Monday, April 19, 2010

Possibly The Best Economist In Asia

Get this book and almost overnight you will find yourself a whole lot smarter about macroeconomics. Richard is highly logical and writes in a careful train of thought which allows the reader to follow his arguments, points and case building. He makes economics understandable, he is highly persuasive. I was at Nomura Securities back in the late 80s while he was at Nomura Research Institute (he joined in 1984), and even then he was already highly respected by everyone at Nomura. Till today, he is still at NRI. I am sure he could have gone anywhere if he wanted to but NRI allowed him a lot of room to do what he does best. He had been a significant advisor to the last 2 prime ministers on ways to get Japan moving again - he also elaborated why the understanding is there but the political will and vested interests made it hard for the then prime ministers to push things through (sounds familiar?!).

p/s I know many Malaysian readers reading will be wondering if Richard Koo is a Malaysian (aghast...another brain drain!!!) ... well, Richard is an American born in the US to Chinese immigrants to that country. Despite working in Japan for over 27 years, he is still an American citizen.

Koo believes that Japan's "great recession" of 1991-2005 contains useful lessons for interpreting and dealing with the subprime mortgage crisis in the United States and with the burst financial bubbles in China and Europe. His book reviews the key characteristics and policy developments of Japan during this troubled period, arguing that Japan suffered from a balance-sheet recession, during which firms struggle to repair their impaired balance sheets and are therefore reluctant to take on new business, even promising business, if that will delay improvement. Under these circumstances, economies respond very differently to new shocks, new opportunities, and new policies from how they would in normal recessions. In particular, monetary policy is much less effective, since demand for new loans is weak. Fiscal action, even including the injection of new capital into banks, is necessary to avoid prolonged Japanese-style stagnation. Not all readers will agree with all its analysis and conclusions, but this book is stimulating and thought provoking.


Chief Economist, Nomura Research Institute

Richard C. Koo joined Nomura in 1984 and is now the Chief Economist of Nomura Research Institute, the research arm of Nomura Securities.

Prior to that, he was an economist with the Federal Reserve Bank of New York (1981-84) and a Doctoral Fellow of the Board of Governors of the Federal Reserve System (1979-81).

Consistently voted as one of the most reliable economists by Japanese capital and financial market participants for nearly a decade, he has also advised successive prime ministers on how best to deal with Japan's economic and banking problems.

Mr Koo is the first non-Japanese to participate in the making of Japan’s 5-year economic plan and the only non-Japanese member of the Defence Strategy Study Conference of the Japan Defence Agency.

Author of four books on the Japanese economy, he recently released a book titled “Balance Sheet Recession – Japan’s Struggle with Uncharted Economics and its Global Implications”. He is also a columnist with the BusinessWeek Online.

He was awarded the Abramson Award by the National Association of Business Economics, Washington, D.C. for 2001. He is also a columnist with the BusinessWeek Online and the only non–Japanese member of the Defense Strategy Study Conference of the Japan Ministry.

Mr Koo holds BAs in Political Science and Economics from the University of California at Berkeley (1976), and MA in Economics from Johns Hopkins University (1979). Since 1998, Mr Koo has been a visiting professor at prestigious Waseda University in Tokyo.


Many experts have been claiming that they know why Japan had to go through its 15 years recession from 1991-2005, even the last couple of years saw only a mild pick up in economic activity. Many blamed the banks for not doing anything with bad debts. Richard's thesis was Japan had a balance sheet recession. He argued that bank lending was still ample, even as foreign banks were allowed to operate in Japan in 1997, there was no noticeable rise in borrowing. Richard saw the enormous wealth destruction affecting many listed companies. Over the past 22 years, real estate prices have lost almost 87% from its high to its low (2003) while a more candid example was the price of golf memberships which has plunged some 93% from its high.

