Economic growth has been the basis of stability in many quarters of the world in the last decade. Emerging economies have grown rapidly in recent years due mainly to their exports, and other developing countries have begun to follow their trail. Developed countries have maintained absorbing capacities in their markets for the products of developing countries and have periodically been able to enhance their development assistance. Now, however, these premises can no longer be taken for granted.

The financial crisis that started in the United States has negatively impacted Japan as well. This is unsurprising, of course, because the Japanese economy is closely coupled with the US economy. Globalization has made many markets interdependent, but Japan’s case is unique: financial crisis is not unfamiliar to Japan. We experienced difficult years throughout the 1990s and early 2000s. Through these recent experiences, Japan has learned several lessons for coping with such financial situations, and our strategies can be implemented now by the United States as it deals with this unprecedented market failure. These can be summarized as the following “3 C’s”: confidence, control, and concerted action. It is important to restore confidence, stay in control, and take concerted action.

Restoring Confidence

Today, the credit crunch we witness is brought about not by lack of funds but rather by lack of credibility. Financial institutions no longer trust each other because they are not confident about other organizations’ real financial situations. Japan has experienced this in the past: our financial institutions were heavily affected by non-performing loans after the bubble burst in the early 1990s. However, it took Japan years to identify the defaulted loans because of the lack of trust between the government, institutions, and the public.

Several problems confronted policymakers and regulators. First, there were no clear criteria to determine which loans were causing the problems. Second, financial institutions were weary of being labeled as problematic institutions possessing bad assets. Also, the general public was not willing to use taxpayers’ money to save private financial institutions. This distrust of the establishments could be solved only through accurate asset assessments and the disclosure of all relevant information before the public could understand and accept the necessity of these drastic measures. We learned that transparency was the key to obtaining the public’s understanding and recognition of monetary support as unavoidable and fair, and thus the key to restoring confidence.

In addition to accurately and quickly identifying non-performing loans, rigorously writing off and cutting off non-performing loans was necessary to avoid losses in the future. Furthermore, financial institutions had to raise capital to keep solvent. When they could not do this by themselves, institutions needed injections of public money in order to continue functioning. However, financial institutions resented being labeled as malfunctioning and insecure. In order to alleviate their concerns, better-performing banks were asked to accept the injection as well. In this way, it was like the Ali Baba story in Arabian Nights—mark all the pots and you will not know which one is the target. This approach of appearing to help all institutions, rather than singling out one particular organization, stabilized the financial system as a whole and reassured the market.

Altogether, Japan injected about US$500 billion of public money into private financial institutions. One hundred billion was used for buying non-performing loans, 120 billion for capital injection, and 190 billion for assuring deposits. After taking these steps, the situation began to change, and the watershed moment was the injection of public money to Bank Risona in 2003.

Financial institutions of Japan are now in a comparatively healthier situation. For instance, non-performing loans, which had comprised eight percent of the assets of major Japanese financial institutions, have dropped below two percent. However, it is true that this process took too much time: if we had been quicker, our scars would have been shallower. We learned that speed was indispensable.

Of course, the situation facing the United States is more complicated than that which Japan experienced in prior decades. First of all, the securitization of mortgages, whose values are hard to evaluate, did not exist in Japan. So-called leverage, or the ratio of asset to equity, was far smaller. Moreover, the economic slowdown was not a global problem, so export could play a positive role in its reversal. However, the very essence of the situation remains valid: securing transparency paves the way to introducing measures that the public accepts as fair. In this regard, it should be noted that the restoration of confidence is not only an objective but also a tool for the recovery process. It is a useful tool because the economy is based not only on mathematics but also psychology: if people think the economy will be weaker, they will refrain from investing or consuming, and this will result in an even weaker economy. I dare to say that, in spite of the gloomy prospect of the economy, the opposite is also true: If people believe that the economy will be stronger in the long run, they will be more vigorous in their economic activities, and the economy will strengthen as a result. In other words, the fortune of the economy can be considered a self-fulfilling prophecy.

Understanding the psychology of the economy, former Prime Minister Junichiro Koizumi said in the beginning of this decade that the Japanese were over-confident in the1980s but became exceedingly pessimistic ten years later. He stated that the ideal must be somewhere in between. This is true today in the United States as well. Overstating the pessimistic side may have a negative effect on the economy. Instead, the government should offer decisive demonstration of its resolve to cope concretely with the situation at hand. Doing so would provide reassurance to the market and will also present a plan for enhancing economic activities.

Governments around the world are already attempting to implement this strategy: the Obama administration has proposed a massive economic stimulus package of US$825 billion. This quick and decisive policy reaction is expected to enhance and support the recovery of the US economy. China has announced an economic package of US$540 billion to be spent in two years to stimulate its economy. In August 2008, the Japanese government announced an emergency economic package of US$120 billion, and it enacted a supplementary budget required under this package in October. In addition to this, Prime Minister Taro Aso’s Cabinet created two additional stimulus packages, one in October and the other in December 2008. These amount to US$270 billion and US$230 billion respectively, although the two packages overlap by approximatelyUS$60 billion. These stimulus plans are mainly designed to help the negatively-impacted domestic industries and to have the effect of providing assurances and stability to financial institutions and investors. It is hoped that these sets of policies will restore the people’s confidence in the market and thus lead to economic recovery.