democracy.Mr. Kan believed that 70% of the policy decisions in Japan were made by bureaucrats and just30% by the politicians. That implied that no matter which party the people elected—including theJapan Communist Party—70% of policies would not change. The principle of popularsovereignty cannot exist under such conditions, nor can we expect meaningful changes in policybased on the people’s will.The LDP had thrived in this system for half a century and was not in a position to implementadministrative reform. That is why it was necessary for the DPJ—which was not bound by thepast—to take power and develop an administrative system capable of reflecting popularsovereignty.If this reflects the core of Mr. Kan’s underlying political philosophy, I suspect we will see moredecisions made by politicians instead of bureaucrats. Mr. Kan’s appointment of ex-Itochupresident Uichiro Niwa to serve as ambassador to China (as opposed to someone from theMinistry of Foreign Affairs) is part of this shift.At the same time, Mr. Kan differs from Mr. Hatoyama in having experience as a cabinet ministerand, as he demonstrated in the AIDS-contaminated blood scandal, being skilled at managingbureaucrats. In that sense, I think there is a real possibility that he will bring something new tothe table. That would be a welcome relief from the last eight months, which have beencharacterized by steady conflict and turmoil between politicians and bureaucrats with fewdecisions being made.
* Policy views of Kan’s economic “brain,” Osaka University’s Yoshiyasu Ono
Mr. Kan’s partner in the aforementioned magazine dialog was Yoshiyasu Ono, an OsakaUniversity professor who is said to be Mr. Kan’s key advisor on economics issues and who wasrecently appointed cabinet consultant. The two apparently saw eye to eye from the time theymet for this interview in November 1999.Strangely enough, I participated in a dialogue with Mr. Ono for the same magazine in February2001. I remember quite well that, with one exception, our views were in perfect agreement. (Allof the dialogues in this series were subsequently gathered together in Mr. Ono’s book,
Reducing Spending Won’t End the Recession 
[Japanese]).Mr. Ono argued that during a severe recession with high unemployment, structural reforms willonly create more unemployment and will not boost the economy. At such times, he argued, thegovernment needs to engage in public works spending in order to boost demand.He was also well aware of macro- and micro-level differences. Companies, for example, can layoff staff in order to enhance efficiency, but a country cannot “lay off” citizens working atinefficient businesses. As such, he said, the kind of “efficiency” that should be pursued bycompanies and governments is naturally different.I concurred wholeheartedly. We also shared a taste for the term “fallacy of composition,” whicharises when what is good (i.e., the right behavior) for the individual, when taken together, is

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