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• Abenomics and the Japanese Economy by Beina Xu Updated: April 5, 2013

SMITH: Good morning, ladies and gentlemen. I - forgive me, because we're starting two minutes later, which is unheard of at the Council on Foreign Relations. But welcome, everybody.

My name is Shelia Smith, and I am the Senior Fellow for Japan Studies. And I am delighted today to be co-sponsoring this event with my colleague Rob Kahn and his geoeconomics group. I see many of you around the table. Welcome.

We have a wonderful opportunity this morning to meet with Robert Feldman, Robbie, as we call him in Tokyo, who is the managing director, chief economist for Japan and co-director of Japan research at Morgan Stanley.

For those of us in the Japan community, we've known him for a long, long time. He is on television regularly explaining the Japanese economy. And I can imagine there's no more exciting time for an economist in Japan to be looking at policy issues than right now.

So when we knew that Robbie was going to be in town, Rob and I both said absolutely, let's please get him over here to talk to all of you about what Abenomics is, what its success - potential success might be, but also just his evaluation of what's been happening in Japan since Mr. Abe took power.

So I'm delighted to - to share the table this morning with Robbie. He does have a very extensive report from Morgan Stanley which he's going to share with us. I've sent the link. Didn't realize we needed hard copy. Hard copy is being furiously copied upstairs on lots of Xerox machines, so it's coming soon.

But in the meantime, I thought we'd turn the stage over to Robbie so he can get us started this morning. Again, welcome Robbie, and thank you for making time to come and speak with us.

FELDMAN: Thank you, Sheila. Thank you, CFR, Rob in absentia, for organizing. And thank you everyone for - for coming today. It's great to see all these luminary names around who I've been seeing in print for so long, and then to - to have a real - real, live seminar with folks.

I should spend a little bit of time on just self-introduction first, just a second. I first went to Japan in 1970 as a high school student. I was on the AFS program. Anybody know AFS? Probably a few people know AFS. Great problem. And like many of us involved in Japan, I sort of fell in love.

It's not just all the puns and the word play that you can do in Japanese, which is wonderful as a language, but intellectual fascination of dealing - particularly for an economist. Maybe for political scientists as well. But the intellectual fascination of dealing with Japan has just kept me at it for 40-plus years now. It's - to me, it's the most interesting economy on Earth. So that's what kept me going.

This is a particularly interesting time, not only because of what Abe is doing for its intrinsic interest, but also partly for its implications for the rest of the world. When I see the debate in Europe about austerity versus growth, that is exactly the debate that Abenomics is about.

We had the previous government, the DPJ, and partly LDP-supported regime, which is an austerity regime. Now we've switched to a growth regime. So if Abenomics is in fact successful, that will be an important data point for the rest of the world to be using in their economic debates as well.

So what I'd like to do today is just spend a couple minutes on the philosophy, the politics and the tactics that Abe has been using, and then go a little bit into the monetary, the growth, and then the fiscal side. Talk a little bit about some of the numbers, what has to be done next, what are some milestones.

And then if we have a little bit of time, I'd like to talk a touch about the Fukushima issue and energy, which is really a much more global issue than one would think from thinking about the Fukushima accident by itself. But the more I think about it, the more global issue that gets. And I built a little model to help organize thought about that.

So if I may, let me start with the philosophy. I think Abe's actually quite unusual. First of all, I think as someone said at a meeting yesterday, it's very unusual for a Japanese politician to come back after having failed. And Abe's first term in office was not exactly a success, but he spent a number of years studying, doing new things, redeveloping or developing his own economic philosophy.

And what he's come up with is something that I think is actually quite - quite intriguing. He gave a speech in the Diet in October 2012. He had become the party president again, wasn't yet prime minister. And he mentioned two things in the speech I think are particularly relevant. One is about where growth comes from, so economic philosophy and then a fiscal philosophy.

On the growth part - I have it in the materials that'll come in a minute - but he said the key thing about growth is innovation. So he's taking a supply-side approach to the growth strategy. New technologies, new businesses, creative approaches. Government has a role in supporting innovation, and then he goes into all the wonderful things his government did when he was in office first.

But basically the idea is by spurring innovation you create new employment, new business. Very supply-side approach. Probably one of the few in the G-8, much less the G-20, who would take that approach. Unusual in the LDP as well because they're mostly Keynesians.

On fiscal issues, what he has said is essentially 180 degrees reverse of what the previous government, in cahoots with his own party, was doing. In August of last year, they passed a bill that would raise taxes and talk about social security reform.

They talked about social security reform, came up with a report just released about a month ago that really had nothing in it that would contain the social security problems. They talk about raising more taxes on business, expanding benefits further in a country that's already spending too much.

Abe's view is completely different. In that speech last year, he said, to resolve the fiscal problem, we have to cut sharply the things that need cutting. So first, spending. Secondly, we have to raise tax revenue. But to raise tax revenue, the first thing you have to do is get out of deflation and grow the economic pie.

And then third, if that's still not enough, it's OK to hike taxes. So his order of fiscal reform is exactly the opposite of what the opposition and his own party agreed to a year before. So this is to me quite an encouraging set of philosophical statements. Fine. What about the politics of it?

When I talk about Japanese politics, I use a philosophy map. The horizontal axis is big government versus small government. The vertical axis is what I call active engagement in foreign policy, you could say hawk, or passive detachment from foreign policy, call it dove.

And of course there are four quadrants. Another little business school-type four quadrant diagram. Very nice, but it's actually kind of useful. Because if you think about the governments that we've had for the last really 20 years since the Hosokawa government, they have ranged basically from the lower left, that is big government, passive foreign policy, to the upper right, small government, active foreign policy.

How are you ever going to have a policy, a coherent government, if you've got the entire spectrum of both economic philosophy and foreign policy philosophy in the same government? So that's why governments were so incoherent for so long.

The results of the last two elections have solved the issue on active engagement. That's where the country is right now with a little bit of help from Beijing. But the economic issue is not really solved. There are more people in the small government group now as a share of the LDP than there were before, but the (inaudible) is still in the coalition.

We have these smaller sort of pro-market parties. The Renaissance Party from Osaka and the Your Party, the Watanabe one, now affectionately known as My Party because of the way he's talking about, but whatever.

These are now a big help - at least the small reg (ph) parties are a big help to Abe because it gives him an offset to the sort of more big government-leaning forces in his own party as well. So the politics of this look like they're working out pretty well.

There was a conference a couple days ago where Ishiba spoke. And one of the things he said I thought was most interesting - this is the secretary general of the LDP, the guy who Abe beat for the - to be prime minister.

What he said is that we're now trying to move from call it politics of confrontation to politics of coexistence. OK, sounds nice. In order to do that, he added, you have to expand the pie. So even the sort of anti-reform call it interest group-dominated parts of the LDP now also understand that this growth strategy is really part of their own survival. So I think that's a nice - a nice step forward.

In terms of tactics, I think Abe has done very well. I'm using a reference now to that book from 30 years ago I'm sure we've all read, the Getting to Yes book from Fisher and - and Ury. I was sort of thinking about what was going on and it just popped into my head that what Abe has done on TPP on the Trans-Pacific Partnership, the trade negotiation, what he's done on the consumption tax, what he's done on growth strategy follows the prescriptions of that book very very well.

You separate the people from the problem. When he was trying to appoint a BOJ governor, it wasn't about Muto or Kuroda or this guy or that guy. It was about, and he redefined the issue to make it about what characteristics do we need in a governor to do the things we need to do.

Got to exit deflation. Got to be in contact with the global community. So what people who are the potential candidates have the characteristics do to the job we need done? It's a very, very different approach from what we're used to. OK, so separate the people from the problem.

Focus on interests, not positions, OK? I want Muto. No, I want this guy. No, I - no. What's the interest? The interest of the country is in exiting deflation. So that worked well. Invent options for mutual gain (ph). The list of potential candidates for BOJ governor expanded quite substantially. And then have clear metrics for - for measuring progress. So that's all part of the tax debate as well. So he's done pretty well in that.

The last question of course, what is his best alternative to a negotiated settlement? He's in very good shape now because his support rates are high. This is in a way what Machiavelli suggested. You play to the people to keep the aristocrats under control, and he's done that pretty well. So he's got a very strong bargaining position now.

So you have to say the way he has organized the governance of policymaking has been very good. Expanding the issues to bring more people to the table in a direction that he wants to take them. And the consumption tax debate is a very good example. It used to be about do you or don't you hike the tax.

Now it's about how do we implement fiscal reform and growth at the same time with a package of measures, the tax included but other things as well that will get us closer to where we want to do. I think it's a very, very encouraging approach to governance. So that's the main - main elements of the - Abe's philosophy, the politics and the tactics.

Let me go into monetary policy, growth policy and fiscal policy. I think - do folks have the handout now? OK, good. Monetary policy, page 28. I'm a big fan of what Kuroda did. I think it was stunning. Almost exactly 10 years to the day before the big monetary announcement, the baseball player Matsui was - had his first at bat in Yankee Stadium and he hit a grand slam home run. That's exactly what Kuroda did at his first at bat in monetary policy.

But the - there are still some issues here. It's nice to have them very aggressive on money supply expansion. They're controlling the yield curve very well, moving out, et cetera, et cetera. But there is no particular guarantee that that amount of monetary stimulus will actually generate the inflation that they've set (ph).

