Richard Koo, chief economist of Nomura Research Institute, rose to prominence early last year with the publication of his fascinating book, Balance Sheet Recession. He has just been interviewed by the brilliant Kate Welling at Welling@Weeden. Although I have not yet set eyes on the interview, I am sure it is top class. However, Richard Russell (Dow Theory Letters) last week provided a taste of the discussion in his newsletter, some of which has been worked into this post.
Koo defines a balance sheet recession as one that emerges “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”.
According to Koo, American consumers are suffering from a balance sheet problem and will not increase consumption until their personal finances are back in order. The banks are not lending mainly because nobody wants to borrow and, furthermore, the banks want to build their own balance sheets (raise cash) and get rid of toxic garbage.
Koo says it’s up to the government to make up for the private sector’s problems by spending and continuing to run deficits. Thus we would be “buying time” through government spending while the private sector has time to repair its balance sheets. He claims it is absolutely necessary for the government to spend and run deficits. If the government cuts back on its spending and stimulus, the US economy will swoon and more money will be lost than was lost during 2008-2009.
Again, when asked what would happen if the government cuts back on its fiscal stimulus, Koo replies: “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.
“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.”
In summary, Koo’s message is that we will have an all-out recession if government spending and the budget deficits are cut back before consumers’ balance sheets have been restored and they start buying again. Does anybody still expect the economy to be coaxed back to recovery without pain?
