Li Lu's 2019 Annual Book Review
The Age of the Great Recession: The Other
Half of Macroeconomics and the Fate of Globalization
November
19, 2019
The
book I want to recommend this year is “The Age of the Great Recession: The
Other Half of Macroeconomics and the Fate of Globalization,” written by Mr. Koo
Chao Ming (Richard C. Koo).
This
book is about the big issues in the world today.
1. First—
Monetary policy.
Basically all the major economies today, such as
Japan, the United States, Europe, and China are over issuing currencies on a
large scale. The over issuance of base currency has reached astronomical
numbers, resulting in low interest rates, zero interest rates and even
negative interest rates in the Euro, which has never happened before in
history. At the same time, the contribution of currency issuance to real
economic growth is minimal. Except for the United States, the economies of
major developed countries are basically minimal or zero. Another
consequence of this situation is that the debt levels of various countries
relative to GDP are
increasing, and at the same time, all asset prices, from stocks to bonds, and
even real estate, are at historical highs. How long will this abnormal
currency phenomenon last? How will it end? When this ends, what
does it mean for global asset prices? No one can answer these questions,
but almost everyone's wealth is closely related to this.
2.
Second— globalization.
Globalization in the past few decades has closely
linked the fate of all countries in different stages of development, but
global trade and capital flows have been separated from the monetary and
fiscal policies and are independently exercised by each country. Therefore,
globalization and global capital flows have formed considerable conflicts
with each country's own economic and domestic policies, and have also made
relations between countries increasingly tense. For example, we are now
seeing an ever-increasing China-US trade conflict. We are also seeing such
instability within many countries and regions around the world, from Hong
Kong to Paris to Chile, street politics is becoming increasingly fierce in
various places. At the same time, within these countries, far-left and
far-right political forces have gradually replaced the moderate and rational
forces, making the entire world more uncertain. Under such
circumstances, no one can predict what the future global trade and capital
flows will look like.
3.
Third— in such an
international environment, how should the macroeconomic policies and fiscal
policies of various countries respond? What policies should be
implemented for different countries at different stages of development?
All
three issues are of paramount importance in today's world. Someone who is
able to answer these questions with a reasonable theory deserves respectable
academic achievement, as simultaneously answering all three questions is
almost impossible. In this book, Koo Chao Ming provides a convincing
perspective, and put forth some basic concepts with a complete logical framework.
Although these three questions do not have straight-forward answers, they at
least give a very important perspective. Whether you agree with his
theory or not, it is worth pondering and considering.
Now
a brief background about the author Koo Chao Ming. He is the chief
economist at the Nomura Securities Research Institute and has had a broad
influence on the Japanese government over the past three decades. I
first heard him about a decade ago at a YPO (Young Persons Organization) international
conference in Japan. He gave a keynote speech at the conference,
explaining what Japan called the "lost decade" (of course it is now
"lost twenty years", or even "lost thirty years").
Koo
Chao Ming explained these economic phenomena following the burst of the
Japanese bubble such as zero economic growth, currency oversupply, zero
interest rates, large government deficits, and high debt. There are
different interpretations of these phenomena in the West, but they are
basically believed to be caused by the failure of Japanese macroeconomic policies. But
for the first time Koo Chao Ming gave another completely opposite but more
convincing interpretation. He put forward a new concept of his own
unique economics—balance sheet decline. He attributed the economic recession
in Japan at that time of the Great Economic Recession caused by the rapid
expansion and decline of the private sector (business and household) balance
sheet after the asset bubble burst.
In
the Great Recession caused by balance sheet decline, he put forth one of the
most unique views, claiming that the goals of the entire private sector have
changed fundamentally, they are no longer in pursuit of maximizing profits,
but in minimizing liabilities. So at this time, no matter how much the
currency is issued, the first thing the private sector and individuals do
when they get money is not to invest and expand their business, but to pay
off their debts.