The CPI so far has been accelerating, but it's mostly due to costs, not due to wages, or not due to domestic elements. So the jury is still out on whether this is going to work. I don't think there's going to be any major move of monetary policy until maybe the spring, when we'll have a year's worth of, more or less, of experience under this.

I don't think it's cooked in the -- in the price index yet that this is really going to work. So they might have to move to a different regime even in the spring of next year.

There are some ideas. Nobody, of course, is talking about them in public. But some of my contacts at BOJ are actually beginning to think of how they might do better communication, that is, move to a price level targeting regime or something like that in the spring.

But basically monetary policy seems to be on track for now. We've got to watch the prices. We've got to watch wages. There is a new attention to wages, finally, in discussions of monetary policy now. Because if you're not going to get wages going up, prices don't help you.

But the BOJ now understands that. So this is a broader understanding. So I think monetary policy's actually doing fine.

Growth -- let's skip a few pages forward. On page 47, I have a little radar chart of what I consider to be elements of this Third Arrow policy.

That's a cute phrase. If we do everything together, we're stronger. You know, it's nice as a political phrase.

But if you look into the contact, I think, there's a lot of different things going on at the same time. He's done well on agriculture. I think it took a lot of guts for him to come out and say no to a very important interest group for his own party. And he did it in a way that was the perfect getting to yes approach. He said, look, we've got an energy problem. We've got to import gas. We've got a geopolitical problem. We need to make sure the U.S. is still on our side to keep peace in the region.

He goes to Washington. He sits down with Obama and says, "Are you really serious about absolutely no tariffs whatsoever on anything? What about autos and what about sugar?" And Obama says of course there's room for negotiation.

And that -- what that did was not so much U.S.-Japan negotiation material, but it allowed him to come back to Japan and say, "They're not forcing us into this. This is a negotiation where we're equal partners and we'll do our best to negotiate a good deal."

When he announced that he would go into DPP on that basis, his support rate went up. Very interesting. Because he managed to use the national interest to balance out parochial interests of some very important support groups of his own party. So that's kind of clever. So agriculture's doing fine.

Medical, as you know, he's got a bee in his bonnet about this one because of his own (inaudible) colitis condition that was not treatable with medicines available in Japan when he was PM. They were available, but they hadn't been approved in Japan. So as Prime Minister, he couldn't use them. And that was part of the reason his first term in office failed -- he's angry.

(LAUGHTER)

So they've done some neat things about creating their Japan Institute of Health, National Institute of Health, et cetera, et cetera, to pull things out of different parts of the bureaucracy. Basically to show folks, a, who's boss, but also to improve the communication between different parts of the government.

Energy -- I think they're doing fine on energy. It's not great, but it's pretty good because they've expanded the budget for energy, not so much in total quantity of money spent, but in the way it's allocated.

I was told a few years ago that something like 90 percent of the energy research budget was spent on nukes. And now they're expanding into other types of energy, quite intelligently. I think we've got some folks from the trading companies here who will know a lot about energy.

But this, to me, is very encouraging, OK. So it'll be gas in the short term, maybe a little bit of a so-called clean coal. I'm not so sure there is such a thing. But so fossil fuels, particularly gas in the 15-20 year range, and then they're working very hard on a number of the renewables as well. So good.

Education -- I think this is one of the most encouraging parts. One of the reasons I'm in town with Paige (ph), and Sheila and Patty, et cetera, is for the Japan-U.S. Friendship Commission. We've been doing this initiative on education for a couple of years now. It has borne immense fruit.

The new Minister of Education came into office. He said, "Education is an economic issue." Oh, that's a new idea. At least for them it is. Moreover, he's now made the TOEFL test, the test of English as a foreign language, as the key indicator or the key standard for entry into national universities.

Every mother in the country is now going to be pushing their kids to go learn English better. That's really cool. That's exactly what the Koreans did de facto and it worked like a charm.

The TOEFL test -- if you look historically at the English tests, Japan and Korea were about the same 30 years ago in international English testing. Korea just went through the roof. Japan's just kind of waddled along a little bit. It's better than it used to be. Taxi drivers are beginning to speak English now. It's all nice. But the gap is huge.

Korea's about average in terms of these global scores. Japan is way, way behind.

(UNKNOWN): So Robbie, is that a prerequisite? You don't enter university if you don't pass the TOEFL?

FELDMAN: Basically for the higher-end national universities, yes.

There is also an idea out there, not sure they're really going to force this through, but have it also the standard for civil service exams. And my understanding is that the Ministry of General Affairs said, "Well, why do we have to do that? We don't have to deal with foreigners."

Huh? Huh? Well, whatever. It's happening, so that's good.

Government reform -- very, very important, I think. (Inaudible) said in June, has repeated recently that he's now going to centralize the appointment of senior bureaucrats in the Prime Minister's office, like he did with, say, the BOJ governor, but it's going to go down to the (inaudible) level, to the bureau chief level. So they'll be political appointees, for a change.

Not going to necessarily bring them from outside industry. Probably choose them from inside the bureaucracy. But this is going to change the incentives and make the command and control structure a lot easier to control.

Suga himself, whose the Cabinet Secretary now, very serious guy, has been doing this extra-legally. It's not illegal. He says, "Well, I want that guy." And because he's Cabinet Secretary and he's serious, it happens.

So this is actually beginning to impact policy already. So that's the good news.

Employment governance, we're not there yet.

(UNKNOWN): (Inaudible) across the entire bureaucracy or is it just focusing on certain...?

FELDMAN: So far it's been three or four of them, but including Ministry of Health and Welfare, which is a very important one, of course.

Employment, we're not quite there yet. They need to do what they call monetary compensation for dismissal. That is to say, it's hard to fire folks if you're even a reasonably large company. Small companies, they can do whatever they want. But for the larger companies, it's hard. That has to be addressed because we will not have a fluid labor market otherwise.

Part of that is the governance issue. Because you can't give companies the right to hire, fire workers -- the right to fire workers unless you're giving -- enforcing stockholders, institutional investors, to fire non-performing managers or non-performing boards.

So obviously there's some discussion about this with Keidanren, with other business groups.

I would emphasize here that the power of Keidanren has been falling. There's an alternative thing that (inaudible) set up called JANE (ph). Half of Keidanren's membership is also now membership in JANE (ph), as well.

Abe just doesn't seem to like Keidanren very much. So there's some real sort of push against the business community -- it's very uncharacteristic here.

So there might be a little progress, but I haven't seen it clear yet.

Tax reform -- a lot of good ideas out there. I think Abe did a very good job in balancing this consumption tax hike with corporate tax cuts. The idea there being, of course, you need to raise the indirect, lower the direct taxation for an economy that is aging. OECD's been saying this for years, but for an economy that's aging as much as Japan is, it's even more important.

So there's some progress there.

Immigration -- well, not too much progress. Some -- it's not taboo. You can discuss it in public. But taking another couple thousand tech guys from Bangalore, that's not really going to move the needle very much.

Electoral reform -- another one. We're hopeful on that. We can get into that later on, if you want.

Let me skip to fiscal policy. Things here are interesting. Let's see here.

Yes?

(UNKNOWN): You went through all the reforms -- which ones are -- I mean, some of these are going to be more important for economic growth in the short term. Some of them are going to be more important for the medium term. Some of them may have absolutely no importance. They may be important for Japan's society.

Which of these kind of -- I mean, if one of the key aspects of this whole thing is, as you said, supply-side structural reforms, which ones are actually going to make a difference?

FELDMAN: In the short run, it's going to be tax reform and employment. In the medium term, I would say it's the education, the energy, probably medical as well.

Agriculture's important, but economically, even if the IIE's right and it's 2 percent of GDP instead of, I mean 1, it's not huge, but it's kind of good to get for the region. So I would put that one second down.

Immigration's a much, much longer-term issue. The electoral reform I've included in here because you're never going to get the fiscal issues, particularly the spending issues solved, unless you stop overweighting the elderly in the electoral system. But that's a longer-term issue.

Yes, Tom?

(UNKNOWN): You didn't mention women?

FELDMAN: That is part of the employment reform.

Actually, I think the problem is men.

(LAUGHTER)

To be a little more frank. And the reason the problem is men is -- it's very clear in the data, the participation rates for women are actually pretty stable. They're not high enough and there's obviously glass ceiling issues that are there. But the participation rates for men have been falling.

(UNKNOWN): Participation in the labor force?

FELDMAN: In the labor force, yes.

And this is because they're -- they had higher participation. They're retiring as they get older. We've got to get the elderly to work more. That's one of the reasons I was particularly happy to see (inaudible) get the job at the BOJ. Because I think he's 70 or 71. So we get some work out of these guys.

(LAUGHTER)

Got to keep them working a little longer, et cetera, et cetera.

So that's as part of the employment (inaudible).

Anything else on the -- on the growth before I switch to fiscal? Yes?

(UNKNOWN): Does it include the things that people used to talk about (inaudible), issues about inefficient sectors and services and food (ph) and stuff like that. And I don't see anything about economic efficiency of regulation or barriers, cartel-like (ph) behavior.

FELDMAN: I would actually include that in the governance elements. What they did on education with the standards is part of it. Below all this is called a sub-text, which is these national economic zones. This is Takenada's (ph) idea that he sold to Minister Shindo (ph) at General Affairs, who sold it to Suga who sold it to Abe.

