Transcription
Good afternoon, and thank you so much for having me on this event one more time.
Uh, we live in a very difficult world, in that what we thought was perfectly reasonable, perfectly sustainable, things are no longer considered sustainable. I mean, all these, uh, as I was just mentioned, the real economic relationship between China and the United States are moving further and further apart. Oops. Okay. Okay.
And the war in Ukraine is still continuing with seemingly no end in sight. And [clears throat] last year, I made the same prediction, unfortunately, that the war in Ukraine will continue, even with, uh, very poor performance on the part of the Russian army. And that was because, as I was already introduced, Putin managed to increase per capita GDP of Russians by 12 times in 14 years. 12 times in 14 years. You know, if anyone had this kind of economic achievement, he's a national hero. And so, even though there was a little bit of decline here once, uh, he invaded, uh, Crimea, for most Russians, Putin is still a national hero. And so, a little bit of military, uh, setbacks here and there is not going to kick him out of the, uh, presidency that easily. And so, even if the Russian army is not doing very well in Ukraine, my guess is that he will stay on until something really horrible happens. And with this kind of economic achievement, it's very difficult for outsiders. Even Mr. Prigozhin, who tried to do this military, uh, protest against Putin, probably realized that even though he may be able to take over parts of, uh, Russia, he does not have the performance record like this one.
Unfortunately, when the news reports, CNN, BBC, talk about Ukraine, Russia, they only talk about the politics or the military issues, never economics. But it's economic performance that is keeping Putin in place. So, we have to know, really pay more attention to what's happening to the economy, what's happening to per capita GDP of Russia. Unfortunately, both Russia and Ukraine stopped publishing the new GDP numbers for obvious reasons. So, this chart is exactly the same chart as you saw last year. I apologize for that, but I think it's important to remind ourselves that this is where Putin's support comes from.
That's the Russia and the Western countries. As I indicated you last year, they were so determined to make sure that Putin will not win. Not saying he has to lose, but he cannot win. And that's that comes from the Western consensus that dictators should never be appeased. If you give them something at the beginning, they want more and more and more. And that's basically what happened in 1938 between Adolf Hitler in Germany and Neville Chamberlain of the UK. At that time, Germany was having a great economy, just like Putin, and he wanted to get back all the territories that Germany lost after World War I, and he was actually taking some of them back. The Western democracies wanted to stop him, and then this little piece of real estate, uh, in Czechoslovakia. Uh, there were some Germans living on the other side of the border still, and Hitler wanted this back. And Neville Chamberlain said to Hitler, "If this is the last piece of real estate, maybe we can have a deal." And Hitler said, "Yes, this is the last piece of real estate I will ever want." So Neville Chamberlain then said, "Okay, let's have a deal." Well, one year later, or less than one year later, Hitler attacked Poland, and World War II started. And it was such a huge shock, and that issue has been reminded in all schools in Western [snorts] countries. So I went through San Francisco public school system, whether you were studying in junior high or in high school or college, that event in 1938 is always reminded, uh, uh, to make sure that people understand we never appease a dictator. And so the West has no reason to, uh, step back, and the Ukrainians, apparently, after 18 months, are still willing to fight. So you put the three together: the Russians, the West, and Ukrainians, there's still no reason for war to end. And so this thing is going to be with us for quite a while until something happens in Ukraine, something happens in Russia, because the other parts are not likely to change.
And, and [clears throat], Russian economy is only 7% of the US economy, only 10% of the Eurozone economy. It's about the size of South Korea. And so, if the war continues, the Russian economy will be weaker, weaker, their military, uh, strength will be depleted. And that's basically what the West wants, in that at the end of the day, whatever the treaty might be, uh, peace treaty might be, Russia will be so weakened that it will not be able to do anything like this again to Estonia or, uh, Moldova, Finland, and so forth. And that's basically the Western goal.
But what is even more important, and that was already mentioned at the beginning, is that this Russian invasion of Ukraine has completely changed the Western thinking about priorities. Before that, for the last 30 years, the Western priority was always on economic welfare, because this ideological battle between the communist and, uh, democracies were already over, or so they thought, uh, when the Soviet Union collapsed. So the Western thinking was that now that we know what the final result was, that is that you have to have a market economy and democracy to be really a winner. Even those countries that are still practicing communism, authoritarianism, will eventually come toward this final goal. And therefore, we shouldn't really worry about ideology, we just talk about economic welfare. And that was the world for the last 30 years before the Russian invasion of Ukraine. But once the Russians invaded Ukraine, all those people in the West realized that just because a country has become richer doesn't mean they're going to be free and open. And of course, that's happening across the Taiwan Strait also. So all these things are changing.
Now, [clears throat] what's most important is national security, fighting for, uh, defending freedom, democracy, human rights, rule of law. Economic welfare is now back to the, to the back seat. And you can see that in so many areas these days. For example, Germany's decision to stop reliance on Russian energy. When you think about it, Germans were dependent on Russian energy for 40% of the energy needs are met by Russian supplies. For Germany to say, "We're not going to be dependent on Russian energy," means huge cost increase for German households, German businesses, their competitiveness will be, uh, reduced. But they said, "Let's do it. We're not going to be dependent on those guys any longer." And was it about eight months ago? German air force actually sent a whole bunch of fighter planes together with their support planes all the way to this part of the world. First to Singapore, they went to Japan, they went to South Korea, then went to, uh, I think Australia, to do military exercises with air forces in this part of the world. Something like that. Who could have predicted 18 months ago that the German air force will actually bring all the fighter planes to do exercises in Asia? Germany, after World War II, just like Japan, became such a pacifist country because the war was so bad for them. So they, so once the, uh, Cold War ended, Germans really decided to have, uh, have good friends with everybody. So even though Germany had tanks, Germany had fighter planes, many of those were completely, uh, unmaintained. So Germany is making lots of tanks, but many of the tanks in the German army are not maintained enough to run. And that was true with the air force too. That Germany is sending fighter planes to this part of the world. Why? Because of Taiwan. That's the kind of change that's happening around the world. This is now such an important place among the scheme of things in geopolitics that even Germans are willing to send fighter planes. I'm sure they wanted to do practice with the Taiwanese air force, but that was perhaps too, too strong of a message. So they did practice with everybody else around Taiwan. How many people could have predicted such a big change in German behavior, even to the point of sending fighter planes to Asia?