Because
the sharp decline in asset prices at that time put the entire private sector
and households in a state of technical bankruptcy, what they had to do to
repair their balance sheets, was to keep saving and pay off debts. In
this case, the economy will inevitably lead to a large-scale
contraction. This decline is like the 30 years US economic crisis, once
the economy begins to shrink, it will spontaneous head into a downward spiral. In
the Great Depression, within just a few years, the entire US economy shrank
by nearly 46
percent.
The
method adopted by the Japanese government is to issue currency on a large
scale, and then, with large-scale government borrowing, directly invest in
infrastructure to digest and residents' idle large-scale savings. With
this method, Japan has kept the economy at the same level for more than a
decade. Although the economy experiences zero growth, there is also no
decline or recession. According to Koo Chao Ming, this is the only correct
macroeconomic policy choice.
As
a result, the Japanese economy has not experienced a massive 46% reduction like
the United States in the 1930s, while giving the private
sector sufficient time to slowly repair its balance sheet. So until recently,
the private sector and households have started to return to normal. Of
course, due to this, the government's balance sheet was seriously injured.
The Japanese government's debt is the highest in the world today. But
this is still the best policy choice compared to other options. This was
the most distinctive interpretation of Japan I heard at the time. The
observation of the Japanese economy since then has confirmed his idea to some
extent.
The
West has always has been critical of Japan's policy, and its attitude towards
Japan did not change until after the 2008-2009 Western Great Recession. Years
later in 2008-2009,
all of a sudden the entire West encountered a similar situation to Japan in
the 80s
with a big bubble burst at the end of the decade. At
this time, the main assets of the West also began to depreciate sharply, and the
entire private sector fell into technical bankruptcy, so the situation was
very similar. The policies adopted by the major western countries were
all excessive currency issuance.
Then
only main experience influencing the Western central bank was of the 1930s, in the
Great Depression era. In the summary, of the last 30 years, the main conclusion of
the economics professor Milton Friedman was that a fundamental
error has occurred in monetary policy in treating an economic policy crisis. Federal
Reserve Chairman Ben
Bernanke in 2008 was a strong supporter
of this view. He even thought that in extreme cases, banknotes could be
sprinkled directly from helicopters. Therefore, in response to the 2008 crisis,
Western countries began a large-scale currency oversupply. But contrary
to expectations, the result of currency oversupply did not bring about a
rapid recovery of economic growth. These large amounts of over-issued
currencies were actually utilized by the private sector to pay off debt, so
economic growth remained sluggish. Except for a small amount of economic
growth in the United States, the Euro zone economy was still basically stagnant.
The
government's first response was to increase the issuance of currencies. For
this reason, central banks in various countries even invented quantitative
easing (QE) which
previously not deployed. Central banks traditionally regulates the money
supply by adjusting reserves (the most important part of the base
currency). After the implementation of QE, the Fed's excess reserves
have reached 12.5 times the
statutory reserves. Afterwards, the major western central banks followed QE,
and the corresponding multiples reached 9.6 times in the euro area, 15.3 times
in the UK, 30.5 times
in Switzerland, and 32.5 times in Japan! That
is to say, under normal economic conditions, if the private sector can
effectively use these new currencies, inflation can reach the same multiples
(such as the US— 1250%). In
other words, if these currencies enter the asset investment class, asset
prices can rise sharply several times to levels of a speculative bubble, there
might be a chance to strongly stimulate GDP growth.
But
the actual situation is that the economy is still growing only slightly, and
some asset prices are gradually rising. The biggest consequence of this
policy is the formation of interest rates close to zero, and even the
negative interest rates of about $15 trillion in the euro zone
today. This has shaken the fundamental assumptions of the entire
capitalist market mechanism, but at the same time it has not brought about
the expected economic growth. At this time, the phenomenon in Europe as
a whole began to look more and more like Japan. Everyone started to
rethink the Japan’s previous experience. Koo Chao Ming's summary of
Japan and Japan's fiscal policy have regained interest from major western
countries.
