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This morning with Richard Koo, chief economist of the Nomura 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.
The balance sheet which overhangs the United States and in peripheral
Europe are now big source of concern as everybody moves towards fiscal
austerity,
Richard thanks for joining us.
Richard Koo
Well, I thought that was somewhat unfortunate, because this so-called
“QE1”— where he was putting a huge amount of liquidity to save the US banking
system, that part, made sense.
There was a financial crisis and a loss of confidence in the
financial system and institutions, everybody was on defensive, and the central
bank was the only provider of liquidity to keep the things going.
That part is fine, any central bank faced with that kind of crisis,
implemented it— during Lehman shock, it had to do that, and Japan had to do
that too. When securities collapsed in 1997; that was the 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 stop.
The Bank of Japan pumped in huge sum of liquidity to get
things going again, but with QE2, where the goal is no longer fixing 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 are hoping for.
Because I think what we have in United States is a situation
where even with zero interest rates, the private sector is minimizing debt— so-called
deleveraging and they are leveraging because all the assets they bought with
borrowed funds during the bubble days have collapsed in value, but the
liabilities are still on their books and their balance sheets are underwater.
And if you have cash flow, the right thing to do under those
circumstances is to use the cash flow to pay down debt.
Now when everybody does it at the same time, economy enters a
fallacy of composition— in that everybody's doing the right things— repairing
balance sheets, but when everybody does it at the same time, we enter a very
strange world that happens once maybe every 70 years.
For a national economy, if someone is saving money— you're
paying down debt, then you better have someone on the other side borrowing and spending
money. When no one is borrowing spending money, with zero interest rates, and everybody's
deleveraging, what happens?
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 there are too many borrowers, interest rates are raised,
if there are too few borrowers, interest 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 are still
deleveraging— no one's borrowing money.
What happens when I get 1000 dollars for income decide to
spend 900 and save 100 dollars?
The 100 dollars gets stuck in a banking system somewhere. It
becomes a leakage to the income streams
Because there are no shoes in the vault, right?
I was borrowing and spending money yeah the economy shrinks
from 1,000 to 900 then because only 900 was 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. He decides to save $90 and
that $90 gets stuck in a banking system because people are still deleveraging.
Then economy goes from 1000 to 810 to 730 very, very, quickly,
even with zero interest rates and that's the danger we faced in Japan and
that's exactly how the Great Depression got so bad, so quickly, in the U.S—
from 1929 to 1933— everybody was paying down debt— no one was borrowing money.
And I see the same danger in this part of the world as well.
When you're in that kind of situation, you try to pump in money through QE2 or
QE3 there will be no takers— the money can enter the financial system, but it
cannot go any further, because in the real economy, people are all deleveraging.
Some people talk about the government spending money, must mean we are
using grandchildren's credit card— this kind of thought is really common, but
you have to remember as well, what kind of economy are going to leave behind
for the next generation?
If you cut it now and allow the economy to go from 1000 to
900 to 810 to 730, 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 art, 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.
Interviewer
Science, research, similarly right?
Basic science research you don't have R&D and new product development
in 10, 20, 30 years down the path.
RK
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 society
going. If these people no longer were able to have those opportunities because
they have to go find work or the school programs were cut drastically, then
that's all cost of the future generations and that part seems to be missing
from the debate.
Interviewer
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 is your workforce? How strong is your infrastructure?
How elevated is your understanding of the arts sciences and elements of culture?
Those are all assets of a society and that's not a dimension.
RK
A lot of young people lost their education opportunities
during the 1930’s— 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
Interviewer
Now here's an interesting element. You sit in Japan with friendships with
the United States and have very close observation of China— I know you travel
to both places. The Americans are saying we don't trust government we have to
cut off government.
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. The
government isn't good. How do you explain that? How do you see it?
R.K
Well, China was
actually headed toward a perfect balance recession September 9, 2008 when
Lehman shock hit, Chinese housing prices and the Chinese stock market was
collapsing— we were all in the same boat at the time.
But the Chinese in early November 2008 put in a massive
fiscal stimulus— 17% of GDP, that's 3X larger than President Obama 787 billion
dollar package.
The Chinese implemented it very quickly, and as a result,
even though the economy was headed toward a perfect balance sheet recession, because
of this massive fiscal push from the government, it bounced off.
When the Chinese announced that package, everybody around
the world was laughing.
8% GDP growth? No way!
