Richard Koo: How the West is Repeating Japan's Mistakes

this morning with Richard kooky economist of the número Research Institute in Tokyo he's also the author of the holy grail of macroeconomics a book that's had tremendous influence around the world leading American and European economists are now studying it looking at the implications for their societies of what Richard calls the balance sheet recession that afflicted Japan for 15 years between 1990 and 2005 balance sheet overhangs in the United States balance sheet overhangs in peripheral Europe are now big source of concern as everybody moves towards fiscal austerity Richard thanks for joining us thank you for the invitation I read in the most recent copy of your newsletter occasionally very interested in the quantitative easing - yes the implications for the currency the fallout of the g20 meeting in Seoul and how perhaps from what we know about balance sheet recessions that monetary expansion at this zero interest rate level may not be very effective why don't you describe briefly your thoughts when you heard that Ben Bernanke was going to embark on this second stage of quantitative easing well I thought that was somewhat unfortunate because the so-called QE one where he putting huge amount of liquidity to save the US banking system that pot made sense in a sense that there was a financial crisis there was a loss of confidence in the financial system institutions everybody was on defensive central bank was the only provide the liquidity to keep the things going that part is fine any central bank faced with that kind of crisis Lehman shock had to do that and Japan had to do that too when sign your securities collapsed in 1997 was first default in the so called non collateral call market in Japan's history Japanese companies all got really scared the whole thing came to grinding started of the Japanese Lehman that was a Japanese Lehman and the Bank of Japan pumped in huge sum of liquidity to get the things going again but qe2 where the goal is no longer fixed in the financial system but to get the economy going I'm afraid it's not going to produce the kind of result a lot of people hoping for because I think what we have in United States is a situation where even with zero interest rates private sector is minimizing debt so-called deleveraging and there the leveraging because all the assets they bought with borrowed funds during the bubble days have collapsed in value but the liabilities are still networks and their balance sheets underwater and if you have cash flow the right thing to do under the circumstances to use the cash flow to pay down debt now when everybody does it all at the same time economy enters what I call fallacy of composition in that everybody's doing the right things repairing balance sheets but when everybody does it all at the same time we enter a very ah strange world that happens once maybe every 70 years and that is that for a national economy if someone is saving money you're paying down debt you better have someone on the other side borrowing and spending money but when no one is borrowing spending money even with zero interest rates everybody's deleveraging what happens right in the usual economy if I'm a member of the household sector half thousand dollars of income I spend nine hundred myself decide to save hundred dollars nine hundred is already someone else's income that's not a problem the hundred dollars go through the financial types and the banks the securities houses they will then give it to someone else who can use it that person borrows it spends it nine hundred plus one hundred thousand dollars against the original income of the thousand dollars the economy moves forward if too many borrowers raise the raised too few rates are lowered and adjustments are made but in the world we are now and the world we found ourselves in Japan for nearly 15 years was that you bring rates down to zero people still deleveraging no one's borrowing money then what happens when I spent when I get thousand dollars for income decide to spend nine hundred and save hundred dollars the hundred dollars gets stuck in a banking system somewhere it becomes a leakage to the income streams because there are no shoes on the vault that's right I was borrowing and spending money yeah the economy shrinks from 1,000 to 900 then because only $900 that's the part that was spent that's someone else's income that person gets it decided to say let's say he decide to say 10% he spends 810 decide to save $90 and that $90 gets stuck in a banking system because people still deleveraging yes then economy goes from 1908 hundred ten seven hundred thirty very very quickly even with zero interest rates and that's the danger we faced in Japan and that's exactly how Great Depression got so bad so quickly in the u.s. from 1929 to 1933 everybody was paying down that no one was borrowing money and I see the same danger in this part of the world as well and when you're in that kind of situation you try to pump in money through qe2 or QE 3 there will be no takers the money can enter the financial system but it cannot go any further because the real economy people in the real side of the economy are all deleveraging you know people talk about all government spending money must mean we are using grandchildren's credit card you know that kind of talk which is you know are very popular things to say but you have to remember what kind of economy are going to leave to the next generation as well if you cut now and allow the economy to go from 1908 hundred ten seven hundred thirty there will be a lot more young people who won't be able to go to schools school programs we have be cut for the many local school districts they won't be able to study our they won't be able to study science because all the programs are being cut and that's a huge cost to the future generations as well science research similarly right you know to basic science research you don't have R&D and new product development 10 20 30 years down the path right and it's not just science and the arts field all of these areas where people have to come up with new ideas to get the sex society going if these people no longer were able to have those opportunities because they have to go find