And what they're going to do on this is basically attack some of those bedrock regulatory issues, particularly in agriculture, in education, in medical, in labor. And the result of that is supposed to be precisely the stuff that's been on that agenda.

So it's kind of there, but it's not explicitly -- call it -- for example, wholesale efficiency is not on here. And I think part of the reason for that is, yeah there's (sic) still some issues there, but they're so good with inventory control now and with the -- say the -- the convenience store network, but it's not as much of an issue as it used to be.

(UNKNOWN): Are those national economics -- is that an urbanite (ph) -- is that an urban focused...

(CROSSTALK)

(UNKNOWN): ... in your mind or is that...

FELDMAN: Good question.

Yeah, it was initially thought of as an urban focus policy. The government never said it, but basically the idea was Tokyo, Osaka and Ngoya (ph).

OK?

Then, what started happening was the regent (ph) started saying, hey what about me, what am I chopped liver? They all want to started (sic) -- started wanting to participate in these things. And so what they're saying now is they can have a non-contiguous economic zone.

OK?

So, for example, companies that have, you know, majority of external directors will have different set of labor rules, regardless of where they're located. OK, so the zone would not be defined geographically, it would be decided on -- based on rules rather than borders. That's -- that's kind of interesting.

In -- what is it, today is what?

The 24th?

Yeah, by -- call it maybe October 10th or 15th at the latest -- the next stage of this will be announced. There's a fellow named Dohata Tatsuo Hata (ph) who's, I think, a Maryland trained Phd. He's been running the working group on this. He's very, very good. And they've gotten ideas from every corner of the country. They're shifting -- sifting them down now and they'll put out sort of the next stages within a couple weeks. And we oughtta see some very good things.

From a narrow-minded stock market point of view, I think the most interesting one would be if they eliminate double taxation of dividends, but that's one of the many things that they would be looking at.

Can I move to fiscal for a sec. Nobody wants to talk about fiscal policies.

(LAUGHTER)

FELDMAN: I note that the average age in this room is probably a little higher than the average age in the country as a whole. So it's not going to be an easy discussion.

(LAUGHTER)

FELDMAN: But, somebody's gotta do it.

(UNKNOWN): (OFF-MIKE) supposed to keep work at it.

(LAUGHTER)

FELDMAN: That's right.

Let's start on page 34.

I did a project a couple years ago with some European and American scholars on the fiscal stuff -- updated it now. But, I think the essence of the issue is in that little graph on the top of page 34. The red line is social spending, the blue line is other spending.

You can't raise taxes enough to close the fiscal gap. What you've got to do is get the red lien down and if you want to have some growth you're gonna probably have to get the blue line up, because that's where R&D and education and infrastructure, which is actually not a very high, you know, spending number, right now.

Those are the numbers that have to change.

OK?

Let's switch to page 40 for a sec.

The government put out a -- the Japanese government put out a -- an estimate of fiscal -- well they had their fiscal outlook report. This is a cabinet office document, not mock (ph), cabinet office -- these guys are good economists. They know the accounts very well. They know how to do projections well. It's a very, very interesting document.

They start out with deficits. And they all project the deficits forward. They'll give you a deficit number for 2020, but they don't give you a spending line and they don't give you a revenue line.

Huh?

That's a little strange.

Now, given the deficit line that they're projecting, I can very easily see why they wouldn't want to publish a spending line or a revenue line, because it would be too politically sensitive.

On page 40, I've got their number for estimate -- it's still an estimate, because we haven't gotten final data but -- 2012 deficit is $53 trillion.

OK?

Even if they do both tranches (ph) of the consumption tax hike, that's worth $10 trillion, so what are we gonna do about the other $43 trillion? This is a debate that hasn't really begun in earnest, OK? It's the same issue that the U.S. faces, it's the same issue that Europe faces, it's the same issue that China faces: How do you control spending?

The forecast, or the scenarios are very interesting. They're assuming ovitnomics (ph) works. Page 41, you've got nominal GDP at 3.4 percent, real GDP at 2 percent. How are you gonna get that with an aging population? You'd have to have a major acceleration of productivity growth to get that.

But let's be generous, assume it happens, OK?

Even if it does, you get my little sort of exaggeration minus 5.6. That's their deficit even if everything goes right with their spending controls built in as well. That's not enough to stabilize the debt to GDP ratio.

Yeah, Angel (ph) .

(UNKNOWN): Well, isn't this what the implicit assumption of (inaudible) and others that they will keep on hiking their consumption tax rate until it reaches European levels that they don't want to say it because...

FELDMAN: Yeah, that's basically the...

(UNKNOWN): ... (inaudible) kind of happen.

FELDMAN: Yeah, that's what they're thinking. Problem is, it's not enough.

(UNKNOWN): Well...

FELDMAN: You'd have to take the consumption tax to something like 29 percent.

(UNKNOWN): Oh, I thought it was a bit lower. OK.

FELDMAN: No it's not.

Turns out that's sort of the next page -- since we're there, let's shift the page.

Page 42.

I've got their numbers for 2012 in the first column. OK, if they do nothing you're in red, but that's not going to happen. So if the presumed cabinet office scenario -- and I say it's presumed, because I had to back-calculate what their revenue and spending numbers were from the deficit and some assumptions that they talked about in the text.

But, if we do what they say they're going to do, you get the deficit to 5.6 percent of GDP as we saw before, $35 trillion. Spending is this, blah blah blah. You would have to cut social spending per captia on the elderly by about 17 percent if the consumption tax only goes to 10 percent.

OK?

So they know they gotta do a little more no the consumption tax. Public is buying that. It's not a major problem for the public.

OK?

If you really want to stabilize debt to GDP, you have to go into the -- the final column here. There's a debate in Japan about what they call the Domar (ph) condition and that is the primary balance has to be a certain level relative to debt, as a surplus, in order to stabilize debt to GDP.

Government has always taken the position that zero is good enough, because they say, in the long run, R equals G, that is to say, the interest rate equals the growth rate. There is no period in Japanese history when that's ever been true, but -- and that's what is -- it's an easier target. I don't like easy targets. So I put in the real target here.

They have to get to a surplus of the primary balance at 1.8 percent. If they're gonna do that they would have to, as Angel (ph) was just saying, go up to 16.7 percent on the consumption tax and cut per capita spending on the elderly by about 25 percent.

(UNKNOWN): I don't get what you just said.

R has been less than T (ph) for a long time in Japan though, and it's going lower.

(CROSSTALK)

(UNKNOWN): Why would you think it would not -- I mean, I think they're assumption is too pessimistic. You say it's too optimistic. I mean, the facts are real bonds are deeply in agony.

FELDMAN: Actually if you go back and look at the JGB data, OK, look at the nominal GDP data, OK, the -- the average over either a 20 or a 10 or a 15 year period -- whatever period you want to take is about 1.4 percent, positive.

So, R is greater than G. Right? I sent those numbers off to Takanaka (ph) the other day.

(UNKNOWN): I think (inaudible) the last 10 years, that's not true. And if you look in the last year, it's definitely not true.

FELDMAN: Maybe the last year, maybe not. OK, but we gotta take a longer year period.

(UNKNOWN): But it seems to me that the way out of this for them is not to have what you assumed on page 41, a 10 year bond yield at 4.2 percent. I don't think that's going to happen.

FELDMAN: Well, that's their number.

(UNKNOWN): Right, I don't think that's going to happen. I think it's gonna be a lot lower this quarter (ph) (inaudible).

FELDMAN: If it is, that's great.

(UNKNOWN): The market already seems to be expecting it.

FELDMAN: Not -- not so clear, because the market today is a little bit short sighted in what's going to happen, and there's a lot of BOJ pressure, particularly on the Wong (ph) end as well.

(UNKNOWN): Well that's going to be an important part of them getting out of this (inaudible) the BOJ has to keep that pressure for 10 or 20 years.

FELDMAN: Well, maybe not 20, but maybe 10. It's not clear to me if they're successful on the inflation outlook that they can hold the long end of the curve down that much.

Up the five, seven years I think it's OK. But, if we're talking 10 plus, that's a little harder.

You seem to have a comment as well.

(UNKNOWN): No, no, no I'm agreeing with you.

(LAUGHTER)

(UNKNOWN): Isn't -- isn't sort of the -- in a sense the secret big unknown in Japan is who's -- who's gonna control the bond market?

FELDMAN: Yeah.

(UNKNOWN): I mean, if it's BOJ they can get what they want, because they'll have fast, nominal growth and a very suppressed bond market. And it's the bond vigilantes (inaudible) everything falls apart. (inaudible) sense to me that's the big call on Japan, who's gonna control the bond market three, five seven years out.

FELDMAN: Yeah, we did a little survey about a client's -- domestic client's, OK, a couple days ago. And I asked them, OK, if they changed the consumption tax -- one of the arguments on the consumption tax, oh if we change the pattern the world will lose confidence and bond yields will go through the roof.

OK?

That's one of the arguments that the pro-tax guys have been using. I'm a little skeptical on that, but I asked our clients, 20 percent of them agree, 80 percent of them don't.

So whichever way, you know, our -- this disagreement works out, it's not an issue for three or four more years. But, three or four years down the road, then it gets to be a bigger (inaudible) particularly if a current account has trouble, which is something else a little bit worried about.