But they actually achieved 8% growth and even higher than
that. The Chinese people become more confident— they start spending money, the economy
began to pick up further, and now China is about the only winner in this world
game of economics.
What I admire about China is that they have very practical
people, otherwise that civilization wouldn't have lasted 5000 years, and they
are not beholden to ideology of 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.
The 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. The economy was doing very well, but their leaders
were very, very, scared. Everybody was doing fine economically; why should their
leaders be scared?
Well, we have to remember current leadership in China is not
elected by the people; they dumped the communism in a garbage can.
So they really have some legitimacy problems, if you are elected
by the people and economy goes down you can still tell the public that, “look I
have two more years to go.”
Well, if you are practice communism— defined by the
Communist Party and the chairman— 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.
Interviewer
You have to deliver the goods?
Exactly that's the only claim to legitimacy they have and
that is, 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, and once the bubble bursts an
economy starts shrinking and people's living standards start falling…
You have a political crisis?
Exactly! That's what they already about.
So when they saw that Japanese managed to keep their GDP
from falling even though Japanese commercial real estate fell 87% from the peak
nationwide.
Just imagine this scenerio— Manhattan down 87%, San
Francisco go down 87%, Chicago down 87%, Orlando down 87%, now what kind of
economy in the U.S do you have left?
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
Chinese saw that and says, “this is what we have to do then,”
and that's what they did.
At the moment China is the only winner because 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 and they can add to their national prestige and national power while
everybody else is still struggling.
Interviewer
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 will,
in a shriveling
economy, will the Americans be able to continue? And at the same time exert a
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 the idea of having a small government is fine as
long as private sector is healthy. And I'm looking forward to that, but right
now, once in every 70 years, when this huge bubble burst and the private sector
balance sheets were in horrible shape, the private sector is no longer forward
looking.
They are 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—and when you're in this situation if you try to shrink the government
the whole thing shrinks and economy falls into this 1000-900-810 (income
saving) that scenario.
And there would be there will be less money for defense, and
other countries who are trying to take advantage of the U.S weakness will have
a field day. 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 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. Once the private sector is healthy
then we reverse our predicament.
Interviewer
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 5
or 7% 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?
It's a very difficult estimate to make, because there's so
few examples in the past that we can rely on. The Japanese took nearly 15 years
before deleveraging stopped around 2005 and the bubble burst from 1990; 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 30 to 35 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, 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 Hashimoto listening to all these
people who told him that fiscal policy is not working— you're putting so much
building bridges to nowhere roads to nowhere look economy is going absolutely
nowhere.
The IMF, the OECD, they all told him to cut budget deficit. 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, and I am 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.
Not unlike Roosevelt in 1937
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% and to bring this
thing down because damage was so large it took us 10 years.
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 so it's very
interesting to not look that
R.K
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 the usual balance sheet obsession world where private
sector is deleveraging, in trying to repair their balances, there should be no
borrowers.
Even if the bankers are willing to lend but in China there
were still borrowers, and those are the regional governments and provincial
governments.
People who don't think their balance sheet gets measured
That's right! And prior to November 2008 regional governments
always wanted to borrow more for their mega projects because these regional
governments are always competing with each other.
But central government was trying to say, no, you can't
borrow so much.
And the central government also told the banks not to lend
too much to the regional governments. But in November 2008, two months after
the Lehman collapse, the whole world was in shambles.
So, the central government says okay, you can lend to the regional
governments as well and there though the regional government so you can borrow
some money.
Massive funds went out of the Chinese banking system to the
regional governments. And of course regional governments spent that on their
mega projects. The money then flew into the private sector and we have a
massive housing bubble in China at the moment.
In Shanghai, ordinary condominiums cost nearly 1 million US
dollars, for people who are making so much less than the national average. 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’ve been working so hard for the millions for nothing?”
So, I think they clamp down on housing market. The bubble is
real, and we could see some blood in that industry or in that sector going
forward.
But they can always offset the huge negatives, from this
side by massive public spending on the other side, so that the total GDP should
be maintained, over some sort of growth. But we could see some areas of Shanghai
real estate, for example turning into non-performing loans or something worse.
Interviewer
Are you seeing rapid
wage growth in China?
There has been.
So they can become more affordable through increasing wages right?
Yes, they could also catch up with what happened to the
housing.
Thank you for coming and seeing us today
Welcome.
Interviewer
It's always good to catch up with you and we look forward to
seeing you at the Bretton Woods conference. Thank you very much
