The Public Nature of Money and the Financial Crisis
I began writing the preceding section in this series (the "Freedom" section) in April 2008, however, six months later, a crisis occurred that dramatically altered the global economic landscape. After Lehman Brothers failed in September, the idea of a free and global market was in tatters, and countries around the world began increasing the level of intervention in their economies, including not only financial systems but also in areas of industry and employment.
In the preceding section, which ended in October last year, I discussed, in a nutshell, the superiority of the free market economy over a state planned economy. Citing the superiority of the market economy in detail at a time when governments all around the world were preparing to step up their market intervention may seem absurd. Indeed, my editors were concerned about the development of the series before I began to write this section. Economic conditions continue to change drastically, and honestly we are not sure where our discussions will go. Therefore, perhaps the tendency to write as I think and think while I write will be stronger in this section than in the previous section.
However, problems in the market economy system revealed by the crisis are the very topic that I had planned to discuss in this, Part II of the series, at the time I set out to write the series. The market economy system appears to be a self-contained moving entity that does not need outside support. However, it is actually supported by a public good. What this crisis has shown in a dramatic way is that the function of the market economy collapses very easily when this public good trembles and falls apart. The public good that supports the market system is money. Money is a general term for the vehicle or medium used for exchanging goods and services and could be described as the foundation of the modern market economy. Not only cash but a wide range of assets with a settlement function, including bank deposits and MMFs, function as mediums for exchanges. (Assets with a settlement function effectively can be called money even if they do not systematically function that way.) What trembled in the crisis was credit money that is created by financial institutions, or the credibility itself of financial institutions that enables the creation of credit money.
Consequently, the main topics in this section are credit money and credibility, and the public nature of money. Now, I would like to introduce some fairly peculiar views in relation to the financial crisis we have just experienced: The bubble means that certain assets such as real estate and high-risk securitized instruments very quickly begin to play the role of money. In other words, without any real design, assets issued by private entities start playing a public-good role as money. For example, a property that is meant to be a means of generating cash flow (money) in the form of rent income begins to be used in the role of money (a medium). I could go so far as to say that a bubble is a self-referencing cycle like Godel's theorems applied to the existence of money. When asset prices begin to fall, the risk of the assets is exposed and market players then lose confidence in the assets. As a result, the assets will cease to be able to play the role of money. The disappearance of money, as it were, will rapidly obstruct activities in the real economy, and production and employment will deteriorate sharply.
The question of how to treat the public nature of money is important when thinking about policies for resolving the crisis. In particular, the question of whether the disposal of nonperforming assets in the financial sector is needed for an economic recovery is crucial. There seems to be confusion in discussions about this very question in Europe and North America, similar to that which has occurred in Japan in the past. The problem needs to be discussed.
Prolonged Sluggishness in the Global Economy
Before we do that, though, I would like to consider briefly how the financial crisis is likely to unfold.
Although the global and Japanese economies staged a slight recovery toward the summer of 2009, I expect this will be only temporary, given that housing prices continue to fall and commercial property prices, which began to fall dramatically early last year, also continue to decline. The United States has not developed any radical policy for disposing of nonperforming assets. Although asset assessment standards in stress tests are said to be tough, they do not seem to appropriately consider the effects of long-term (meaning more than two years) losses and distress selling at the time of a panic. To prevent distress selling, the U.S. government needs to keep the balance sheets of financial institutions healthy enough that the institutions have enough capital to allow for distress selling. To do that, the government needed to set aside a significant amount of additional public funds. However, the government cannot do that because of public antipathy towards financial institutions. The situation is very similar to that in Japan in the late 1990s after the handling of the housing loan crisis. It is very probable that there will be another crisis in the financial market, triggered by further falls in house prices. We should assume that the disposal of nonperforming assets by U.S. financial institutions will take a very long time.
Excessive consumption (the tendency for households to increase borrowings and use the proceeds for consumption against a backdrop of an asset bubble) in the United States will undergo a significant correction with this financial crisis. If Americans start to spend money in accordance with their income, domestic U.S. demand will shrink structurally. Once it shrinks, it will not recover. Japan's trade surplus declined 50% year on year in fiscal 2008. It is unlikely that this decline will be reversed.
The global economy will resume sustainable growth only if countries and regions other than the United States?particularly emerging economies such as China and India in Asia, and countries with a trade surplus such as Japan and Germany?achieve domestic demand-led growth and become drivers of the global economy. To do that, be it Japan or China, these countries need to radically change their economic structures, a process that will take time.
As sluggishness becomes the normal state for the global economy, we need to assess the essence of the market economy system.
* Translated by RIETI from the original Japanese article in the series, "Gödel's money" published in the August 03, 2009 issue of Kinzai Financial Weekly