Anyway, so there are some numbers here that I think need to be put into the debate, and they all have to do with spending, because there's just no way you can hike taxes enough to solve this problem.

OK?

Let me just spend a couple minutes finally on energy if I may.

There's a lot of talk now about how many nukes are gonna come back and this that and the other. My answer is probably not as many as the government would like,, because they do have some you know pretty good procedures in place now to do very thorough checks of whether there are fault lines under the reactors and stuff like that.

And the other thing is there's some conservatism even on the part of the pro-nuke guys for the simple reason that, if there's one more accident it's over. So they themselves have to be pretty careful about this as well. So out of -- I would say the upper limit over the next two to even three years would beget 10 maybe 12 nukes back on line.

(UNKNOWN): Two years?

FELDMAN: Two to three years, yeah.

Which raises an issue which is really a global issue as well, what do we do about energy as a whole in say a 15, 20, 50 year horizon. If Japan is not gonna have nukes around what do we replace them with? OK? If we don't have nukes to replace fossil®MDNM¯s and fossils keep going up in real terms, there's a problem and it's not just a Japan problem.

So what I've done is I've tried to put some stuff together, page 65 has a cute little chart on what I call the energy imperative.

What I've got here is the real price of oil, in Japan. OK, this is in Yen terms, relative to ex (ph) food and energy prices. So the dark blue line is the price of oil in real terms. In Yen.

The light blue line, or I should say the thin line -- oh it's not light blue for you guys. It's red and yellow.

SMITH: They may have black and white copies.

FELDMAN: You have black and white copies, OK.

(LAUGHTER)

(UNKNOWN): So the ones with gaps...

FELDMAN: The flatter line, OK?

(LAUGHTER)

FELDMAN: This is what I call energy productivity. Energy -- real GDP per quad of energy. Quad is 10 to the 15th BTUs. OK? Remarkably in the last sort of five to eight years, energy productivity in Japan is actually rising.

That's kind of cool. It hadn't risen for a long time, but it is now. After the quack, I can tell you people got really serious about not using stuff they don't have to use. So that's good.

The problem here is that the real price of energy has gone up a lot faster than productivity has. So that's the issue that has to be dealt with. I mean, I don't care if gas prices go to $15 a gallon as long as mileage goes to 100. But if it doesn't then the price of transportation goes higher. So that's the issue that the economy is facing now.

I built a little model based on page 67. This is meant actually to be a global energy model because you can't talk about energy in isolation. You have extractables and renewables. The energy sources on the right hand side. You have GDP on the left hand side. And there's a couple of matrices that connect the two sides. If there are any energy freaks around who like modeling and stuff, all the Greek letters spaghettis (ph) on the next -- next couple of pages.

But the point of this model is to say what are the technological bottlenecks that if broken would allow energy prices not to go up anymore? We've got a race between discovery on one hand and technology on the other.

If oil and other fossil-fuel extractable fuel supply continues to go -- to expand at the rate it has for the last 20 years, if technology, various and sundry things, continue to expand at the rate they have the last couple of years, the last 20 years, nothing really big is going to change in terms of the prices. But the quantities go up a lot.

So for example, when I ran the model, page 66, I -- 68 I guess it is -- shows what happens if the last 20 years of technology and technology discovery continue as they are. The red area is the extractibles quantity. The yellow is the renewables quantity. That's nice because renewables take a much, much larger share of the total energy supply. But you know, the extractables are up too, OK?

What happens to CO2 or other pollutants in that scenario? So the implication of this is that there has to be a lot of push on those technological bottlenecks to raise the -- the productivity at all stages of that set of matrices that I had before.

Turns out that the most important one -- this is, in a way, where Japan comes in -- page 72. I've got a little grid there of all the different technologies and this and that and what a called a pertrebation (ph) of each technology would do if, you know, sustained over a long period, what that would do to CO2 and GDP.

Turns out the best trade-off is the little "z" I've got there in that. What that is, it's square feet serviced per unit of GDP, smaller houses, less space, 'cause you don't have to heat it or air condition it. So if we can figure out how to use space a little more efficiently, relative to GDP, then that would have a major impact on CO2.

We're moving off of Santokyo (ph). We're gonna move from Ebisu into Otemachi, much better building, but a lot less space. So I'm not personally an experiment...

(LAUGHTER)

... of this particular parameter. We'll see how it goes. But the point I'm trying to make here is that Japan has an immense amount to contribute in terms of energy technologies that the rest of the world hasn't seen yet. There's neat stuff. You can go to Tokyu Hands and buy this thin-filmed Saran wrap that you just put on your windows and save, like, 30 percent of your electric bill. It's completely transparent. It's amazing stuff.

The gas turbines that are being installed in Japan right now -- I think we have a gas turbine representative here. These are great -- great machines. They have something like, at best, if used with co-generation, something like an 85 percent thermal efficiency at the best. Even the direct efficiency is something like 58 compared to a coal plant that will have something like 42. So of the BTUs and a lump of coal, only 42 get into the electricity.

So if we can make major progress, and Japan has a lot to contribute on that, then we've got a much, much safer world. I just wish we had better -- what is it -- proposals at our meeting yesterday for energy research.

So let me stop there and just open things up for a Q and A.

FELDMAN: Thank you. That was terrific. I was furiously writing notes. I'm not sure if I kept pace with all of you -- that you had to give us there. But I thought maybe what we could do for those of you who are new to this process, just put your placards up, and I will get you in the order that you put your placards up. If we have people who want to jump in on a topic and don't want to wait in line, absolutely just put your two fingers up, and I'll invite you into the conversation, all right?

Carl (ph), I think you were first.

(UNKNOWN): Thank you. I wonder if you would comment on the impact of the Olympics and what you see generally as the role for infrastructure expenditure?

FELDMAN: Mm-hmm?

(UNKNOWN): I noted that the new Maglev is going to be built by 2027.

FELDMAN: Mm-hmm.

(UNKNOWN): That suggests a high-level expenditure on the standing rate increases you were talking about.

FELDMAN: OK, thanks very much.

At this point, the estimates of the economic impact of the Olympics go from about $3 trillion to 150. So somebody's including some stuff that probably shouldn't be there, more on the lower end of that. But I think the Olympics has both quantitative and qualitative aspects.

The quantitative really has to do with improving Tokyo infrastructure and maybe a little bit in the rest of the country. There's now serious talk about linking Haneda and Narita finally with a high-speed train, maybe Maglev probably not. But going through Tokyo station, better connections.

Similar things would probably be done in Nagoya, which probably needs it most. Better use of the Kansai airport would be a big one of part of the economic sense. But basically there is a sense that the infrastructure around Tokyo has to be rebuilt. And this is a great opportunity to do it. Nobody's gonna really question it that badly.

There's a little talk about, "Oh, they're just gonna put more concrete out and blah, blah, blah, it's all DELTP (ph) politics." And maybe there's some of that in it, too. But we do need the -- for example, the ring road around Tokyo. If you want to take a truck from Nagoya to Sendai now, you have to go through central Tokyo 'cause the ring road hasn't been completed yet, OK? So if we they can get that completed, that's great. So that hard stuff will be there.

To me, the soft part of this is probably a little more important because finally, finally, we've got something a few years out in the -- in the future to look forward to and then back calculate from. So some of the very short-term stuff that has been -- was it -- tying politics into a pretzel, is now harder to focus on because we've got this longer-term thing out there.

And the other sort of soft infrastructure is the language. Because now there's a very, very clear incentive to raise the English level, raise the levels of Chinese and Arabic and, you know, other languages to invite guests in. And that'll have implications far, far beyond the Olympics. So I'm positive on that.

The Maglev train, itself, I don't think it's going to happen, frankly.

(LAUGHTER)

It's very expensive, and where are they going to get the electricity? It's a -- it's a power hog. The original idea was to power the Maglev train with the electricity from the -- what was it -- the first nuke they shut down, the one in Shizoku (ph). What's the name of the -- the -- the -- that power plant? I forget. But basically, it's the one they shut down first. It was the first one built in the country, smack on top of an earthquake fault.

So if that one doesn't come back, and it will not come back, where are they going to get the electricity for this thing? Now, if there is some big breakthrough, well, maybe. Also, I'm not sure that there's strong public support for building it 'cause you can already get from Tokyo to Osaka in three hours. It's not so bad. So why would you want to spend all of that money to get it to, you know, an hour and a half?

Now, if you're talking about maybe going from Tokyo to, you know, across the ocean to Seoul or something as an alternative to air -- air flight, well, maybe. But eh. The economics of it just don't add up to me, so I'm not a particular Maglev fan. The only ads I've seen for it are in Kosama Osaki (ph).

(LAUGHTER)

FELDMAN: Thank you.

Michael, you want to ask...

(UNKNOWN): Let me raise the ghost of BOJ past here.

FELDMAN: Uh-huh?

(UNKNOWN): Your -- your comment about if the current effort was not perceived to be succeeding...

FELDMAN: Mm-hmm?

(UNKNOWN): ... one movement (ph) might go with the enhancement of the communication...

FELDMAN: Yeah.

(UNKNOWN): ... effort and going to price-level target (ph).

FELDMAN: Mm-hmm?

(UNKNOWN): So I guess the question I'm raising is...

FELDMAN: Mm-hmm?

(UNKNOWN): ... how do you look at the proposition that...

FELDMAN: Mm-hmm?