And finally, of course, Swiss and Austria, two supposedly neutral countries. Swiss for hundreds of years, Austria since 1945, both joined sanctions against Russia. So they're no longer neutral. But these massive changes are happening in the Western world, and that has huge implications on, uh, those of us here as well. For example, in the past, for, if until 18 months ago, if these Taiwanese companies had a business with Chinese companies, and the Chinese companies had a business with a Russian company, no one cared. This was perfectly okay, and a lot of business were going on like this all over. But now, if someone finds out that these Taiwanese companies or Japanese companies having business with these Chinese companies are are providing something that might have military implications, that might help the Chinese or the Russian army, then people will go after these companies and say, "What do you, what do you think you're doing?" The CIA may be knocking on the door. And suddenly, when something like that happens, the investment that we made on that company, the loan you made to the company, or the shares you bought of the company, could suddenly, uh, drop in value because now the authorities are trying to stop these companies from doing business with, uh, its partners or whatever in China or elsewhere. So we have to be a lot more, uh, alert about these geopolitical risks compared to just 18 months ago. Something that's completely unthinkable 18 months ago are now possible now.
And so that's the first point that I want to make on, uh, geopolitics. Then let's go get back to the economics. Uh, you know, we have this inflation problem, and the Federal Reserve have been raising interest rates, and that has been rocking the markets all around the world. We have some banking crisis, even in the United States, and, and even in Switzerland as well.
The first, the initial trigger of this, uh, inflation was this supply-side problems. And how did the supply-side problems come? Well, this shows the, uh, inventory to sales ratios in the United States. And during the pandemic, you never knew when customers will come back to your store. So they allowed the inventory to fall quite substantially. And then the economy began the recovery, and suddenly all these guys said, "Oh, we have to, uh, rebuild our inventories." Well, if one or two companies are rebuilding inventories, that's not a big problem. But when everybody tries to build the inventories at the same time, how do you rebuild inventories? Well, if this is the demand, you have to order more than the demand to have to build up your inventories. But when everybody does this all at the same time, then everybody runs into shortages. And that's basically how this, uh, inflation started, all from the supply side. But I'm happy to say that that part of the problem is beginning to work itself out, and some American retailers are even saying they have too much inventory now. And so we are making progress, but we are not at the end of the process yet.
So, in my view, I think we have four key factors that brought us inflation. One is the demand problem. That's the one that I just described to you, that everybody's ordering at the same time to increase their inventories, to try to meet the pent-up demand, and everybody does it all at the same time. Of course, uh, there will be tremendous, uh, excess demand. And the other one is energy. And to a lot of us in this part of the world, this is energy that is, uh, adding to our inflation. The energy one is very tricky. And as I mentioned this last year as well, in that until 2021, the world was was the same in a sense that the demand for fossil fuel was always there, always increasing. So those energy suppliers trying to, uh, find new oil fields, new gas fields, there's always a very big risk. But at the end of the day, there was always demand. So even though there were price fluctuations, the fact that demand is always there was a huge sense of relief for those people making investments. Now, that world doesn't exist anymore, because now there's a rule that says you cannot sell diesel cars, you cannot sell gasoline cars after 2030 or 2035. And China has that law already. Europe has that rule already. And at some point, the US will have it. Japan maybe here as well, that you cannot sell, uh, cars running on diesel fuel or gasoline. And it's not going to stop with cars. It's going to go to trucks. It's going to go to buses. It goes so many other places. Air conditioning, everything, office buildings, all of that.
So now, for energy producers, you know that the demand for fossil fuel will be falling after, say, 2035. That gives you only 12 years to recover all your costs and make handsome profit. In the next year, it'll be much less. If it's 12 years, next year will be 11 years, the following only 10 years to recover all your costs and make profits. So my guess is that the energy market is going through a very different, uh, reorganization, as it were. And you can see that in the behavior of, for example, Saudi Arabia. Saudi Arabia used to be very close to the United States in so many areas, because Saudi's interest in keeping the energy prices stable was very much in the interest of the Americans as well. But you might have noticed that last year or so, that Saudi is doing something quite different, and sometimes siding with the Russians, OPEC, and others to keep the prices up as high as possible, because if you're Saudi, and you know that you're not going to have much in revenue from oil after 2035, you better get all the revenue you can get between now and 2035. So their priorities have changed, their diplomatic prior, uh, relations also also changing, because this is a new world for them. We cannot blame them for that. If I were will in Saudi Arabia, I would be probably thinking the same way too. So energy is one of the things that I think prices will remain relatively high going forward. There might be, there will be volatilities because this is a rather speculative market as well. But my sense is that it will remain relatively high for, for, uh, quite some time until 2035.