work or the school programs or cut drastically then that's all cost of the future generations and that part is seems to be missing from the debate well when they talk about fiscal policy and deficits that's the flow of activity but what you might say the stock of activity right or there's give me the stock of accumulated benefits of that activity like how educated as you workforce how strong is your infrastructure how elevated is your understanding of the arts sciences and elements of culture yeah those are all assets of a society that's not a dimension a lot of young people lost their education opportunities during the 1930s because the government did not do the right things once the stock market collapsed and who's paying for that cost that part is missing from our debate all together now here's an interesting element you sit in Japan friendships with the United States very close observation which of China and I know you travel to both places yes the Americans are saying we don't trust government we have to cut off government mm-hmm at the same time people are saying we admire what the Chinese are doing and the Chinese are doing things infrastructure education so forth run by the government all of these models exist and yet the Americans at this critical juncture are saying we have to shut down the government we can't trust the government government isn't good you know how do you explain that how do you see well our China was actually headed to a perfect balance recession September 9 2008 when Lehman shock hit Chinese house prices were collapsing also Chinese stock market was collapsing and so we were all in the same boat at the time but the Chinese in November early November 2008 put in a massive fiscal stimulus 17 percent of GDP that's three times larger than the Oba President Obama 787 billion dollar package and not only that it was implemented very very quickly and we know how Chinese can how quickly they can implement things as a result even the economy was headed toward a perfect balance sheet recession because of this massive fiscal push from the government if the whole stuff and when Chinese announced a package everybody around the world was laughing 8% GDP growth no way but they actually achieved 8% growth even higher than that and the Chinese people become more confident start spending money the economy began to pick up further and now China is about the only winner in this whole world game of economics and what I admire about China is that they have very practical people otherwise that civilization wouldn't have lasted five thousand years and they are not beholden to idealogy or one type or another especially these guys the Communist to begin with so whatever that works they just put in place and some of the charts that I have used over the years which show that Japanese GDP never fell even after the bursting of the bubble Chinese paid great deal of attention to that chart because at that time about five years ago China had both the housing bubble and a stock market bubble and economy was doing very well but their leaders were very very scared and with everybody doing fine economy and doing fine why should the leaders be scared well we have to remember current leadership in China is not elected by the people and they dumped the communism in a garbage can so they really have some legitimacy problems if you elected by the people and economy goes down you can still tell the public that look I have two more years to go well you so you shut up ah if you do practicing communism and communism is defined by the Communist Party and the chairman of the party you can define whatever the communism to your to your liking and if someone complains you can grab the guy put him in jail and that's the end of the story but at least there's some legitimacy there but now these people have nothing do you have to deliver the goods exactly that's the only claim to legitimacy they have and that is that under their leadership the living standard of Chinese people have improved dramatically which is true but if a third of the improvement or the half of the improvement is due to the bubble it once the bubble bursts an economy starts shrinking and people's living standards start falling when you have a political crushes exactly that's what they already bout so when they saw that Japanese managed to keep the GDP from falling even though Japanese commercial real estate fell eighty seven percent from the peak nationwide we just imagined Manhattan down 87 terraces go down 87 Chicago down 87 Orlando down 87 now what kind of economy have left here right with Japan managed to keep the GDP from falling below the peak of the bubble for the entire 20 a period after bursting of the bubble so China Chinese saw that and says this is what we have to do then that's what they did and so at the moment China is the only winner because they are putting the fiscal stimulus they continue to put in the fiscal stimulus that's necessary and as a result the economy is doing very well tax receipts are growing they can spend more on the military they can add to their national prestige and national power while everybody else is still struggling how is the United States given the tremendous burden of military responsibility our country's been carrying where we spend more than the rest of the world combined on events how in a shriveling economy will the Americans be able to continue to I say exert that kind of presence in national security around the world well I think the way we are headed smaller governments is the wrong way to go because that idea of having a small government is fine as long as private sector is healthy and and I'm looking forward but right now once in every 70 years when this huge bubble burst and the private sector balance sheets are in horrible shape private sector is no longer for looking a backward-looking trying to repair their balance sheets by paying down debt even with zero interest rates you know the fact that America is a deleveraging with zero interest rate shows how sick the private sector is right and when you're in this situation if you try to shrink the government the whole thing shrinks and economy falls into this 1910 that scenario and there would be there will be less money for defense other