(UNKNOWN): ... the credibility of any such commitment hinges on a pretty solid belief that the instruments of policy actually can manipulate, can generate the outcome that you were promising (ph)?

FELDMAN: Yeah, that I think is really kind of a two-sided question. Because my view is that the BOJ can't do it alone, even if it wanted to. You've gotta get the stuff that was mentioned over here from Joe (ph) the -- the -- call it the regulatory side of the economy moving much more aggressively so that monetary -- so the money can flow to somewhere where it will make a difference.

So one of the things that OCRODOS (ph) come out on -- he's a big, you know, tax hike (ph) guy -- he said, "Look, we made a deal. And the deal was that we are aggressive on monetary policy if you're aggressive on fiscal and structural policy." So now you've got a chance to do on the fiscal stuff. I want to see this. I haven't heard Cowada (ph) or the BOJ come out and be particularly forceful about the structural side.

So if they have to do something on communication policy and say, you know, January, February of next year, there are also going to have to be players in the next round of structural reform talks. Typically, they don't stick their toes into that, but I think that's going to have to happen.

So to me, the -- the culprit (ph) credibility of the BOJ hinges very, very strongly on the credibility of the rest of the government doing the right things at the right time. Because in the end, credibility...

(UNKNOWN): Expansion of the supplies side...

FELDMAN: Mm-hmm?

(UNKNOWN): ... will raise the inflation rate.

FELDMAN: Not -- actually, that's exactly what I'm not saying. In fact, I've got a little graph on here to try to illustrate the point. It's on page -- where is it? It's in here somewhere. And Olbay (ph) has been very explicit about this -- page 45, I guess. But the purpose of these third arrow policies is to expand investment, OK?

So these -- the Third Arrow is not about the supply side. It's about both the supply and demand side, and the assertion -- not where (ph) there's a lot of evidence on this -- but the assertion is that the investment will come first, and the supply side of expansion comes later, and probably not quite as much, so that you're moving the demand curve out more than you're moving the supply curve.

If that's the case, then Third Arrow is the best thing that ever happened. 'Cause you get a lot of real growth. You don't' get too much inflation. You get some. And so, you don't get -- yields up. It's great and blah, blah, blah -- OK, good for fiscal. So that page 45 is exactly what they're trying to do. Whether it's successful, that's not so clear yet. But, to me, this is absolutely essential for the BOJ to be credible.

Does that answer the question?

(UNKNOWN): Two fingers.

FELDMAN: Joe? Two?

(UNKNOWN): When did BOJ consider other tools, like buying equity in (inaudible) instead of (inaudible)? I mean, they're buying a trillion...

FELDMAN: Mm-hmm.

(UNKNOWN): ... or so, but this market is $500 trillion, so why not just buy a lot more?

FELDMAN: ETFs are the way they go on that. That's probably the easiest thing for them to do, because you don't get up into issues about voting rights and stuff like that.

The first -- that's probably what they would do first. So a little more JGBs, a little more ETFs. The REP (ph) market isn't really big enough. One of my big criticisms of the BHA, starting, you know, even a couple years ago on this -- REEP (ph) issues -- it's wonderful for them to do it, but it's not a market that's big enough to operate in, so why would you make a deal out of it? Shouldn't they be -- and this was my suggestion to them -- shouldn't you be actually expanding the REEP (ph) market, redoing it so it's big enough for you to operate in? And I have not seen that, at least not out of the BOJ..

(UNKNOWN): But on the ETF, at least, they're -- ETFs will expand automatically to take in more stocks...

FELDMAN: Yeah.

(UNKNOWN): ... but I assume they could branch out?

FELDMAN: Yes, they could. And that's easy. It's really easy to do. (inaudible) So, my guess is, that's the first thing they would do, instead of going sort of ahead of the rest of the world. Or most of the rest of the world into price level targeting.

(UNKNOWN): Now, this may not be the right time, but since we talked about this third arrow -- you brought the third arrow up here in response to the question...

FELDMAN: Mm-hmm.

(UNKNOWN): Can we look at your next page, page 46?

FELDMAN: Sure, sure.

(UNKNOWN): And can you help us understand what you -- there's going to be a -- there's going to be some statement -- an announcement. The prime minister's going to speak on October 2nd.

FELDMAN: Mm-hmm.

(UNKNOWN): A great third arrow moment. He's going to address consumption tax, I guess, as well, right?

FELDMAN: Yeah, mm-hmm.

(UNKNOWN): So, where do you see -- you see some early gains, as I think you explained very well. But where do you see the emphasis coming down?

FELDMAN: Mm-hmm. The...

(UNKNOWN): Help us understand that graph.

FELDMAN: The October 2nd, or whatever it is speech is going to be essentially what he's going to get back from the rest of the policy makers, particularly from MOTH (ph), and return for going ahead with the 3 percent Consumption Tax, OK? One of the things he's got to get is corporate tax cuts, which MOTH (ph) does not want to do, but they have to do, because they got what -- some of what they wanted, so he's going to get something back from them.

So, that's one thing.

The second thing is, they're going to have to work a little more aggressively on some of the structural reform issues. And the reason there is very simple. In the expert committee meeting that they had on the Consumption Tax talks with a diet (ph), basically, everybody in the LDP (ph) is saying, "Yeah, we're in favor of hiking the tax, and then I'll spend the money in my district."

(UNKNOWN): Mm-hmm.

FELDMAN: And (inaudible) is trying to control that. So, his way of saying, "OK, if you want to spend a little money" -- and there are good projects to spend on, like the ring road (ph) I mentioned. If you want to spend a little more money, we have to push a little harder on the deregulation issues, as well.

So, what I'm looking for in that -- in that announcement is the balance between -- call it "pro-growth tax reform" -- not so much tax as tax reform -- spending policy that actually has some return on investment as the criteria for choosing projects, and then the structural side.

So, to me, the balance is the issue. Over the last two weeks, that balance has gotten better.

(UNKNOWN): So, he's basically spending off the LDP -- spending off the MOTH (ph) and trying to create his own path forward, correct?

FELDMAN: Exactly, yeah, with public support.

KAHN (?): With public support. All right. Thank you.

Rusty, I think you were next.

(UNKNOWN): Yeah, thank -- thank you, Robbie, for all the homework. And I'll work on the equations tonight and let you know if there are any...

(LAUGHTER)

My question is an ECON 101 question on debt servicing. As Japan pushes toward more inflationary policy, interest rates go up.

FELDMAN: Mm-hmm.

(UNKNOWN): Reports that they may have to go external financing. How can Japan handle the debt servicing in that kind of environment?

FELDMAN: OK, the answer, I think, to that is, they've got a few years -- they've got a window. Maybe seven, eight years. 'cause the average duration of the debt now is I think about seven years.

A did a little exercise a while back saying, OK, if they lifted the entire yield curve from zero duration up to 30 -- whatever it is -- by 100 basis points, how long would it take for the average interest rate, given the, you know, maturity since -- to rise by 100 basis points. And the answer that I got was about seven and a half years, OK?

So, if all interest rates go up today, the debt servicing doesn't go up quite as fast. You could make an argument that that would actually be the best thing that ever happened to them. Because it would ring so many bells that they would finally get serious about -- about spending control. Like my little CRIC cycle -- the Crisis Response Improvement Complacency cycle that I've been using.

So, you know, if it helps concentrate the mind, it might not be such a bad thing. But, you know, I wouldn't recommend it. Crises are not, you know, recommendable. So -- so I'm not too worried about it. Yeah.

KAHN (?): OK, Mark -- Mark Magnan (ph)?

(UNKNOWN): Yes. Thank you very much. This is great.

In a particular -- you know, the third arrow has been sort of land-based (ph) in the public, so I'm glad to hear you sort of package it a little bit.

In particular, could you talk about what you see in agriculture reform?

FELDMAN: Mm-hmm.

(UNKNOWN): And do you see anything in terms of land-use laws that are being talked about or put into effect? You've got a nice chart on page 48, but I think those -- that's your agenda...

FELDMAN: Yeah, mm-hmm.

(UNKNOWN): ... and not -- not necessarily...

FELDMAN: Not theirs, yeah. Mm-hmm.

(UNKNOWN): So, could you talk in more detail, focusing on changes to TPP (ph), (inaudible), anything that goes beyond that?

FELDMAN: OK, sure.

I was lucky enough to do a little panel with Minister Hayashi the other day. And he made a very interesting statement. He said TPP is neither necessary, nor sufficient for agricultural reform in Japan. OK? It's helpful, but it's neither necessary, nor sufficient.

He knows -- everybody else knows -- that the average age of a farmer is almost 70. They're not going to have any agriculture in 10 years unless they get some new blood in. So -- and even Ishiba, who's the -- the head of the -- the -- or the secretary of the party now -- he did a plan seven or eight years ago, when he was Ag minister, that actually addressed a lot of these things.

So, I would say the sense of crisis in Japanese agriculture itself is not exactly low. It's -- and it's not about the farmers, it's about J.A., it's about the distribution system. The farmers are fine, OK? And they'll do even better. And they see opportunities there.

For example, I was -- I gave a little lecture a couple months ago to some regional civil servants. Afterward, a woman from Tottori Prefecture -- this is among the most rural of the prefectures -- she comes up to me, gives me her business card, and it has a picture of a watermelon on it. OK? Most people have pictures of themselves, if they have a picture at all. This one had a picture of a watermelon.

