Koo: don’t be surprised by the crappy economy
First I wanted to thank you for the wonderful comments I’ve been enjoying and compiling from my last post about what’s corrupt about the financial system and what should be done about it. Even if I don’t end up doing the teach-in (hopefully I will! In any case I’ll go down there, even if it’s just to try to set up the teach-in for a later date) I think this is a really fantastic and important discussion. I’m putting together a final list of issues tonight and I think I’ll make a flyer to bring tomorrow, so if I don’t actually conduct the teach-in (yet) I’ll at least be able to give the info booth the flyers.
And it’s not too late! Please keep the comments coming.
Today I want to start a discussion on Richard Koo’s book, which is about Japan’s so-called “lost decade” (a reader suggested this book to me, and it’s fascinating, so thanks! And please feel free to make more suggestions for my reading list).
You can actually get a pretty good overview of his book by watching this excellent interview by Koo. For those of you, like me, whose sound doesn’t work on their computers, here’s his basic thesis:
- After the housing bubble in Japan burst, a bunch of firms, banks and otherwise, became technically insolvent. This meant that, although they had cash flow, they owed more than their assets.
- Because they were insolvent, they didn’t maximize profits like in normal times; instead they minimized debts.
- In other words, they didn’t borrow money to grow their businesses, like you’d expect in normal circumstances, which is proved by looking at data showing that corporate borrowing went down even as interest rates lowered to zero.
- The CEO’s didn’t talk about this because they don’t want anyone to know they’re insolvent!
- Investors are also somewhat blind to this, because they typically look at growth and cash flow issues.
- Japan’s government made massive investments in order to cover the lack of private investments.
- Rather than this being a mistake, this was absolutely essential to the Japanese economy and prevented a massive depression.
- Moreover, the idea that Japan had a lost decade is false: actually, there was a lot going on in that decade (actually, 15 years) but people didn’t see it. Namely, the balance sheets were slowly improved over the entire economy.
- This is a lesson for us all: any time there’s a massive credit bubble which breaks, we can expect a balance sheet recession where behavior like this is the rule. The U.S. economy right now is an example of this.
I have a few comments about this. I wanted to mention that I’m only about halfway through the book so it’s possible that Koo addresses some of these issues but on the other hand the book was published in 2009 but was clearly written before the U.S. credit crisis was really full-blown:
- A friend of mine who recently traveled to Japan noted that the people there live extremely well. In fact, if he hadn’t been told that their country has been in recession for nearly twenty years then he’d have never guessed it. This supports Koo’s claim that the Japanese government absolutely did the right thing by bankrolling the economy when it did. It also brings up a very basic question: how do we measure success? And why do we listen to economists when they tell us how to define success?
- Not every country can do what Japan did in terms of investing in its economy, although the U.S. probably can. In other words, it depends on how other countries see your credit risk whether you can go ahead and bail out an entire economy.
- Some of the businesses in the U.S. are clearly not technically insolvent; we’ve already seen ample evidence of cash hoarding. On the other hand, I guess if sufficiently many are, then the overall environment can be affected like Koo describes.
- In general it makes me wonder, how many of the firms out there today are technically insolvent? How insolvent? How long will it take for those that are to either fail outright or pay back their loans? If we go by this article, then the answer is pretty alarming, at least for the banks.
In general I like Koo’s book in that it introduces a new paradigm which explains something as totally self-evident that had been mysterious. It’s pretty bad news for us, though, for two reasons. First, it means we could be in this (by which I mean stagnant growth) for a long, long time, and second, considering the hyperbolic political situation, it’s not clear that the government will end up responding appropriately, which means we may be in it for even longer.
mathbabe 
This is an interesting and plausible hypothesis.
I don’t think that the large US corporations that are hoarding cash are doing so to avoid making redundancies (declaration of interest: I was made redundant from one in April). I think they are takeover war chests to be deployed when the markets bottom out and/or in defence when bottom feeders try to eat them. There were several US companies that prospered from this strategy during the great depression in the 30s (although you can debate how much was planned in advance).
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mathbabe – some points. In a balance sheet recession, those who can borrow don’t because they don’t see aggregate demand supporting growth that would justify debt. Obviously, as a corollary there are also many more than before who cannot borrow (which of course impacts negatively aggregate demand so circle back to first group).
What these simple observations mean is that by and large policy responses in US so far have been entirely pointless – and it shows right? Fed policy has interest rates at zero – obviously better than Euro Central Bank having insanely high rates (under the circumstances) – but pushing on a rope. Likewise, the trillions sloshing through the banking system to re-capitalize banks and provide them with liquidity, also pushing on a rope. So how Geithner and Summers still have jobs is amazing.
The debate needs to be how many Hundreds of Billions in direct grants to states to keep state and civic employees on payroll, and how many other Hundreds of Billions should fed spend on DIRECT employment of more than 2 million people on national 5 year beneficial energy efficiency and water/sewer other infrastructure projects. That is the only way out. By the way, it will never be cheaper to purchase/supply necessary energy efficiency and infrastructure projects. Must do it now.
Last observation, there was a time when the imperial palace in Tokyo alone was theoretically “worth” more than entire Los Angeles County. Tokyo property values have fallen 90% from the highs. Imagine that in NYC or LA or etc. Massive federal stimulus in Japan was a massive success. Indeed, I travel to japan 3-4 times a year and you would never know they have had a “lost” 2 decades. When my japanese colleagues come here they are shocked at how decrepit things are.
Thanks – HLB
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