countries who are trying to take advantage of the u.s. weakness will have a field day and I would argue that it's good that China is doing the right things right putting the right set of policies but the way to counter that which because because the Chinese are doing the right things Chinese economy is doing well and therefore the defense spending is increasing the right way to counter that is not to tell the Chinese to do the wrong economic policy but for us to putting the right economic policies and that's not small government at the moment the government has to play a key role to keep the GDP from falling so the private sectors the income to pay down channels yes and once the private sector is healthy then we reverse our row when you look at the United States in comparison with Japan and the length or the duration of repairing of balance sheets if we were to engage in five or seven percent of GDP fiscal plan how many years do you think it would have to go on until the private sector had put themselves back into that place of balance ah it's a very difficult estimate to make because there's so few examples in the past that we can rely on but Japanese took nearly 15 years before deleveraging stopped stopped around 2005 bubble burst ah 89 1980 so that's 15 years this is against the commercial real estate prices falling 87 percent nationwide u.s. commercial real estate prices fell about half of that 44 percent and house prices down about 3035 percent which of course much smaller than the Japanese our numbers and so I don't think US you take 15 I think and make it much shorter than yours right right but to do that we have to do everything right and Japan did not have to take 15 either we make two mistakes in the middle in 1997 Prime Minister she motto listening to all these people who told him that fiscal policy is not working you're putting so much building bridges to nowhere rose to nowhere look economy is going absolutely nowhere the IMF the OECD they all told him to cut budget deficit and I was advising him at the time and I said no you don't cut if you cut now the whole thing will come crashing down but I was just the private sector economist not even the Japanese so he listened to all these big shots from abroad and decided to cut we enter five quarters of negative growth complete meltdown of the banking system to go with it not like road unlike Roosevelt in 377 exactly and as a result it took Japan nearly ten years to climb out of that hole the budget deficit instead of decreasing by 15 trillion yen 3% of Japan GDP it increased by 16 trillion yen 68 percent and to bring this thing down because damage was so large it took us ten years and another small mistake was made by Prime Minister Koizumi in year 2001 when he tried to limit Japanese government bond issuance to 30 trillion yen a year but the gap was bigger than 30 trillion he's tried to keep it at 30 and the economy began showing negative growth again so those two mistakes cost Japan nearly 10 years in my view and I don't want United States to make the same mistake and you could see China maybe with a bold aggressive pre-emptive response they're already out of it they didn't you have to go five years right right so it's very interesting to not look that they have a little bit overboard in the other area and that is that when China putting the massive fiscal stimulus in November 2008 the government also told its banks to lend as much money as you can to get the economy going but under usual world use your balance obsession world where private sector is the leverage in trying to repair the balances there should be no borrowers even if the bankers are willing to lend but in China they will borrow us and those who are the regional governments provincial governments and people who don't think their bail she gets measured that's right that's right and prior to November 2008 regional governments always wanted to borrow more for their mega projects because these regional governments always competing with each other but central government was trying to say no you can't borrow so much and they told the central government also told the banks don't lend too much to the regional governments but November 2008 two months after the Lehman collapse the whole world was in shambles so the central government says okay you can't let the regional governments as well and there though the regional government so you can borrow some money also massive funds went out of the Chinese banking system to the regional governments and of course regional governments spent that for their major projects the money then flew into the private sector and we have a massive housing bubble in China at the moment Shanghai ordinary condominiums costing nearly 1 million US dollars for people who are making so much less than the original average and so now they have these housing bubbles problems that they have to deal with and that part I think they are very serious now because they are afraid that if this kind of house prices remains there could be a revolt somewhere down the line with the people saying we're working so hard for the billions or anything yeah and so I think they clamp down on housing market is real and we could see some blood in that industry or in that sector going forward but they can always offset a huge negatives from this side by massive public spending on the other side so that the total GDP should should be maintained or the some sort of growth we maintain but we could see some areas of Shanghai real estate for example turning into non-performing loans and or something worse than that are you seeing rapid wage growth in China person are they have been Tom so they can become more affordable through increasing wages right but also they can catch up with what happened to the house - yeah ok I thank you for coming and seeing us today all right welcome it's always a catch up with you and we look forward to seeing you at the Bretton Woods conference sake thank you very much

Channel: New Economic Thinking

Views: 62,116

Keywords: INET, new economic thinking, soros, paradigm, finance, financial crisis, china, japan, balance sheet recession, crisis, monetary, policy, theory, economics

Id: Tt3KdH1uk-c

Length: 21min 36sec (1296 seconds)

Published: Sat Feb 26 2011