On the supply side, of course, the COVID-19 disrupted a lot of things, and that was a very serious issue on the supply side. But that problem seems to be coming to an end. Although, looks like there's another COVID [snorts] version that's coming around, and we all have to be careful all over again. But compared to like two years ago, this COVID-driven supply disruptions seems to be more or less under control. But then we run into another one, which is on this side here. I would argue that there was a labor market reset in so many countries around the world because of COVID-19. What do I mean by the labor market reset? When COVID-19 hit, more than 20 million Americans lost their jobs literally overnight. Unemployment rate went to all the way to 15%. The worst in 90 years. When one or two people are losing jobs, and then those job people might stay around the same city, same similar industry, so that they can get back to the, uh, initial job when the company gets in a better shape. But when 20 million people lose their jobs all at the same time, you cannot afford to stay and wait, because everybody's looking for jobs. So what happened is that so many people start moving to other industries, other geographical locations, wherever they can find their jobs, because otherwise you have no jobs, no food on the table. That means all the expertise, the skills, know-how that these 20 million people had were decreasing every day, because these people are looking for jobs in other industries, in other locations. What that meant was that effectively, the labor supply curve was shifting to the left, because their skill levels are falling. And then so that when the economy recovered, and they wanted these people back, you, because the labor supply curve has shifted to the left, you have to pay a lot more to get the same workers with the same skills. And that's how you ended up having these wages rising, and employers scrambling to get the workers, because it became so hard to get the same level of workers again. And you can see this in this chart here. Those countries where unemployment rate went sharply higher, so United States, Canada, the wage levels are also going much, much higher. And those countries where unemployment rate did not move up much, whether in here, Japan, or here in Italy, the unemploy, I mean, Italy's unemployment rate was high to begin with, but it did not shoot up like in the United States or Canada, then labor, uh, wage increases has been very stable. Because in the case of Japan, for example, most of the workers were still, uh, working. Japanese unemployment rate never went higher than 3.4%. So most people still with the firm. So their skill levels were still there. Nothing was lost. So when the demand came back, they could go back and start producing those things, because all the skills was, skill sets are still there. But in the case of other countries like US and Canada, they had to get the workers from, uh, other industries or other areas. They don't have all the skills needed, and that's why the prices went up, uh, so much higher. So I would argue that this problem, the labor market reset, especially for countries like United States, UK, and Canada, will be with us for a while, because once you lose your skill levels, it's going to take a while to regain it. So we might see this, uh, labor market issues for another one or two years, perhaps even longer, because we have no, no historical example to see how long this process is going to last. But my guess is that at least a year or two, we're going to be facing with this, uh, labor market problems, because of this, what I call, labor market reset.
So those are the factors that brought us inflation. But what about the factors that brought us deflation? Are they all gone? Because depending on how you think about the factors that brought us deflation, you know, our view of the future will be very different. If the factors that brought us deflation are all gone, then we have to really think about wage-price spiral, like we saw in the 1960s and 70s. But if those factors are still there, then once everything is normalized, then we should go back to that world that we were there before COVID, COVID-19. And I would argue that those factors that brought us deflation are still with us. And the only thing is that the other factors are on top of it, which is pushing the prices higher. But if they are gone, we might come back to the same world that we were before COVID-19.
So what were those three factors that brought us, uh, deflation? I think there are three. One of them is what I call balance sheet recession. And I'm, I'm sure those who listen to me are sick of this thing already. Uh, balance sheet recession happens when everybody's in the, uh, in the bubble with borrowed money. And when the bubble bursts, asset prices collapse, liabilities remain, balance sheets underwater. These people all have to repair their balance sheets. They're technically bankrupt. How do you repair your balance sheets? You pay down debt. So people start paying down debt. That's the right thing to do at the individual level, individual companies, individual households, that's the right thing to do to repair your balance sheets. But when everybody does it all at the same time, we get into a big problem in that in the national economy, if someone is saving money or paying down debt, you need someone else on the other side borrowing and spending money. In a usual world, it's people like us, you and I, in the financial sector, plus the central bank, taking the money from the savers, giving to someone who, uh, who can use it. If there are too many borrowers and the economy is overheating, central bank raises interest rates. If too few borrowers, economies are slowing, central bank will bring rates down. That's how you keep the economy going. But in a balance sheet recession, everybody's paying down debt. No one's borrowing money, even at zero interest rates. And that's how we get into this, uh, huge deflationary, uh, spiral. When you get into that situation where no one's borrowing money, because the private sector cannot change their behavior because they are doing the right thing, you need the government to come in and borrow and spend. So government has to be the borrower of last resort. But this whole concept of balance sheet recession did not exist when, uh, when these bubbles burst. So most government officials said, "No, government should not borrow money, should not borrow money." So they did not borrow enough money, and as a result, we had deflation. And then government then told the central bank, "We cannot borrow money, we have too much debt." So central bank brings interest rates down. So all the central banks brought interest rates down. But there was another thing that we were not taught in our economics, and that is that you have to have borrowers before monetary policy can work. But when borrowers disappear or are repairing balance sheets, you bring rates down to zero, nothing happens. And of course, nothing happened in the United States after 2008, Japan after 1990, because borrowers were not there. They all paying down debt. That's how we get into this, this inflation, deflation situation.
And the other, and this part is becoming better and better, because if you continue to pay down debt, at some point your balance is balanced again, and then you can say, "I'm out of this mess now, I'm going to start making money." Not that simple, unfortunately, because those people who had to repair their balance sheets, I hope none of you had this horrible experience, but if you do have this experience, you know, it's a very, very painful process to repair your balance sheets. And after that, you say to yourself, "I will never want to borrow money again." This is a kind of a psychological trauma. And Americans who lived through the Great Depression, which was the biggest balance sheet recession in history, those Americans never borrowed money until they died, because the experience was so bad. And we are having that in many parts of the world as well. Many Japanese corporate executives still are traumatized by that experience. So even though balance sheets are becoming cleaner every day, the trauma unfortunately is still there.