It turns out, she had just been in the Middle East selling Tottori watermelons. They sell for 3,000 yen in Japan. They sell in Dubai for 30,000.

(UNKNOWN): Wow.

FELDMAN: So, this is an opportunity that people in the regions are now beginning to understand. And it's the J.A. that's the blockage to this. Very strong politically. They have been losing political strength. The fact that Abi (ph) decided to go ahead and do this is a perfect example. They don't have anywhere to go. They don't have a best alternative to a negotiated agreement. What are they going to do, go ask the DPJ? No. They have nowhere to go now.

Electoral reform, when it happens -- and it will happen, maybe not enough -- will also reduce their power.

So, I think there's some -- some real agenda stuff there.

On land use itself, two things are happening. One is, the government has already proposed a national land rental bank, OK? The idea is, a lot of farmers don't want to let go of their land. (inaudible) this is traditional Japanese agriculture, and their ancestors have held it for years and years and years and years. Baloney. It's not true. Most of these folks got their land in the post-war reforms, OK?

But, OK, it's all politics. Let's say their ancestors held the land. But they're not going to farm it, and their kids don't want to farm it. So, the idea now is, the government is going to organize a national land bank to rent out this stuff, and turn these farmers -- current farmers into (inaudible) J.A. (ph). And so, they'll just be essentially stockholders in a larger land bank. That is official policy already.

The second part is the national economic zones. And for those, Nagoya, Tokyo, Osaka don't sound like big farming prefectures. But, in fact, there's a lot that can be done. And so, if we actually go the full route on that, and allow -- which is one of the ideas out -- we'll see if Haute (ph) can get it through -- but allow corporate farming ownership for corporate ownership of farmland, as an experiment, and it works, that would be quite -- you know, quite positive.

The last thing that's going on is to declare Hokkaido a special agricultural export zone. And so, you could push aside the -- the J.A. -- some of the other blockages -- or we'll call it anti-competitive practices that are built in now -- and just let that prove that Japan agriculture actually has a huge, huge global market.

My guess -- and it's just a guess -- is that the IIE's (ph) calculation, the TPP would add 2 percent to GDP in Japan. It's probably too conservative.

I mean, if that 30,000 yen per watermelon is true, no.

(LAUGHTER)

Maybe I missed my calling.

(UNKNOWN): My question follows up on the agricultural issues. I'm just -- that was my question, as well.

I wonder if you could talk a little bit more about part- and full-time farmers. Because my understanding has always been that, key to resistance politically to agricultural reform are the part-time farmers.

FELDMAN: Mm-hmm.

(UNKNOWN): What is Avi®MD+IN¯®MDNM¯ (ph) thinking about that? What policies might be in place? Do you see anything happening at all?

FELDMAN: Yeah. I think the part-time farmer issue is not quite as serious as the distribution issue. It's the J.A. issue, more than the part-time farmer issue. My sense is that the part-time farmers are probably a little more in favor of the liberalization, and it's the J.A. system itself that's against it.

So, I haven't heard a lot of talk...

(UNKNOWN): Part-timers are -- are for more liberalization?

FELDMAN: Yeah, because...

(UNKNOWN): Usually, we hear the opposite.

FELDMAN: Yeah. This is just the sense I have. I haven't done a survey or anything like that. But if there is a liberalization, they will be able to use their land a little more efficiently. That is, if they -- if the part-timers can -- OK, instead of giving a little bit of rice to these guys or those guys, getting the J.A. to sell it for them -- if that land can be used more efficiently, they actually stand to have a higher income.

So, my sense is that they're -- they're kind of waffling on that one. The real opposition comes from the J.A. organization itself. When I talk to people involved in -- call it "agricultural finance" -- stuff like that -- they're kind of sitting on the fence.

At the last J.A. annual meeting -- I think it was about three or four weeks ago -- everybody gets up and makes their speeches and pounds the table about how terrible TPP is and how awful it is and how it's going to destroy their country, et cetera. And then say, "But by the way, if it's adopted, this is what we should do."

(LAUGHTER)

So, these guys can see the handwriting on the wall. My view -- and I've expressed it to them directly -- is that, for an institution like, say, Norinchukin, it's the best thing that ever happened to them. Because local banks don't really know a lot about how to lend to agriculture. And the Norinchukin and their network do. And they know who's good and who's bad.

So, if there really were a liberalization that allows more efficient use of farmland, I think it's Norinchukin that would benefit the most.

KAHN (?): But (inaudible) English is the A.G. --

FELDMAN: Agricultural Cooperative Bank...

KAHN (?): Cooperatives Bank...

FELDMAN: ... Banking System, yeah.

KAHN (?): Right.

All right. We may come back to agriculture, but in the meantime, Phillip (ph), I think you're next on my list. Thank you.

(UNKNOWN): Oh. OK.

I don't know if I should be pressing this down.

KAHN (?): No, you just -- go ahead and speak.

(UNKNOWN): OK. I cheated.

Now we're on to banks. I'd actually like to ask a question about your thinking, Robbie, on -- on what I would broadly call transmission mechanisms of this massive monetary base expansion...

FELDMAN: Yeah, mm-hmm.

(UNKNOWN): ... into the -- into the rest of the economy. And I'd like to get your perspectives on two issues.

One -- one is the banking system. And it seems to me that, you know, one of the things people are focused on is the Japanese banking system is actually up and running again...

FELDMAN: Yeah.

(UNKNOWN): ... for the first time in, what, almost 20 years. And so I'd be interested in how you see that playing out and how important that is to - to Japan coming back to health.

And then the other obvious transmission mechanism which has certainly worked so far, and I'm interested in how far - how much further you think it's got to go, is the exchange rate and maybe some of the politics surrounding that as well.

FELDMAN: OK: Very good. Very good. In terms of the banking system being up and running, let's say it's up and shuffling. And the reason it's up and shuffling instead of running is that there's not a lot of loan demand.

I'm more on the demand side than the supply side in terms of transmission mechanism blockages. I think the banks will lend money. Whether it's good loans or bad loans they don't care, but they'll lend money if somebody wants to borrow. So to me, the regulatory issues are the - the best way to get lending growth going again. There's also over-banking to a certain extent, but that's not - not (inaudible).

So you're entirely right that having a call it or a more or less solid banking system is a huge benefit when they get these regulatory things going. They also deserve a lot of credit for implementing a good regulatory system. It's something that they really did right.

I went and visited the FSA a couple years ago as the Lehman stuff was beginning to blow up. It hadn't quite blown up yet. One of my interlocutors at the FSA asked me, you know anything about these, you know, subprime mortgage things that are going around? You heard - heard this? Yeah, I kind of - I don't know too much about this.

Said, well you know, we got some regional banks here that were beginning to buy it. Did they buy something weird, I ask. And he says, well, we went around and we talked to these guys. And we sat them down and said, OK, you bought this subprime, you know, loan package. Can you explain to me please the risk-return characteristics of the product that you bought?

And the guys from the regional banks would kind of study their shoes for a while. No idea what they were doing. And so the FSA said, look, if you can't explain the risk-return characteristics of - of your portfolio, you shouldn't own it. And so it was good regulation that kept them out of that.

So they do - I think the FSA in Japan deserves a lot of credit for, you know, doing the right thing on regulation. Now whether that helps them at this point I think also has to do with loan classification systems.

Unfortunately under the DPJ government, they decided to - what was it - change the definition of what a bad loan is instead of changing the treatment of bad loans vis-a-vis capital. So basically the idea is let's lie to ourselves about what's good and bad instead of recognizing what's bad and saying, OK, but you can have a couple years to work it out. So that still has to be worked out.

We just did pass a milestone in that it doesn't seem to be a major problem. But if I can just reiterate the main point, the fact that we have a - call it a non-capital challenged banking system, it will be a great help if the regulatory stuff, the Third Arrow stuff gets moving.

On the exchange rate in terms of the - the transmission mechanism, I think it's very important, but I think it's gone not quite but almost as far as it's going to go. And the reason for that is that - from my reading at least - there's a lot of concern now that if the yen gets too much weaker then the energy costs and other import costs are going to outweigh any benefits you get from the export side.

I travel around the country a lot. I was in, you know, Okosaki (ph) and other places around Nagoya recently. Everybody's happy that the yen's weaker, but all they've seen so far is costs go up. So the benefit to - net benefit to Japan from the yen going say to 110, 120 probably isn't that high.

My expectation - I got my, you know, neck stuck out on this - is that if we wake up tomorrow and for whatever reason the yen is at 110, my expectation is that the Ministry of Finance in Japan would do reverse intervention, that they would probably want to stop it there.

I have a big debate with my colleagues about this. They've got 120 for their end 2014 forecast now. They say intervention doesn't work. It wouldn't matter if they did it anyway. I disagree with that. So we'll have a debate about it. You probably have an opinion as well. Many people may have an opinion.

But my sense is that the exchange rate, that the transmission mechanism has probably that is - the level of exchange rates has gone about as far as it's going to go. Maybe a little more, maybe 5, 10 percent more.

The - what's in the pipeline still has a year and a half, two years to - to come through. But I don't think there's much more after that. That would be my - my view. So they're going to have to work on the domestic agenda and not rely on the exchange any more than they have already. Do you have a view on - on yen-dollar?