Koo
Chao Ming used a relatively simple framework to explain these
phenomena. He said that according to the saving and investment behavior
in the economy, an economy will always be in one of the following four
situations, as shown in the following table.
Under
normal circumstances, there should be both savings and borrowed investment in
an economy. This way, the economy is in a state of relatively positive
growth. When the general economic crisis comes, savers lack money, but
there are still borrowers and investors, and investment opportunities. In
this case, the central bank’s role as the last resort currency provider is
very important. This is the most important conclusion of the 1930’s Great
Depression— the central bank as a lender of last resort, the last provider of
funds. It provides funding and then lends to the private sector.
However,
what everyone did not expect is the third and fourth situations which have
not occurred before—what will happen to the economy when the borrowers and
investors are missing? For example, in Japan, there are savers, but in
the past few decades, the private sector has no incentive to borrow and
invest.
What
should we do? By 2008-2009, the situation in the
entire West was that there were neither savers nor borrowers, and the savers
themselves disappeared when the crisis occurred. There were almost no savings
in the United States, and assets fell on a large scale. Technically they were
under bankruptcy. At the same time, there were basically no investment
opportunities in Europe. After several rounds of QE,
with the base currency issued on a large scale, and with no one willing to
invest— there is no investment opportunity in the economy. People get
their money back from the bank in the form of negative interest
rates. This has never happened before.
The
main contribution of Koo Chao Ming's basic research framework is the third
and fourth cases, that is, the phenomena in absence of borrowers. For
example, Japan belongs to the third case, where some people save but no one
borrows. In this case, he believes that the government must bear the
responsibility of the ultimate borrower, and through fiscal policy, the
government directly invests. Because if you do not do this, the private
sector will not be willing to be a borrower, and the economy will start to
shrink, and once the economy starts to shrink, it will itself have an accelerating
downward spiral mechanism. This acceleration can even lead to halving
the economy and mass unemployment, and the social consequences are
unimaginable. Hitler came to power in the 1930s,
and the resurgence of Japanese militarism was directly related to the Great
Depression of the time.
The
fourth scenario is what happened in 2008-2009, with neither savers nor
borrowers. At this point, the government should act as both the ultimate
funding provider and the ultimate borrower. For the United States, from 2008 to 2009,
it passed the central bank's oversupply of currency and the Treasury
Department passed the TARP bill, which directly
injected capital into all systemically important commercial and investment
banks, which simultaneously solved the problem of lacking both investors and
depositors, thereby stabilizing the economy. Western Europe may still be
in the third or even the fourth situation to this day. There are neither
savers nor borrowers, and because of the limitations of within the Euro zone,
European countries can only use monetary policy (control of interest rates
and money supply). The binding Euro contract has limited European countries,
especially Southern European countries using the same fiscal policy (control
of tax rates and government budget/spending) to expand domestic demand, and
such restrictions could have disastrous consequences in the future.
Koo
Chao Ming used the above framework to analyze the unique economic phenomena
facing the world today (the third and fourth situations), and also put
forward some views on the economic policies of developed countries.
He
then considered the question: Why did asset bubbles occur in both Western
Europe and the United States? Why did they not find a way to grow after
the asset bubble burst (except for the United States, which has relatively
weak growth)? In order to answer this question, he put forward in my
book what I think is the second more unique perspective. This
perspective is particularly meaningful for China today. He proposed that
there are three different stages of economic development in the context of globalized
trade.
First
we introduce in development economics is an important concept—Lewis Turning Point
(economic development where surplus rural labor is fully absorbed into the
manufacturing sector). In the early days of
urban industrialization, surplus rural labor is continuously migrated to
urban industry, and once industrialization develops to a certain scale, the surplus
rural labor force experiences shortage, since the economy enters full
employment. This turning point is called the Lewis Turning Point. This
observation was first made by British economist William Arthur Lewis in
the 1950’s.