The other factor that we have to worry about is that as Alo already mentioned, it's much cheaper and much more profitable to build things outside the developed world. So Taiwanese companies rather expand factories in India or Bangladesh or Vietnam instead of expanding more here. Uh, same thing for the Japanese. Uh, Americans will find Mexico is much better than expanding factories in Pennsylvania or New York, and the Europeans are finding the same with Eastern Europe, because wages in Eastern Europe are much cheaper. When that is happening, the companies are still maximizing profits. They are not repairing balance sheets. But if you look at their domestic operation, they are not borrowing money, because the money they need is the Vietnam currency, the money they need is the Bangladesh or Indian currency, not Taiwanese dollar or Japanese yen. But the household sector in all of these economies are still saving money. But the corporate sector that used to borrow money are no longer borrowing at home. They're borrowing abroad. Then you still get into this very similar situation to balance sheet recession. And I think that's what we ended up for all these years. And on the supply side, the fact that all these other countries, Bangladesh, India, trying to attract factories from abroad, uh, by setting up new industrial parks, more infrastructure, so that, uh, companies can start their business production very quickly. As long as those, uh, opportunities are there, globalization will continue. Cheaper products made abroad will come into Taiwan, will come into Japan, and then that has to the inflation as well. All of these factors, I'm afraid, are still with us.
And if I may skip this chart and go to that one, this shows what's been happening to money supply and the credit in each of these countries. So this one is the case of the United States. The red line is how much liquidity Federal Reserve pumped into the economy. The next one is money supply. How much money people have in the bank. And finally, this green line is how much money banks lent out. And if you remember your economics, we were all taught that these three lines are supposed to move together, right? So central bank increases monetary base by 10%, money supply, credit also increasing by 10%. And that world did exist until 2008. Three lines moving together. But once we hit the bubble, once the bubble burst in the United States, Chairman Ben at the time increased monetary base, QE1, quantitative easing 2, QE3, 400%. But look what happens to the, uh, credit here, the green line. It actually goes down, because people are paying down debt. So the amount of, uh, loan out there was actually shrinking for the first three years, and then gradually increased thereafter. Of the three lines, I pay most attention to this green line. Why? Because central bank can add all the reserves into the banking system at once. But for the money to come out of the banking system and enter the real economy, banks have to lend money. It cannot give away money, because this money actually belongs to depositors. And this is how much money, uh, banks lend out. So even though central bank put in this much liquidity in the system, only this much actually came out. And that's, and if this is about 3% per year, that's not enough to produce inflation, which is why inflation rates remain so low for so long.
Now, that's the world that existed all the way until COVID-19. But starting 2021, something happened, and suddenly Americans are borrowing money here. So if I may just, uh, go here, I just magnified that part of the chart here. When COVID-19 hit, there was a big increase in borrowings, because all these companies thought they have to have some cash in the bank so that they can pay whatever they have to pay, even though the income might be drying up. But then they realized that, oh, it's not so bad. So they pay back the debt to the bank. But starting around 2021, they stop borrowing money like crazy, increase of about 11% per year compared to 3% per year before that. Now, I don't know what is the reason behind this, and I'm trying to ask a lot of people to find out why there was a sudden pickup in this borrowings. But, you know, this is already after 10 years of the Lehman crisis. So their balance sheets must be cleaner. Inflation rate was high. Interest rates are low. So real interest rates are very low. So those are probably the factors that was behind this, uh, increase in lending. But from the perspective of the Federal Reserve, the fact that bank borrowing is skyrocketing means you could really have a classic inflation, right? Because the money is coming out of the banking system, entering the real world very rapidly. That means there might be too much money chasing too few goods. That's a classic inflation. And I think this is one of the key reasons why the Federal Reserve suddenly, November 2021, start arguing that we're going to be inflation fighter, not a deflation fighter, whereas before that, Jay was still saying, "I'm the deflation fighter, not inflation fighter." This sudden change, I think, has a lot to do with this one. And they kept on raising interest rates, interest rates, interest rates, and finally, this is, uh, beginning to slow down, which is a good news as far as inflation rate is concerned. But I will get back to this a little later, because this is only happening in the United States. In other parts of the world, this is Europe, no such pickup in borrowings here, still very steady, slow. Uh, this is UK, still very slow, actually coming down a little bit. And this is Japan, no sharp pickup in, uh, bank lending. And finally, just for the contrast, this is Taiwan. And Taiwan, three lines up, more or less moving together. So Taiwan is still in the textbook world. Taiwan is not experiencing balance sheet recession, which is a good thing. This is, we are in a normal world here. We can still use our textbooks to see, you know, what might happen next, because these lines are more or less moving together. Uh, so if you compare all these, uh, together, this is the Taiwan line, this is the American line, and the other three are the Eurozone, UK, and Japan. Although Taiwan line is moving rapidly higher, but there's no pickup. Right? The key point is whether there's acceleration. Only US have this huge acceleration here, which then prompted the Federal Reserve to tighten monetary policy. The other three of, uh, UK and Eurozone are tightening monetary policies, but not to the extent of the United States, because you, the differences are quite, quite clear.
