The United States & Japan in the Post-Crisis World

February 10, 2010

Robert Dohner
, Deputy Assistant Secretary for Asia, United States Department of the Treasury

Jeffrey Shafer
, Vice Chairman, Global Banking; Senior Asia Pacific Representative in New York, Citi

Robert Dohner, Deputy Assistant Secretary for Asia at the Treasury Department, shared his reflections on the challenges facing Japan and the United States in the aftermath of the global financial crisis.

Mr. Dohner went to Japan in 1997 for a five-year stint as Treasury's Financial Attaché in Tokyo. During his time there, he witnessed, and worked on, a historic banking crisis, the failure and takeover of some of the world's biggest financial firms, and an array of fundamental financial reforms. The country fell into a deep recession; the government adopted extraordinary monetary policy measures. "I remember when I left Japan in 2002 thinking to myself that I had witnessed a once-in-a-lifetime event," he said. "Little did I know."

Just over a year ago, "the global economy faced the abyss," he continued. The G20 nations agreed to aggressive measures to stabilize the world's economies and markets. By their Pittsburgh meeting in September 2009, "it was clear that these efforts had been successful in avoiding what could have been a far worse global financial crisis and in blunting the force of the recession. But even so, for both the U.S. and Japan this may well turn out to be the worst postwar recession we've experienced."

As the G20 nations move forward to reform financial system regulation and supervision, it's vital that they harmonize their efforts, he said. "If we allow a global race to the regulatory bottom, we guarantee that financial firms will simply shop for the least regulated jurisdiction. Instead, we must work together to set off a race to the top."

Two issues "around which a consensus has been forming" bear special mention, Mr. Dohner continued. The first is capital standards; the second, leverage ratios.

"A key function of capital is to ensure that a banking firm can absorb losses and continue to operate as a going concern. Capital can only fulfill this purpose if it is permanent, deeply subordinated, and does not obligate the issuer to make periodic or other payments to investors." Thus "the inclusion in regulatory capital of deferred tax assets and non-equity hybrid securities should be subject to strict, internationally consistent qualitative and quantitative limits."

Leverage constraints serve to limit "the degree to which gaps and weak spots in the risk-based capital framework can be exploited" and reduce the impact of "categorical misjudgments about risk by market participants and regulators," he said. By dampening balance-sheet volatility of financial firms and their intermediaries, leverage constraints can have macro-prudential benefits as well.

"In Pittsburgh, the G20 leaders committed to developing, by the end of this year, internationally agreed rules" to bolster capital standards and inhibit excessive leverage, "with the aim of implementation by the end of 2012."

The G20 recognize that the high global growth rates of 2000-07, dependent as they were on U.S. consumer spending, "could not be sustained and will not be repeated," Mr. Dohner said.

In the three decades from 1955 to 1985, U.S. household financial wealth ranged between 4 and 4.5 times disposable income, and household saving rates were stable, at about 8 percent of disposable income, he indicated.

With the real estate and stock market boom during the first decade of this century, U.S. household wealth soared to a peak of 6.4 times disposable income in 2007, and savings out of current income fell almost to zero. Then came the collapse. "From the peak in the second quarter of 2007 to the third quarter of 2009, U.S. household wealth fell by 19 percent, or almost $13 trillion. The household saving rate has jumped, and now stands at 4.8 percent, quite a bit higher in fact than the saving rate of Japanese households."

In the years to come, "there are strong reasons to think that the U.S. saving rate will remain at this level, and may even increase." The Obama administration aims to bring the federal budget deficit down to about 3 percent of GDP by FY 2014. "As a result, growth in U.S. demand will be restrained, and the U.S. will not be the engine of global growth that it was in the last decade."

Reducing China's current account surplus "is a critical part of the rebalancing of the sources of global demand," he said. For Japan, lifting domestic demand and shrinking the country's reliance on exports is "a clearly stated and welcome goal of the Hatoyama administration. But the more important contribution is likely to come from actions to increase the dynamism of the Japanese economy."

Current discussions on this center on three issues, Mr. Dohner said: labor market reform, to lessen the divide between regular and temporary workers and increase labor force flexibility; pension system reform, which will boost the ability of workers, especially in mid-career, to move from one job to another; and raising productivity growth, particularly in the service sector, which accounts for over 70 percent of total output and employment in Japan.

Raising productivity growth in services "involves a variety of policies to increase competition and innovation," among them regulatory reform. Mid-1990s reforms in Japan's telecom market "led to a 60 percent drop in prices and a 20-fold increase in demand." Deregulation likewise brought lower prices and higher demand in electricity, trucking and petroleum products. Going forward, "the DPJ growth strategy identifies medical and nursing services as a sector that can generate ¥45 trillion in additional demand and 2.8 million new jobs through promoting the entry of private firms, reducing approval lags for drugs and medical equipment, and other measures."