The
first stage was the early urban industrialization process before the arrival
of the Lewis Turning Point. The second stage is that after the economy
has passed the Lewis turning point, society has entered a state of interactive
growth of savings, investment, and consumption, also known as the golden
age. The third stage, which is a unique stage proposed by Koo Chao Ming, is globalization, after the economy
has matured and entered the advanced economy stage, it will enter the stage
of being chased by other developing nations.
Why
does this happen? Because in this period, as domestic production costs increase
to a certain level, investment in other developing countries overseas become
more advantageous. In the early days, the advantages of overseas
investment were not clear because of various cultural and institutional
obstacles, but when the domestic production costs reach a certain level, and
after some basic capabilities for overseas investment were established in
other countries, overseas investment becomes far more beneficial and
lucrative than domestic investment. At this time, capital inflow and
investments into the country will deteriorate and domestic wages will begin
to stagnate.
1. In
the first stage, that is, during the early industrialization of cities and
towns before the arrival of the Lewis Turning Point, capitalists had absolute
control, and it was generally difficult for laborers to have pricing power
and bargaining power, because there were many surplus people in the
countryside, and with many people looking for work— companies will naturally
exploit workers.
2.
The second stage, that is,
after the Lewis turning point, has entered the mature stage of economic
development. At this time, the company needs to increase investment by
increasing investment in production equipment to meet the needs of employees,
increase wages, and improve the working environment. And production
equipment, etc. During this period, because the labor force has begun to
be in short supply, economic development will lead to rising wage levels,
rising wages will cause rising consumption levels, saving levels and
investment levels will also rise, and the company's profits will rise,
forming an interaction. Upward positive cycle. At this stage, almost
everyone in the society can enjoy the fruits of economic development, and at
the same time, a consumer society dominated by the middle class. Even for
people with low education, wages are increasing. Living standards are
improving. So this stage is also called the golden age.
3.
In the third stage, society
began to divide. For the labor force, only those jobs with relatively
high technical content, such as science and technology, finance, trade, and
international markets, will continue to get good job returns, and those with
lower education levels in traditional manufacturing jobs will gradually
receive lower wages. The gap between the rich and the poor in society
has further widened. The domestic economy and investment opportunities
have gradually depleted, and investment opportunities have been transferred
overseas. During this time, GDP growth mainly depends on
continuous technological innovation. If the ability in this area is
relatively strong (such as the United States), GDP will still grow at a low
rate; if the ability to innovate is not strong and the rate of innovation is
not fast (such as Europe or Japan), the domestic economic growth is weak, and
investment is transferred to overseas or irrational areas.
Koo Chao Ming believed that Western
society entered the third stage in the 1970’s,
when it was mainly chased by the four dragons of Japan and Asia. To a
dozen years later, 80 years,
China began to enter into the international economic cycle, the Japanese have
begun to enter into the catch-up phase. After catching up, the opportunities
for domestic economic growth have sharply decreased, and it is easier for
economic growth to enter areas prone to formation of bubble, whether in
Japan, the United States or Western Europe. Derivative securities caused the
formation of huge bubbles and subsequent bubble bursts. After the bubble
burst, because domestic economic growth opportunities are still limited and
growth potential is still small, the private sector on one hand needs to
repair its balance sheet and on the other hand lacks investment
opportunities, making its economic behavior no longer pursue maximization of
profit, but to change to minimizing debt. In this way, some predictions
based on traditional economic theory have basically failed.
Koo
Chao Ming pointed out that at different stages of economic development, the
government's macro policies will have different functions, and therefore need
to employ different policy or tools. This view is most inspiring to
China today.
In
the early industrialization process, economic growth mainly depended on
capital formation, manufacturing, and exports. During this time, the
government's fiscal policy will play a huge role. The government can
concentrate limited resources and invest in infrastructure, resources,
export-related services, etc. These will help emerging countries to quickly
enter an industrialized state. Almost all countries have adopted active
government with supporting policies at this stage.