Then we run into another problem, and the problem is that this is the first time in history where central bank has to tighten monetary policy with all these excess reserves already in the system. In the past, excess reserves in the banking system was very small. So, uh, the amount of reserves in the banking system was not an issue. But this time, because of all the quantitative easing, the amount of excess reserves in the US banking system is $3 trillion. That's 1,600% higher. 1,600 times than the amount of excess reserves that was in the system just before Lehman collapsed. So with so much excess reserves, how do you tighten monetary policy? And this is important, because in the past, in the textbook world, without quantitative easing, central bank had two tools to tighten monetary policy. One is to squeeze the availability of reserves, and the other is to raise interest rates. And when Paul Volcker, apparently Jay Powell's hero, uh, when he was tightening monetary policy back in 1979, he basically squeezed the availability of reserves. And because there was so little excess reserves in the banking system, when that reserve was squeezed, all these banks had to scramble for the reserves. Short-term interest rates went to 22%, and that killed the economy and the inflation very quickly, as in the textbook one. But this time, that option is not available. The $3 trillion of excess reserves, even if Jay Powell removes one trillion, there will still be two trillion left. And what does that mean? If someone comes in to borrow to, uh, to borrow from the bank, and if, let's say, the interest rate is 5%. In the past, if the someone says, "I'm willing to pay 6%," can we borrow the money? But if the bank did not have excess reserves, this bank will have to get more money from the depositors, go to the bond market, or go to the, whatever market to get some money to lend, which is a very complicated process, which is why it was difficult for these people to borrow, even if they are willing to pay more. This time, if the interest rates 5%, and someone comes in, "I'm willing to pay six," banks have $3 trillion to lend. So, "Oh, of course, sure." So as long as people are willing to pay a little higher than the official rate, the money can keep, keep on going, uh, into the economy, because banks are stuck with so much excess reserves. As a result, even though Federal Reserve already raised, raised to 5.25%, the market is really not all that tight. I mean, financial market is not all that, uh, tight. And you can see that from this chart. This blue line is, uh, financial condition index put together by the Federal Reserve Bank of Chicago, and the other one is the Federal Reserve policy rate. And in the past, every time the policy rate goes up, the red line goes up, the blue line also went up. So every time the Fed tightened monetary pol, uh, financial condition also tightened. But recently, that relationship has broken down. The Fed has tightened this time, you know, quite substantially, from almost zero to 5.25, 25. But the financial condition index is still minus 0.3, minus. Minus means it's still looser than the average of the last 50 years. It has to be in a positive range before it really starts squeezing the inflation. But the fact that we're still in a negative range means that it's not really tight enough to squeeze the inflation. That's why Jay Powell keeps on talking about, "Financial condition is not tight enough. Financial condition is not tight enough," because he's referring to this thing, and it is not tight enough to really kill the inflation. So we are in a very different world. This is the first time in history where central bank has to tighten monetary policy with this humongous amount of excess reserves already in the system, and that all the, uh, tightening has to be on interest rates, because they cannot use the other tool of, uh, squeezing availability of reserves. And you can actually see this in many of the Federal Reserve publications. This is a quote taken from, uh, Beige Book of the Federal Reserve, and you can see that, for example, San Francisco Fed, as late as October of 2022, by then the Fed was tightening quite substantially. Competition for loans remained brisk, liquidity was elevated. All these banks are trying to compete with the other banks to make sure that they can lend, and liquidity is elevated. Of course, there's $3 trillion of this stuff out there. So, how do you tighten monetary policy in a situation like this? No one knows, because there's no example to follow.
Well, at least part of this was working, and that's the long end of the market. Longer than the market, uh, 10-year US Treasuries, 30-year mortgages did go back, uh, go up substantially, and that is resulting in some responses in the real estate market. For example, commercial real estate in the United States is has fallen, and some of the house prices are beginning to fall as well. So those are, that part of the monetary tightening is working. But I would say only that part of the monetary tightening is really working. The short end of the market, I'm afraid, is not working. But in order to kill the inflation, they might have to tighten interest rates. They, they might have to raise interest rates further. And if they do, and if this commercial real estate prices, for example, starts falling sharply, then we're going to end up in another balance sheet recession all over again. So, it's a very delicate act from this point onward. And this is not just an American problem. This is what's happening to European house prices, and they also going pretty high, and some of them are beginning to come down in Netherlands and Germany. But if it's, it's good that some of the prices are coming down, because the prices are already too high. But if it goes down substantially lower, then suddenly we'll be back to balance sheet recession all over again. So that's where the central bank has to navigate very, very, uh, carefully. And the banking problems we are seeing, starting with the, uh, Silicon Valley Bank, Signature Bank, First Republic, all are coming from this source, same reason. They never thought Fed will have to raise interest rates this much. If it's just two or 3%, you know, holding of long-term bonds or commercial real estate mortgages, the price might go down, but it was completely within, you know, uh, they can handle it. But now they realize that Fed is raising interest rates to 5%, may, may even go to close to six, then all these long-term fixed-rate mortgages assets that these banks are holding, the prices are going down very sharply, and that's affecting the, uh, health of the banking system. My guess is that, uh, Chairman Powell will have to do two things. They have to tighten monetary policy, raise interest rates, but without causing the banking crisis. So that's going to be a very delicate act from this point onwards. And, uh, Jim Powell is also reducing the excess reserves in the banking system, so-called quantitative tightening, the opposite of QT, opposite of QE. And they're still doing it, even though interest rates are kind of stable, but Federal Reserve is still doing the QT. So Federal Reserve is still tightening. No question about it. But if they tighten too much, and the real estate prices, for example, start falling very sharply, then we're going to have balance sheet recession all over. So they have to do this in a very delicate fashion, very carefully, in small steps, to make sure that things do not really go over the cliff. That's where the Federal Reserve is right now. And this is a problem all central banks, uh, that did quantitative easing will have to face going forward. And I'm so glad that Taiwan does not have this problem, because Taiwanese central bank was smarter than the rest of the guys, did not do QE. And so this problem will not arise here, but it's going to happen in Europe, in UK, in Japan, as well, as of course, the United States. So, [clears throat] we, when we are looking at financial markets, we have to remember that this is the first time in history the central bank is tightening monetary policy with excess reserves in the banking system, and that is causing all sorts of problems here and there that we never had to even think about in, in the earlier world where excess reserves are always limited.
