Courtesy of The Pragmatic Capitalist
Richard Koo is the Chief Economist at Nomura Research Institute. For those who aren’t familiar with Koo, he is one of the world’s premiere experts on deflation and one of the head advisors during Japan’s long-running bout with their 20 year balance sheet recession. Koo describes this recession as one that occurs “after the bursting of a nationwide asset price bubble that leaves a large number of private-sector balance sheets with more liabilities than assets. In this type of recession, the economy will not enter self-sustaining growth until private-sector balance sheets are repaired.”
In an interview in April Koo was highly critical of the government’s response to the crisis. Koo believes the government has not only misdiagnosed the current balance sheet recession as a credit crisis, but also believes we are at serious risk of a second and potentially worse downturn if further actions are not taken:
“The economy will collapse again and the second collapse is usually far worse than the first. And the reason is that, after the first collapse, people tend to blame themselves. They say, ‘I shouldn’t have played the bubble. I shouldn’t have borrowed money to invest – to speculate on these things.
But a second collapse affects everyone, not just the bubble speculators, and it also suggests to the public that all the efforts to fight the downturn up to that point – all the monetary easing, the low interest rates, quantitative easing – have failed and even fiscal policy has failed. Once that kind of mindset sets in, it becomes ten times more difficult to get the economy going again. So the fact that Larry Summers was talking about ‘temporary’ fiscal stimulus had me very, very worried. That whole Larry Summers idea that one big injection of fiscal stimulus will get the US out of the recession, and everything will be fine thereafter, probably led to President Obama’s saying he’s going to cut his budget deficit in half in four years.
We had these false starts. The economy would begin to improve and then we’d say ‘oh my god, the budget deficit is too large.’ Then we’d cut fiscal stimulus and collapse again. We went through this zigzag for 15 years.”
Koo thinks the only way to overcome the balance sheet recession is through government spending in an attempt to counteract the lost economist activity of the borrowing consumer. In a recent interview Koo reiterated his primary concerns from earlier this year:
“Until the private sector is finished repairing its balance sheets, if the government tries to cut its spending, we’re going to fall into the same trap Franklin Roosevelt fell into in 1937 (a crushing bear market) and Prime Minister Hashimoto fell into in 1997, exactly 70 years later.”
As we recently discussed, the Japanese stock market had a very high correlation with the various government stimulus programs:
Koo is now reiterating his call for more government stimulus. He says that the problems we’re confronted with are far from over and will not likely be resolved for a long time. He recently said:
“This isn’t a cold, its more like pneumonia.” “[It will take] three to five years to get out of this mess, even under the best of circumstances.”
Koo claims you can’t stop fighting a balance sheet recession until the consumer is finished deleveraging and begins to borrow again:
“If you learn your lesson from the Japanese experience, you don’t remove your fiscal stimulus until private sector de- leveraging is over. When we see the private sector coming to borrow again, I’ll be the loudest person on earth arguing for fiscal reform. That’s the exit.”
I don’t entirely agree with Koo for a number of reasons and actually believe spending has the potential to create substantially larger problems. Part 2 of this piece will discuss why Koo is in fact wrong and the U.S. is walking a far more slippery slope than the Japanese ever walked.