Entering
the second stage, the main driver of economic growth are wages and
consumption. During this stage, with society fully employed, so as long as
wages increase in any sector or field, increase in wages in other sectors will
inevitably occur. Increased wages lead to increased consumption and savings,
and companies will use these savings to increase investment in equipment in
order to increase output, thereby achieving further profit growth, so they
are more able to attract more employees by increasing wages. This repeated
cycle brings positive growth.
This
growth mainly comes from the spontaneous growth of the domestic economy. At
this time, mainly the investment and consumption behavior of entrepreneurs play
a decisive role— individuals and families at the forefront of the market,
because they can better grasp the rapidly changing business opportunities in
the market. So at this time, the most effective is monetary policy
rather than fiscal policy, because fiscal policy and private investment both
come from limited savings, and the poor use of fiscal policy will cause
conflicts with private sector investment by competing for resources and
opportunities.
In
the third stage, the stage of being chased, fiscal policy becomes important
again. Because the domestic investment environment is deteriorating and
investment opportunities are reduced, the private sector is reluctant to
invest in China because of higher returns on overseas investment, but there
is still a lot of savings in the country.
During
this time, the government will come forward, such as in a large-scale social
investment such as Japan, investing in infrastructure, basic education, basic
scientific research, etc. Although the profit is not high, it can make up for
insufficient domestic private sector investment and household savings. Too
much and insufficient consumption can ensure social employment and keep
the level of GDP from
a spiral decline, which is more suitable for economic development at this
stage. Instead, monetary policy often fails at this stage.
The
discussion on the use of macro policies is very meaningful for China's
current development. Although different observers have different
opinions, in general China should have passed the Lewis inflection point in
the past few years and started to enter a mature state of economic
development. We have seen that wage levels, consumption levels, savings
levels, and investment levels have all accelerated in the past
decade. However, because the government's inertia is usually strong,
when the economic development stage changes, there will be a lag effect in
the formulation and implementation of the policy, often staying in the
successful experience of the previous development stage. These
dislocations in macroeconomic policies and stages of economic development
have occurred in all countries and stages.
For
example, in the West today, macro policies are employing monetary policies that
were still relatively effective from the golden age. However, actual results
show these policies are very ineffective, so many Western countries today, especially
Europe and Japan, have a case of currency surplus, zero interest rates and
even negative interest rates. The inflation rate is still very low, economic
growth is still extremely slow, and debt has increased dramatically. Similarly,
after the Chinese economy has entered the mature stage of the post-Lewis
inflection point, the government is still focusing more on the fiscal policy
in the first stage.
We
have seen in the past few years, a series of measures on economic reform with
good intentions to adjust problems brought by the previous stages of industrialization
and large-scale development of manufacturing. However, the actual
implementation has accelerated the withdrawal and closure of private enterprises,
forming a certain degree of national retreat. This hurts the confidence of
private entrepreneurs, causing a certain degree of turbulence in consumer
confidence. The shortcomings reduced the potential level of economic growth
during this period.
Today,
China’s net exports have contributed negatively to GDP growth,
while consumption has contributed 70-80%. Of these, private
consumption is particularly important and will be the most fundamental
driving force for China’s
economic growth in the future. In the golden age, the most important roles
were entrepreneurs and individual consumers. The focus and starting
point of all policies should be on enhancing the confidence of entrepreneurs—
how to establish relatively clean, fair, and standardized market rules, how
to reduce government power over economic operations, reduce decentralization,
reduce taxes, and reduce burdens. From the experience of other developed
countries in the golden age, monetary policy is even more important during
this period.
1. In
the first phase, China's main financial policies were an indirect financial
model, which was practically a compulsory large-scale saving system, with a
government-controlled banking system introduced on large-scale and low-cost
capital into manufacturing, infrastructure and later into strategic
industries such as exports. These policies were successful for China's rapid
industrialization.