So from here, let me move to the next topic. Is China following the Japanese path? And ever since China's bubble, housing bubble burst, I've been getting tons of calls from Chinese, uh, journalists, economists, investors, sometimes policymakers asking me, "Are we going the way of Japan? Are we going the way of Japan?" And some of you might have noticed that last week, I did one event, and that thing went viral in China. 600,000 downloads in like two days, about the topic that I'm going to share with you right now, because, you know, it's not fair that the people in China knows what I'm talking about and people here doesn't know what I'm talking about. So I'll try to explain, uh, how I view this Chinese situation relative to what Japan went through, uh, 30 years ago.
This is what happened to Japan's bubble. This is the Japan's commercial real estate prices. In the Japanese case, it's the commercial real estate that led the bubble, and the housing was was kind of secondary. And it went from, you know, 20 here to 100 in just five years. Of Japanese commercial real estate prices went up five times in five years. So you can imagine how horrendous the bubble was. At the top of the bubble, they said the Imperial Palace Gardens in the middle of Tokyo was worth the entire state of California. That was the most ridiculous period, uh, that Japan was going through. But at that time, uh, people felt rich, spent a lot of money. So GDP was going up very sharply as well, both in nominal and real terms. And then the bubble burst, and it came crashing down, fell to the level of 1973, 87% down nationwide, not just a little corner of Tokyo, the entire country. So just imagine in Taiwan, Taipei prices down 87%, Hsinchu down 87%, Lugang down 87%, Taichung down 87%, Kaohsiung down 87%, Pingtung down 87%. What kind of economy you think you got left in Taiwan?
Then you look at the Japanese, sorry, at the Japanese GDP, it never fell below the peak of the bubble. Even though asset prices fell 87% nationwide, that's the most remarkable part of the Japanese experience in my view. Uh, but it did have an impact on individual companies, and this is what happened to the corporate sector of Japan. Let me explain how this chart is put together. There's a horizontal line going across at zero. If the blue bars here go further up, that means they're increasing their financial assets, bank accounts, bonds, whatever. If the orange bars go further down, that means they're increasing their borrowings, issuing more bonds, or borrowing more money from the bank. And the net number is this line with a small circles. This shows whether the corporate sector, as a group, is a net borrower or net saver. And if you look at the 80s, it's below zero, between five and 10% minus five to minus 10%. That means the corporate sector was busily borrowing money from the household sector and investing in all sorts of assets. And during this time, of course, Japan was, you know, at the top of the world, beating everybody. Then once the bubble burst, you see that suddenly this orange line starts shrinking very rapidly. By 1997, the orange bars are above zero. Orange bars above zero means they are actually paying down debt at zero interest rates. By then, Japan has zero interest rates, and by 1999, the whole line is above zero. So the entire corporate sector is paying down debt, and this is still with zero interest rates, and that goes on for like 20 years. No one told us that companies are supposed to pay down debt at zero interest rates, right? They should be borrowing money, but they're all busily repairing balance sheets. What that means is that during this period, Japanese companies could not use all their cash flow for new product development, more marketing efforts, more export markets. They had to use their cash flow to pay down debt. And that's why the Japanese economy began to slow down. The momentum the Japanese companies had before were lost, because so many companies had to use the cash flow to repair their balance sheets instead of developing new products, uh, fighting in the new markets. And of course, that's where Taiwanese companies, South Korean companies came in to take over the Japanese market. So it did have an impact in slowing down Japan. One company, of course, was not affected by this, and that's Toyota. Toyota came out with a super sophisticated technology called hybrid technology and became the top auto companies, uh, very quickly. How did Toyota do that, and all the others, Nissan, Honda, start losing their the lead? Very simple. Toyota had no debt. Toyota was screwed by the bankers 70 years ago, and the family said, "This company will never borrow money, period." So none of this was affecting Toyota. So Toyota could use all their cash flow to develop hybrid technology, other technologies, and Toyota continued to do very well. But Nissan and others had to fight with this balance sheet problems. So that's why they fell behind. Well, most recently, the orange bars are below zero. So they are no longer paying down debt, which is good. But the net number is still above zero. Why? The balance sheet is already clean. How come they're still not borrowing? Well, as I said earlier, there's a trauma toward debt. They don't want to borrow money. And the second reason is that it's more profitable to borrow outside the country and invest outside. So that's why it's, uh, in this shape. But for Japan to really become a normal strong economy, this one has to come down. That's when the Japanese economy is really back to the, uh, textbook world. So that's what happened to the companies.