(UNKNOWN): No, I was going to agree with you. The question is the fear you hear comes from (inaudible) or from the business community. Because I thought (inaudible) not from the business community. But if you are hearing it now from the businesses, then it becomes more serious.

FELDMAN: It's more small business than big business.

(UNKNOWN): OK. Which makes sense because they are trapped (inaudible). No, no, I fully agree. Can I ask a question?

(UNKNOWN): You are next, yes.

(UNKNOWN): Can you talk about wages? Because to me, the key to the success of this whole thing is that if we see wage growth in the 2, 3 percent range, then we will all start forecasting that inflation is going to be more sustainably higher. If we don't see wage growth, then we are going to say sell the (ph) yen, blah, blah, blah.

Now there seems to be this push to increase wages in the next wage round (ph). Now is this a one-off? Do you think it can be sustained or do you think it's all just part of the call it propaganda for lack of a better word to get it (ph) done, and then - and then (inaudible). So anything you want to (inaudible).

FELDMAN: I would say I'm mildly optimistic on that. Let me give you a couple data points first. I guess it would be page - where are we here - 14, 15 and maybe 16. Yeah, 14, 15 and 16.

Page 14 so far is that the schedule pay numbers aren't doing so great. Total cash earnings may be a little bit better overall, but call - it it's essentially the overtime that has been driving things so far. Then it's bonuses. We're not going to get base wages going up for at least another year.

And the assertion is that base wages are more important than others because people feel that they're committed to that, et cetera. But we're not going to see that for a while. I'm looking at the one on the right-hand side as well, the schedule pay per hour. That seems to be doing a little bit better, but it's not - it's not great.

The other labor market indicators on page 15 and 16, the effect of job offer rate - job offer seeker's ratio on page 15, bottom right, that seems to be doing better, clearly better since the start of the year. And then the other one that I like, but it's not great, page 16, new job offers, which was actually taken down most recently.

So the call it current data is OK, but it's not great. Going forward say 2015, '16, '17, this is when we start getting more economic-wide labor shortage issues because of the aging. People are pulling out of the labor force because they're just too old to work. So the 1946, '47, '48 crop is - cohort I guess is the nicer word for it - they're beginning to actually, you know, leave the labor force in larger numbers now.

This is already a big problem in Tohoku. Because when the - the quake hit, they gave out so - so much good welfare to the folks affected by the - the - the quake itself and the tsunami itself that when they needed workers to start on projects, the welfare payments were better than the wages. So they didn't work, and people from Osaka and around the country came in to work instead.

But there is a labor shortage, a real labor shortage in the construction sector already, and it's - it's a mismatch too because these are skill problems. So that in call it 2014, '15, that's going to put some upward pressure on wages as well.

I will be convinced that things have turned better when I see the wages in convenience stores and for part-time workers and the guys who don't put on ties and go to the office, those are the wages that I want to - want to look at.

(UNKNOWN): Paige (ph), you had a two finger (ph) on this one.

(UNKNOWN): Yeah. Robbie, just a quick question whether immigration would factor into addressing some of these issues about the labor shortage or expectations on wages if there were some relaxation on immigration policy.

FELDMAN: I think it would, but it'll happen after the wages go up. The only example I know is '88, '89 when there actually were some real moves to open up immigration because small business couldn't get labor.

And there's still a problem with small business getting labor, but it's not acute enough that it would put upward pressure on wages and therefore pressure on the immigration. But I think we're going to see wages rise before we see the immigration rules lifted.

(UNKNOWN): (Inaudible), I think you're next.

(UNKNOWN): Thank you. My question is about energy policies. You talked a little bit about energy issues and energy policy. Energy policy is complex in every country, but it's more so in Japan after - especially after the Fukushima accident. They have to think about the safety of nuke, cost of energy, energy technology, CO2 emission, growth of economy (ph), and also public interest (inaudible).

So my question is what would be the best or desirable mix of energy resources from your perspective or supply-side and demand-side perspectives?

FELDMAN: Yeah. It's a - it's a very hard question. This term best mix has gotten very popular. And my worry about the debate is that the whole notion of best next seems to be interdependent of price. It's about price as well as, you know, other elements like safety and things like that.

My personal view, and again this is just from reading and stuff like that, is that the nukes are probably a lot more expensive than they look. Forget about the accident stuff. Well we're not going to forget about it, but put it to the side for a minute.

Where do we get the uranium? Where do we store the waste, OK? My proposal on this is that we put all the waste in the (inaudible) and then give them back to China or give them to China. That's a great idea.

(UNKNOWN): So you'd just take that home, Bill. I think it's a great idea.

FELDMAN: But this waste issue is very serious. I saw a presentation by one of the - a Diet member a couple months ago where he said that even without the - the nuclear accident at Fukushima, within three or four years all the nukes in the country would have to have shut because there's no place to put the extra waste. The pools are full. They can't send the stuff up to (inaudible) because it's not recycling anything, OK?

But even if that weren't - forget about the waste for a minute, OK? How many nukes would we need if we really wanted to use nukes to replace fossil fuels? A lot, OK? I did a little calculation a couple weeks ago where I said, OK, population's going to fall so we'll be using less energy 50 years' time, OK?

Fossils will be too expensive to use, OK, and we'll be digging for them in (inaudible) park, OK? They'll be that expensive, OK? So no more fossils. Half is done by renewables. Half is by nukes. Forget about the infrastructure, OK?

How many nukes would we need in 2060 if half of Japan's energy were to be supplied by nukes, presuming that nukes then are about the same average size as nukes today? The answer is 200. Where are you going to get the uranium, for one thing? Is there enough? There's a big scientific debate about whether there's enough uranium out there.

Talked to Tanaka-san, the former IIE chief. He said, well, we can get it from seawater. This is true. It can be gotten from seawater. But nobody knows how much it's going to cost.

So my conclusion from all this, we should push every technology R&D project we can in every area. It is possible that we'll have, you know, safe nukes at some point and very efficient ones.

So we should not cut that off or cut that technology route (ph) off on ideological grounds.

But we have to give everybody a fair -- a fair shot at it.

My view is that the progress in solar technology, the last just five years has been stunningly good. And if we can get some of these 30 percent efficiency cells like they're doing down in North Carolina now, if those can be sort of brought to market a little faster, that would give us a lot of -- a head start on what's happening in the rest of the world.

So I'm very sort of ecumenical about that, you know. Anything that works, I'm in favor of it. So the -- I -- my view is the best mix is invest your R&D money, more R&D money; take money away from the old folks and the Social Security system -- sorry -- but take it away from them and put it into a broad variety of energy research projects and then just see which one turns out to be most effective.

SMITH: (Inaudible), are you going to talk about your gas turbine?

(UNKNOWN): No.

(UNKNOWN): No --

(CROSSTALK)

(UNKNOWN): Oh, shucks!

(LAUGHTER)

(UNKNOWN): I mean, just seeing the demographics (inaudible), Japanese procreation (ph) becomes more (inaudible) and even though we encourage investment, probably less people who use that investment money and create the innovation, so my question is how to overcome demographic negative impacts versus the Abenomics policies.

FELDMAN: Yes, OK. Very good point.

I don't know if there's a lot of evidence on this, but people say that as you get older, you become less -- what is it -- less innovative, et cetera. Maybe that's true. But you know, if there are incentives to keep yourself, you know, oops, keep yourself, you know, employed or keep income coming in, people will respond to it.

And if you look at the performance of, say, you know, older Japanese who are still in the workforce, it's actually pretty good. So my view is that when people have the incentive to acquire new technologies, they'll do so.

In addition, our definition of "old" is old.

(LAUGHTER)

FELDMAN: Sixty-five is not that old. Everybody agree with me?

(CROSSTALK)

(UNKNOWN): I'm sure we all agree.

FELDMAN: And so we need a better way to define what old means. Now maybe some of the medical technology can help us on that, but I don't see any real reason to define the retirement age in terms of years since birth. There's got to be a better way to do it.

So in a certain sense, what I'm saying is that aging is not the issue; the issue is our ability to redesign definitions and redesign social policies to adapt to a different age structure in the population.

And I think Japan is, in a certain sense, ahead of the U.S. on that. We've got the metabocheck (ph) now, where they go in and they measure your tummy every year when you go in for the -- for the health check -- good idea. While I was in a couple of weeks ago and the doctor said to me, hmm, not bad for an American.

(LAUGHTER)

(UNKNOWN): (Inaudible) as a compliment.

(UNKNOWN): Yes.

FELDMAN: I had to laugh.

But the problem, of course, now is that even though they have the check, there's no -- they don't raise your medical contributions if you fail the test, OK. But in (inaudible) intellectual, I think, your pain (ph) is ahead of the U.S. in linking health outcome or health -- call it indicators -- to the performance of a system.

So I think there's some things we have to learn there.

SMITH: Thank you. That's great.

We are going to run right up against our deadline -- our timeframe here, so I have three people left on my list, Jennifer, Ed and Maria.

So if you don't mind, can you take those three questions for you?

FELDMAN: Sure.

SMITH: And then we'll let Robbie have the last word.

Jennifer, you're next.

(CROSSTALK)

QUESTION: Thanks. Just curious how, if at all, the prospect of L&G imports into Japan's sort of a sharp uptick whether from the U.S. or otherwise plays into your energy picture.

