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Growth & Crises Michael Smitka Fudan University 復旦大學 November 2000 Overview - why so few crises? • Leverage is dangerous! • Banks avoid crisis using rules of thumb • Those rules work - most of the time Why then crises? • Change undermines rules of thumb – Change in types of industry / borrowers – Change in strategic environment / flow of funds – Change in regulatory environment • Mistakes are made … – … and a shock produces crisis Remedies? • Regulators face a new structure – They work by rules-of-thumb, too – And have the same history • An AMF role? – Experience beyond one economy’s limits – But would their advise be taken? – Even once would repay the effort! Japan’s Case • No need for financial controls – project selection was easy – failure was hard / recessions were few & far between • But pricing long-lived assets was hard – Real estate grew faster than economy – Stock prices grew faster than economy – Growth industries grew very fast indeed!! Growth Dynamics • Transition out of agriculture – Fast productivity growth in industry – Urbanization! • Household formation • Infrastructure, housing • But it’s a one-time transition! – And eventually ends Slowdown • Industry no longer needs funds • But households keep saving – Past savings was at low income levels – So accumulated wealth is modest – Need to keep saving to fund old age • Who then will borrow? Shifts in Japanese Savings Flows I (business) 1961-65 17.0 1966-70 16.7 1970 19.6 S (business) S -I 5.2 -11.7 8.7 -8.0 10.7 -8.9 I (household) S (household) S -I 2.8 12.1 9.2 4.3 12.0 7.7 S - I Private -2.5 I (Center S & Local) T -G T -G+S-I 1971-75 15.2 4.0 1976 8.8 1976-80 8.3 2.7 1981-85 8.5 1986-92 11.1 2.3 -8.8 -11.2 0.8 -8 -5.7 2.9 -5.5 4.5 12.8 8.3 4.0 16.4 12.4 7 19.9 12.9 6.1 17.1 11.0 2.8 13.6 10.8 1.3 11.6 10.3 -0.3 -0.6 1.2 4.9 5.3 5.3 1.5 5.5 6.9 1.4 5.7 6.6 0.9 5.7 7.6 1.9 6.9 6.7 -0.2 6.5 2.3 -4.2 7.5 2.4 -5.1 6.8 3.6 -3.2 6.4 8.3 1.9 -1.1 0.6 1.3 1.0 0.7 0.3 2.0 3.4 The Primary Shock: 1970 vs 1976 • Corporate investment fell 10% of GDP • Savings rose! • Banks were left to scramble Interregnum • Japanese fiscal deficits – created a new borrower for banks – MOF policy stopped that by 1982 • Reagonomics: US consumption boom – Export-led growth from 1982 – Appreciation / Plaza Accord stopped that from 1986 Secondary Shock • Bad macro policy – Easy money from 1986 – “Japan as Number One” psychology • Just as banks sought new borrowers – Real estate … and more real estate! – Small business – Also international loans Shocks, continued • “Bubble” economy – Stock prices doubled – Urban real estate prices rose even more • Fiscal policy mistakes accentuated – On-again, off-again policy built up debt • Regulatory policy errors accentuated – Banks allowed to make more bad loans Lessons • Long-lived assets easy to mis-price – Stocks – Real estate • Outside nay-sayers may be right • Rapid growth creates pressures that virtually promise crisis But crises may be inevitable • Even the slow-growing US suffered – Interest rate shocks undermined S&Ls – Regional growth led to real estate bubbles – A new venture, international lending, proved disastrous (esp. to borrowers) • And now deregulation … – Loan quality falling in a boom economy The End • Until leverage strikes again – Deregulation is no panacea – Regulation fares no better