So how did Japan manage to keep its GDP from falling? Well, government borrowed the money. And if government borrows the money, then the economy can, the money comes back to the income stream. Economy can move forward. So this chart shows who borrowed the money and who saved the money in Japan. There's a horizontal line going across zero. Above zero are the people saving money. Below zero are the people borrowing money. And there are four lines here: household line, corporate line, government line, and the rest of the world line. If you add the four lines together, you're supposed to get zero. That's how these things are put together. And as you can see, it is the corporate sector that screwed, screwed up Japan, in that during the bubble days, they borrowed lots of money, this one, and then once the bubble burst, they realized that, "Oh my gosh, we have to repair balance sheets." Then became the huge savers. Corporate sector was actually a bigger saver than the household sector during this period, because the problem was just so large. But the government sector, the green line, went the opposite direction. And this is the part that kept the Japanese economy going. So the point is, if you're in this type of recession, you have to have a government borrowing and spending money. No other policy will work. Whether it's a structural policy, monetary easing, none of those work, because the problem is with balance sheets. Government has to come in and borrow.
Now, then you look at this with the Chinese, uh, data. This shows what happened to house prices in Beijing compared to what happened to house prices in, uh, Osaka and Tokyo area exactly 30 years earlier. And the magnitude of the bubble looks like it's about the same. And of course, recent numbers that are coming out of China, no one can trust anyway. But so, the fact that a lot of people are saying house prices are falling, real estate prices are falling, suggests to me that China is already in a balance sheet recession, because when that happens, and of course, we all hear that Chinese people are not borrowing money, they're actually paying down debt. So that also suggests that China is already in a balance sheet recession. But there is one huge difference between Japan.
And United China.
30 years ago, when Japan was falling into the balance sheet recession, nobody had any idea what kind of recession we were faced with, including myself. Because we were never taught in universities this whole concept of balance sheet recession. So the Japanese government tried this policy, that policy, see what, which one will work. None of them seems to work very well because we had no idea what the disease is until I came up with a concept of balance sheet recession around 1997. But by then, already, you know, asset prices already collapsed.
Today, Chinese are fully aware of this disease called balance sheet recession. As I was already mentioned earlier, I was told by a Chinese professor that nearly half of the PhD dissertations on economics written by Chinese students today are based on balance sheet recession. And I said to myself, I haven't got my PhD. How come these guys all are getting PhD based on my ideas? Only Taiishin is giving me PhD because he always calls me doctor. I don't have a doctor degree, by the way. Uh, so this kind of article appears in Chinese newspapers, Renfe and Gaming. Why the two? You know, I have nothing to do with Mr. Renfe, by the way. Uh, but the fact that this kind of articles showing up in the Chinese newspaper suggests to me that a lot of Chinese pe Chinese people already aware of this disease called balance sheet recession and how to cure it.
And so China is falling into balance sheet recession, but my guess is that they're going to put all the right policies in place and keep that in place long enough until this problem is over. So my guess is that as far as balance sheet recession is concerned, China is in a very good position because they know exactly what to do. And I hate to say this, but in fighting balance sheet recessions, authoritarian governments usually do a better job than democracies. Because in a democracy, if one side is for fiscal stimulus, the other side is always against fiscal stimulus, right? And they fight and fight and fight and why all the time economies going down the drain. But if Mr. Mr. CGPing gets the right advice, he can say, okay, do fiscal stimulus in 20 minutes, this problem's over. And if the banking has a problem, and if he gets the right advice, put some capital into the banking system, and if Mr. orders that, that's the end of the issue. Whereas in the United States or Japan, you know, you could go on fighting and fighting fighting for hours, days, weeks, months, and then the economy keeps on going down and down and down. So, because China is an authoritarian state, if he gets the right advice, they can handle these problems relatively quickly. I'm not saying it's good or bad, but as far as this kind of recessions are concerned, they can often handle it better.
Well, then, is China fully out of the problem? Not quite. And this is where the real problem is. If you look at the Chinese flow funds data, which is exactly the same data as the Japanese one, you notice that the Chinese companies actually stopped borrowing money five years before the bubble burst, starting from two here, 2016, and then start reducing their borrowings. And because the household sector is still saving money and the companies stopped borrowing money, the government had to come in to save this uh Chinese economy. So this green line is the government. This is all happening before the bubble, before the bubble burst, and this is very, very disturbing. Why? Because China is at that stage of economic development where the companies should be busy borrowing money and expanding their production systems. I mean, we know Chinese are very entrepreneurial. They have lots of technology. They're coming up with lots of innovative uh products, very interesting products, and they are still very competitive even with the higher wages that they have to pay because you can see from their export numbers, right? Still a very, very competitive economy. And so if you're a Chinese entrepreneur with a factory to produce these uh newer products, they should be borrowing money and investing, expanding, and then you see that that's not happening. They're actually not borrowing money. I wonder why that is the case. Is it because of these uh conflict with the with the United States and western markets may not be open? I don't know what other reasons uh they stop borrowing money, but that forced Chinese government to actually borrow a lot to keep the Chinese economy going. So even before the bubble burst, starting from 2016, Chinese economy was actually supported by fiscal stimulus of the Chinese government, only mostly regional governments.
But what that means is that by now, reg as as all of you are aware, Chinese regional governments are in very sad shape. They basically, you know, exhausted their borrowing capacity. People are very uh afraid of lending money to regional governments now. But from this point, they have to fight balance sheet recession. So this number has to go much further because this number is likely to go this way, and that's going to be a huge uh challenge for the Chinese economy and for the fiscal authority. My guess is that regional governments probably won't be able to handle it. So the central government has to come in and either help the region uh regional governments or do the fiscal stimulus by themselves because the regional governments on their own probably cannot do any more fiscal stimulus given uh how much that they already are carrying. And so that's going to be a big challenge on the fiscal side.
