[paper] Global Increase of Financial Assets and the Risk of Credit Contraction

Kazuto Uchida: Chief Economist & Senior Vice President NY Research Office, The Bank of Tokyo-Mitsubishi, Ltd.

He joined the Bank of Mitsubishi in 1985. He has been in the present position since 2002. He is a coauthor of "Beikoku Keizai no Shinjitsu (the truth of the U.S. economy)" and he contributed to many economic newspapers and magazines. He received his B.A. from Keio University in 1985.

The end of the Cold War in the middle of the 1980’s brought on two important structural changes in the global economy. The first was globalization and the second was the increase of financial assets. The progress of globalization accelerated the shift of production to the developing countries and brought about deflationary pressure from the aspect of both general price levels and the balance of supply and demand, that is, the pressure of price differentials and the decrease of domestic investment demand which were prevalent in the high cost developed nations. As a result, there occurred the so-called deflationary cycle. However, if this itself accelerate in the transformation of industrial structures and the horizontal division of labor, it is possible to return the global economy to a sustainable growth process. The problem is the expansion of financial assets. In the US, the ratio of the balance of financial assets to the nominal GDP has increased ten times in the past twenty years over three phases, but the burst of the stock price bubble in the US has ended this expansion, and the increase of global capital which had continued for approximately 20 years has stopped. At present, the most frightening issue is not the competitive deflation coming from globalization, but the debt deflation that comes from the contraction of credit in the financial side. The dead end of global capitalism shrinks the international flow of money and causes a backward flow of the favorable cycle of global capitalism in the 1990’s. The most prominent phenomena are the instability of the key currency, the dollar, and the squeeze of the flow of funds to the newly industrialized nations, which is causing a serious situation in the Latin American countries. With the burst of the stock price bubble in the US, the amount of direct investment from Europe to the US decreased dramatically, and the contraction of financial assets has strengthened the adjustment pressure on balance sheets. Within this process, macroeconomic policies such as the monetary expansion and increased fiscal expenditures have been less effective due to the decrease in the credit multiplier and the increase of saving rates. These symptoms have begun to become clear in the US, as it has already been seen in the Japanese economy. To achieve a soft landing of sharp contraction of financial assets in such a phase, there needs to be a continuous supply of excess liquidity so that there is not an over-contraction of credit, and the only thing to be done is to wait for the next inflationary cycle. The factors that caused the destruction of the American economy and its financial sector in the world depression in 1930 were the repatriation of short-term overseas funds from the US and the withdrawal of deposits (the increase of liquid funds). As a lesson from the global depression, it is vital to avoid capital flight from the US. Capital flight will occur more in the process of financial contraction in other countries than in the process of the decrease of confidence in the American economy. At present, the risk is in Japan that has just started a surgical operation of its economy and its financial sector.