"There are likely to be significant gains from opening services to foreign competition," Mr. Dohner added. "Japan has the lowest contribution of imports to services supply of any OECD country and the lowest share of foreign affiliates in services turnover among the OECD."

"Of course, Japan is not alone in this regard," he concluded. "The U.S. needs to increase its investment in infrastructure, education, clean energy and green jobs to ensure that we remain competitive." Thus the president's budget for the next fiscal year calls for an increase of 6.4 percent in civilian R&D funding.


Presider Jeff Shafer of Citi asked the first question:

Will the U.S. and Japan find a way to approach China about these rebalancing issues more effectively together than they could individually?

China's leadership clearly recognizes "that the sources of Chinese growth need to be rebalanced towards stronger dependence on domestic demand, greater reliance on household consumption," Mr. Dohner responded. "Discussion with advice from other Asian emerging markets, past emerging markets like Japan and Korea or current emerging markets, is particularly influential, both on its merits but also not casting these issues as U.S.-China issues when in fact they are global issues."

Audience members joined in:

For Germany, Japan, perhaps Canada, it's taken for granted that we need to see less dependency on exports, more growth in services, more promotion of innovation. But they have bank-centric domestic systems, where the basis of all credit decisions is collateral. Service companies don't tend to have a lot of capital, and need access to a broader capital market. Is all attention now on China, or are there interested parties in Japan that are trying to discuss with us how to promote this?

"It's not all China. We continue to have a very active presence in Tokyo, in fact we have one of the best Treasury officials I know representing us in Tokyo, and very strong contacts with the Japanese government, with Japanese industry and foreign affiliates in Japan," Mr. Dohner said. Japan being the second-largest economy in the world, "a growth increment in Japan makes a tremendous difference."

At this stage, with the economy more stabilized, is Japan's experience with deflation something that we still need to worry about?

That's "colored our response," Mr. Dohner answered, but he'd emphasize the lessons of the 1930s (and perhaps Japan's experience with stimulus packages) as to "the importance of not withdrawing stimulus measures too early in the recovery cycle."

"One other thing I take away from the bubble period, rather than from cleaning up afterwards, is that I failed," commented Mr. Shafer. "We all failed to draw the lessons we should have drawn from what happened in Japan. We looked at it and we said well Japan's Japan, it's different from us." We proceeded to go through "essentially the same bubble process," where the central bank reckoned that "as long as inflation was on its target trend, the fact that asset prices were getting way out of line was something that you tolerated."

"Now that we've had two cases of this ending badly, I think the world has to go forward with a system that focuses on there being more to macroeconomic management than just what the CPI looks like," Mr. Shafer concluded, even if "it's going to be hard for central banks to begin to cool things off when people are making lots of money."

How well are we coordinating in the G20 on financial markets reform, reregulation, tax policy?

"We have certainly recognized the importance of consistent policy measures taken across the major financial markets, not just the G20, but also financial markets like Hong Kong and Singapore," Mr. Dohner said. "It was revealed early in the crisis that differences in deposit insurance policies could lead to large movements of funds and large strains on systems."

"Ultimately, financial sector regulation is done by national authorities, but I think there is a real attempt through lots of international discussion to have an outcome that results in reasonably consistent policies across nations."

When you were in Tokyo, what was the most difficult decision you made related to issues in Japan?

"The decision that I most often had to weigh was whether the desire of some firm, some individual in Washington, some governmental organization or some other organization was a public policy issue for the U.S., and one that I could legitimately approach the Japanese government to ask them to address," responded Mr. Dohner.

"I know that the U.S. brooks little interference in financial regulatory matters, legitimately so, nor should other countries' financial regulatory agencies brook interference. And the questions of whether in the rare instance something did merit approaching Japanese financial regulators I think was probably the most difficult decision that I had to make. And it was something that I rarely did."

Is there a sense that we should go beyond acceptance to perhaps actual support and recognition that there might in fact be systems that are meaningfully different from the U.S. model that perhaps are more appropriate for other nations?

"My group at Treasury spends a lot of time analyzing foreign economies, foreign financial systems, and trying to figure out how they behave. I don't think you can understand the Chinese financial system without an appreciation of the importance of administrative guidance in credit decisions by banks," Mr. Dohner said.

"We have to work together to meet certain challenges, certain issues, as the past two years has demonstrated. That often results in a greater degree of consistency in policy approaches and policy measures. To a considerable extent, everybody changes in that process. And we encourage growth, and we encourage efficiency, policies that raise incomes, policies that bring people out of poverty. So we also encourage a convergence on things that work."

--Katherine Hyde
Topics:  Policy

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