And furthermore, when the Japanese bubble burst, the construction was about 20% of Japan's GDP and it was already on a declining trend. So in when the Japanese bubble burst, it well, sorry, the Japanese bubble was the prices went high and came crashing down, not much impact on the construction. But in the Chinese case, there was a huge construction boom, and now the construction industry is frozen. But that's 26% of China's GDP. If construction is reduced by even by 10%, China will lose uh 2.6% of GDP. So in addition to balance sheet recession driven by balance sheet problems, they have this construction recession that they have to address with more fiscal stimulus as well.
And of course, this decoupling or de-risking the West composed of about 55% of global GDP, and they are the uh per capita GDP of the West on average is $60,000. So all the rich customers are there. If decoupling means you are losing access to this market and you're only left with that one. The non-West is about uh 27% of global GDP, but per capita GDP is only $14,000. So you you lose your best customers, the richest customers, then you're stuck with the poor ones. Maybe that's why Chinese companies don't want to invest because if you invest the factories, invest the production, and then you suddenly you have you lose your market in those economies, then you'll be stuck with this overcapacity.
And finally, the population. As most of you are aware, uh Chinese population started declining uh this year or last year, and many of you have heard this argument that, oh, Japan is doing so poorly because demographics are so bad, their population is shrinking. That argument, in my view, is nonsense because Japanese population peaked in 2009. Japanese bubble burst 1990. So there was a 19 years where Japanese population was growing. So you cannot explain the Japanese deflation during that 19 years because Japanese population was still growing. It's only after 2009 that Japanese population started shrinking. But in the Chinese case, the bursting of the bubble and the population shrinking happening on the same year. So this is going to be quite a bit of challenge for the Chinese policymakers because even though population itself doesn't affect the economy all that drastically right away, people's mind for investments will be affected. When people start thinking that, wow, population is shrinking, the markets will be shrinking, then let's put the production somewhere else instead of at home, you know, people start thinking like that. And so even though population doesn't affect the economy right away, it could still affect the uh investment side of it, and that could affect the economy eventually.
Let me skip that part. So if I compare what Japan faced back in 1990 and China this at this time, Japan had a bursting of the bubble in the balance sheet recession, that was bad enough. And then you at the time, Japan and US had quite a bit of trade friction. It was very ugly trade friction. I was involved in it myself on the American side. Uh, but that was just within the businesses. Japanese markets were largely closed at that time. Americans wanted to sell more semiconductors and other things to the Japanese market, and Japanese said, no, no, no, we don't want it. It's the opposite of the Chinese uh issue. Americans are saying now you cannot buy our semiconductor, and back then Americans are saying, Japanese, you buy our semiconductor. Well, that [clears throat] was the trade friction back then, but basically just those two because population was still growing and so forth.
The Chinese are facing this many problems. Uh, bursting of the asset price bubble and the balance sheet recession, that is one area where Chinese China can handle it quite easily because they already know the disease, they all not know how to handle it. But then there's a construction recession in addition to it. And then of course, Chinese companies are not borrowing money. So government was already running large deficits before that, not the central government, but the regional governments, and that has depleted the regional government's borrowing capacity quite a bit. And then of course, this geopolitical problem with the West. This may be the one that's affecting all the other ones. And then middle-income trap. China is in in the middle of middle-income trap. In that, when you're the lowest cost producer, all the factories from around the world will come to you. But once your cost becomes much higher, all these factories will then start moving away from you to Vietnam, Indonesia, and places like that. And it's not just the foreign companies. Chinese companies may move that too. Looks like a lot of Chinese policymakers have forgotten that they are in the middle-income trap because whenever Americans come up with some sort of a sanctions against China, Chinese immediately come up with their own sanctions, right? And they keep on adding sanctions to each other. But it's China that's in the middle-income trap. And if you do all these sanctions, more less and less people will invest in China, whereas, you know, US is not affected because US is already out of the middle-income trap. But somehow no one is telling Mr. Jin that, look, we are in a middle-income trap, we shouldn't do these sanctions so easily. But anyway, [clears throat] and then these regulatory uncertainties on so many areas, uh, tech industry, financial industry, real estate industry, education sectors. Suddenly government comes up with these regulations, and all your investments worth nothing next day. If you do a few of these, of course, businessmen will become very, very cautious. If you have five ideas, maybe you do only two. The three never shows up because only in the heads of the of these businessmen, but it will affect the e economic growth going forward. And of course, population.
And finally, and this one I have no evidence to prove it myself. But during the COVID-19, a lot of governments provided a lot of help, financial help to the households and companies, at least in the developed world. In China, I hear that they didn't do very much of that, which means most business, most businesses, many households had to weather the COVID-19 lockdowns by themselves. If that's the case, they must have depleted their savings during the period. And now that economy is back, people can work. If all these Chinese houses h households and companies decided that, wow, now we have we have to rebuild our savings, and if they all start rebuilding their savings to the level they had before, that's another balance sheet recession. But on on the asset side, the earlier balance sheet recession I talked about is on the liability side. The liability is too big, so they have to compress it. Now, on this one, the the savings are too low, they want to rebuild it, so it's on the asset side. But the net effect on the economy will be the same, that everybody saving money, no one borrowing money. I don't know how much of that is actually happening, but if, as we hear that people paying down debt, trying to save money, is coming from that reason, then that's another challenge for the Chinese policymakers.
So you put all these things together. I must say that even though China has certain advantages over the Japanese back 30 years ago, taken together, I would say the challenge Chinese policymakers facing is far bigger than the challenge Japanese faced 30 years ago. Which means China is going to, Chinese economy is likely to slow down uh even under the best of circumstances, and if they screw up any of these, it could slow down even more. So, we're going to be facing the second largest economy in the world, our largest trading partner slowing down going forward. And we should be prepared for this, this kind of situation going forward. Thank you very much.