FELDMAN: Yes. Yes, thanks. I think L&G is probably the key fuel for Japan, for the next call it 10-15 years at least. It's partly because diversification of sources. Russia's of course desperate to sell the L&G now that the Qataris are, you know, sending to Europe.

So there seems to be, you know, plenty of that are enough, I should say, L&G on offer. Then the issue is price. And because it's monopolistic negotiation, one seller, one buyer, it's not easy to get to the right price. But those prices will come down because the U.S. is there as a potential exporter as well for geopolitical reasons.

So I think the L&G is really the fuel of the future for the next 10-15 years for Japan.

Added to that, the fact that Japan is ahead of the rest of the world in this methane hydrate research, they did have some successes -- I think it was about a year ago now -- when they got the flair (ph) from the -- from the boat off the coast. They managed to dig into the mud and got some real gas to come up to flair (ph) -- to burn.

If that turns out to be economic -- and we don't know yet -- but could well be -- then that, I think, would completely change the picture, because Japan is, you know, far ahead of the rest of the world in that extraction.

I've read various things about how much of the stuff is around the largest -- the highest estimate I saw was 33 trillion barrels of oil equivalent of LN -- of methane hydrate kind of sitting around on the ocean floor.

So you know, that's a significant amount. And if Japan has the technology before anybody else, that would be very, very important element for them

So I'm a bull on that L&G, so…

SMITH: We didn't do what I said I was going to do.

Let me try again.

Ed, your question -- you're next, then Maria and then (inaudible).

(UNKNOWN): You've hit it just a couple of times, but I -- (inaudible) asking a political science question.

The governments reform, the electoral (ph) reform, what are -- you said it's necessary (inaudible) that subject before. But you say it's not going to be very big. So how is that likely to play out? And, well, and what (inaudible) consequences? Will it be enough to change to help along some of the other reforms that --

FELDMAN: OK.

(UNKNOWN): -- (inaudible) necessary?

FELDMAN: So the other one?

SMITH: (Inaudible) ask political science questions. Thank you.

Maria, you're last.

(UNKNOWN): Oh, thank you very much.

So my question has to do with a political window that prime minister (ph) may have so that he delivers some benefit so that then he can tackle the longer term structural reforms.

And the reason I ask this question, it seems to me that he's really serious about ginning (ph) structural reform. He's going to antagonize vested interests across the border. It's going to be the farmers, the doctors, the zombie firms (ph), you name it.

And many of these interest groups are actually very well represented within his party but has given him the political oxygen to deal with him, I think, is at high levels of popular support.

FELDMAN: Yes.

(UNKNOWN): But people know how very high expectations and they do expect what are job prospects and certainly wage increases.

FELDMAN: Yes.

(UNKNOWN): And there was actually a little bit worried when you mentioned that increases to the wage base will not happen for a while. They will not be forthcoming next year because it seems to me that people may be, you know, they offer him now, I think this is a easy year for Abenomics, where the promises are made, where the fiscal stimulus has been kicking in.

But next year, if the opposite message and fiscal policy begins to actually be implemented and the wage increases are not there, then I think that people may actually begin to wither off his support and how would then he stare down those vested interests?

FELDMAN: Yes. That is exactly the issue that I think (inaudible). Let me start with Ted's question, then move here.

On the electoral reform, the key thing -- the key next event is the Supreme Court ruling on the constitutionality of the 2012 election. That'll probably come in the next few weeks. My understanding is that Abe wants to use that as a trigger for creating a committee under the Speaker of the House, of private sector people to design a new lower House electrical system.

He was very clear the day after they pushed through this purely cosmetic electoral reform, to get it barely under the limit, and it's probably out of date by now anyway, on constitutionality. So yes, it's constitutional now; we're OK.

But by the way, we haven't performed. We spent two years dickering about this thing. We haven't made any snapshots impact on the number of seats or the one man, one vote problem. We need an independent commission. He said that very explicitly in public.

As a result of that Supreme Court decision, they're going to have to constitute that committee. I want to see who's on the committee. But my reaction to his statement was to raise their grade on the electoral reform from an F- to a D-.

(LAUGHTER)

FELDMAN: But that's the best we got right now.

If they don't do that, I think it's very hard to get spending under control.

Because you're not going to get the diet to vote for spending control if the elderly are so heavily over-represented. So I wish I had better --

(CROSSTALK)

QUESTION: (Inaudible) transition look like?

FELDMAN: Yes?

QUESTION: So, I mean, that's partly (inaudible) question. (Inaudible) political window, they have the existing diet, where we -- can they redraw the districts now, right, so you have some changing (inaudible)?

FELDMAN: I guess if you're an optimist, you'd say that everybody's going to know what the system's going to look like when they redraw it. And so they will start playing to those interests now, so they can get reelected next time.

I think that's reasonably good, reasonably good bet.

The question, to my mind, is how are they actually going to redraw the district lines. I actually came up with what I think is the magic solution, which is that you can completely eliminate the one person, one vote problem, not change a single diet member, not change a single district border and still have a completely new system.

And the way you do that is by treating the diet as a shareholder's general meeting instead of treating it as a one representative, one vote system.

That is the guy from Dukdari (ph) Prefecture would have 1.4 votes, or if there are two of them, each would have 0.7 votes. It might not work so great in the diet. Because, oh, he's only got 1 point -- or he's only got 0.97 votes, and I've got 1.13. So I'm a cool guy.

There actually turned out to be a few places in New York State, a couple other places around the U.S. that do this because it was just too hard to redraw the district lines. It would be, you know, an immense experiment if they decided to do that. But they might try to here and there.

So in the end, what they'll -- I think what they'll end up with is the Nikkei's proposal. It's about the best you can do, which is reallocate the seats on a proportional basis among the prefectures and just let the prefectures draw the lines.

That would lower the representation of the regions by 19 seats, raise the cities' by 19 and leave the middle areas untouched. And that's pretty good progress.

I wish I could be -- give them better than a D-, but at the moment, I haven't seen any evidence.

On the short-term versus long-term, I think you've raised exactly the issue. How does he keep his support rate high while they're in the -- call it the Death Valley part of the -- of the reforms?

And I think that really has to do not so much with wages, although that's important, as it has to do with stock prices, which they're very focused on, and also employment per se. Because if they can keep employment, particularly employment for the youth, improving, even though wages aren't going up a lot, and keep stock prices high, it looks like things are working.

But I think the key thing for me is to -- is for Abe to keep focused on the support rate and not fall -- what should I say -- fall prey to insider politics the way he did the first time. I think he knows that lesson. I thing Suga knows it. But you never know. It's politics.

The little chat we had with Ishiba (ph) the other day I thought was quite encouraging. When we first -- just within these four walls. When we first went in to talk with him, we said, "Gee, isn't it nice that politics is stable?" He said, "Yes. The Abe administration will last for three years."

(LAUGHTER)

OK. When he talked to the clients, what he said was, "Well, you know, we're here for three years. If Mr. Abe wants to be re-elected as party chairman when his party chairman term runs out, we will support him."

That's really interesting.

(UNKNOWN): When is that?

FELDMAN: That's still two and a half years -- or two years away from now. So that would give us five more years under the same Prime Minister. That's kind of cool. If Ishiba's (ph) serious about that. And to me, as you point out, that has everything to do with his support rate. So I wouldn't say that the wages are a problem, but employment and stock prices are probably, we hope, enough to keep it going.

And then of course there's the weakness of the opposition. And there's no sign that we'll have an effective opposition party.

SMITH: Robbie, we have a couple of seconds left. But I can't -- I need to ask you -- when you talked about -- you talked about conversations you've had with the leadership and with individuals who are looking at the Third Arrow package.

To what extent do you think the Abe administration is listening to non-Japanese economic and business experts like yourself? Are they -- is the door open? Is it more open than in the past? Do you anticipate being on the Electoral Reform Committee, or...

FELDMAN: I do not anticipate being on the Electoral Reform Committee.

(LAUGHTER)

SMITH: No, but are they more open than in the past?

FELDMAN: I think they're very, very open. And particularly -- they're even soliciting foreign commentary.

A colleague of mine put out a piece on the consumption tax a couple of weeks ago. He got a phone call -- or, excuse me, my colleague got an email from one of the Prime Minister's top economic advisors, Mr. Honda.

We called Honda the next week and say we've got a client coming straight down (ph), wants to talk to you, can we talk to you? He says sure, just drop in. They are actually making a very concerted effort to do road shows, to explain themselves. They're very open to foreign people who are interested in investing in the country.

We were able to do two very, very major senior client, or top client events, with excellent representation from the government. Because they're interested in talking to people.

Now from their point of view, it's sales. They want stock prices to stay high, that's their goal, obviously. But they do seem to be open. And when you talk to them, they're open. Any idea that'll help them stay in office, I think they're happy to.

So I think it's a pretty open administration. Certainly more open than, say, Hatoyama (ph) or Kan (ph). Naoto (ph) was OK, but not great. I mean, he had other problems. So I think it's a big step forward.

SMITH: Great. Well, Robbie, thank you for making time in your schedule to come and talk to us.

FELDMAN: No, it's my pleasure. Thanks everyone for coming.

SMITH: Thank you very much.

(APPLAUSE)

One last announcement for you CFR members is Mr. (inaudible) of Bank of Japan governor will be speaking in New York at the CFR on October 10. So if you're interested, come on up to New York. Should be a pretty large general meeting, but we'll look forward to having you.

Thank you.