2. In
the second stage, a major direction should be how to gradually liberate the
entire society's financing direction and methods from the above-mentioned
system, from indirect finance to direct finance, so that private
entrepreneurs and individual consumers can have the opportunity to become the
main ultimate borrower. We have seen loosening in this area in the past
few years. For example, with the help of financial technology, we have seen
the initial development of consumer credit. Of course, in the long run,
whether we can make real estate mortgage loans better and unleash the
potential of secondary re-mortgage loans are all issues worth studying.
Important
macro policy include— increasing the proportion of direct finance, speeding
up the registration system, enhance the stock market's ability to finance
private enterprises, and establishing an efficient bond market and equity
market. In addition, whether the government's functions can be shifted
from guiding the economy to supporting and serving the economy, and further
reduction in power are also the biggest tests of macro policy at this stage.
In
the past few years, although some of the macro-policy's original intentions were
good, the actual results were not satisfactory because they served
administrative means. In a great sense, this also provides another
perspective and lesson for studying and observing the economic
characteristics of this stage. In the second stage of the golden
development period, some policies may be more effective if they are adjusted
through market spontaneity. However, some man-made practices may fuel
growth. These are the most important topics for China at present.
Now
Japan, Western Europe, the United States and other countries are in the third
stage, while China is still in the second stage, China's future growth
potential is still great. China's per capita GDP of US
$ 10,000 still has a cost advantage for western developed countries,
while other emerging developing countries (such as India) have not yet formed
a systematic competitive advantage. China may be in a period of
opportunity for golden development for quite a long time. Today, China
’s per capita GDP
is around US $ 10,000, but the population with
a per capita GDP of
US $ 20,000 has exceeded 100 million, mainly distributed in southeast coastal
cities. In fact, China ’s leap from a per capita GDP of 10,000
US dollars to 20,000 US dollars did not require the most advanced technology.
China
only needs to spread the living standards and lifestyles of southeast coastal
regions on a large scale in-land. This is the driving force for
consumption growth, and the main driving force is envy and the
"neighbor-effect". I also want to have what other people have—
media, such as television and the Internet, etc. to spread this lifestyle of
100 million people to the southeast coast of more than one billion people, reaching
a per capita GDP
of 20,000 US dollars. In the next few years,
China's wages, savings, investment and consumption levels will continue to
catch up and spiral up. In a positive cycle of mutual promotion, investment
opportunities will remain abundant and excellent.
If
China can learn from the monetary policies of Western countries in the golden
age and make some adjustments to the relationship between the government and
the market, it will be of great benefit to unlock its economic growth
potential. On the other hand, if the West, and especially Western
Europe, can learn some of Japan’s
and China’s fiscal policy experiences and let the government assume the role
of ultimate borrower, and invest in infrastructure, basic education, and research
on a larger scale, it will be beneficial and they will sustain economic
growth.
Adopting
different policies and approaches at different stages of economic development
is also a great contribution to economics itself. Economics is not
physics. There are no axioms and theorems. It must be studied constantly— to propose
the most important policies suitable for this period requires an
understanding of changing economic phenomena and its reality. So in this
sense, the theoretical framework in this book is a breakthrough and a useful
attempt for the study of economics itself.
Of
course, these three questions to be answered in this book are the most
difficult and important questions in the world today, and it is unlikely to
have a perfect answer. The author has a deep understanding of Japan's
experience, and many points in the book also use this as a starting point,
but whether Japan's experience really applies to European countries and the
United States remains to be discussed. Quantitative easing, currency
over issuance, zero interest rates and negative interest rates, inflated asset
prices, social inequality, the rise of populist politics – these
international phenomenon caused mainly by developed countries still plagued
by policy makers in all countries and ordinary people for a long time.
For
China, because it is still in the golden development period of the post-Lewis
inflection point, developed countries such as the West and Japan that have
passed this stage have left a wealth of reference experience for this stage
of economic policy, especially monetary policy. As long as policy makers
can recognize their current stage and make appropriate adjustments, it is
possible to fully release the huge economic growth potential during the
golden development period. China's future is still promising.
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Thursday, November 28, 2019
Li Lu's 2019 Annual Book Review
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