The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession

When corporate Japan faced the 90s recession, they found their liabilities suddenly overtaking their assets by a big margin as the asset values have been knocked down enormously, including share prices. What was strange was that most Japanese products were still in good demand as they made superior and quality products which were still in demand overseas, but Japan's domestic demand shriveled up owing to the drastic wealth destruction effects on a personal level for every Japanese.

Here is why Japan's economy was in recession for 15 years - the Japanese corporates still made money from their products but most of the positive cashflow was used to pay down debt in order to narrow the assets-liabilities gap. Hence corporate borrowing took a nosedive in those 15 years, none was borrowing, everyone was repairing their holes in their balance sheet.

I would take that one step further in saying that these actions literally sucked the velocity of money out of the economy. The saying that $1 is worth about $8 in the real economy as money circulates, now imagine taking out billions year in year out, money just stopped moving. The housewives (who generally control the household finances) continued to save religiously, again sucking the velocity out of money in the system.

Thus the many stimulus projects implemented by various Japanese governments over the past 20 years, most in capital expenditure, failed to lift economy out of a recession - they did not get the Japanese people or the corporates to spend. Japanese corporates continued to hoard cash and paid down debts, and at the same time pulled back on research and capital expenditure.

That was also why in the 90s many Japanese companies began setting up offices overseas in a big way as much of the demand for their products came from overseas and not Japan anymore.

We all must read Koo's book The Holy Grail of Macroeconomics because we would be so much better off to know what type of macro policies to implement and which not to. There is also a need to place more emphasis to "engineer" consumer behaviour, consumer expectations, and how to force a speedy resolution to NPLs at corporate levels and personal levels. Get the updated version which includes Koo's analysis on the effectiveness of how the US/Fed has been in dealing with the subprime crisis.

Balance Sheet Recession argues that contrary to popular belief, it is this massive shift in corporate behavior, instead of structural problems, that is the root cause of both the deflation and the non-performing loan problems that have troubled Japan for so long. It argues that when the causality runs from the corporate balance sheet problems to deflation and banking problems, a highly unconventional policy response is needed to stabilize the economy. After all, the last time anything similar has happened was the 1930s in the US.

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 U.S. 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?

There will probably never be a last word on the Japanese financial catastrophe of the 1990s but Richard Koo′s book may be the most significant analysis ever published. Agree or disagree, any analyst of the current United States situation must consider Koo′s arguments. – Lawrence H. Summers

Richard Koo does it again. By presenting a unique theory regarding the great Depression and Japan′s recession of the last 15 years. Koo offers a new understanding of current problems in the U.S. and other economies. With many pearls of analytical wisdom, The Holy Grail of Macroeconomics: Lessons from Japan′s great recession is a must–read for economist, policymakers and individual investors alike. – Nobuyuki Idei

His power point presentation just prior to the subprime crisis at ACI World Congress:


easystar said...

Hi SD,

Richard is spot on on the reason of this reason - balance sheet under water.

Don't agree with his solution as the counter research shows that money spent by government has < 1 multiplier - yes, it get spent and then stucked, and at the same time crowded out the same 1 yen that the private sector could borrow and spend.

Further, citizens expecting higher tax bill, living expenses (due to weak currencies), will save even more.

The balance sheet of the private household needs to be sorted. This can either be done via the extremely painful and politically unacceptable Austrian way, or the slow death version the Jap are going through.

walla said...

SmokingGun said...


i think crowding out effect is only evident in normal times and not when confidence is shattered to its extreme... like what the recent US financial meltdown has demonstrated.. if there wasnt any help from govt, financial armaggeddon was to have ensued.

In times like this, governments NEED to take bold and active fiscal steps and not just fiddle with monetary policies like what the Japs essentially did.

The TARP and more closely the Malaysian example of Danaharta are good examples.. during those times, the least of your list of worries about is crowding out private sector investments.. cos no one in the private sector is even contemplating borrowings!

easystar said...


Thank you for your reply.

It is correct that crowding out during the TARP time was not really a concern. However, that has now past and going forward, no private sector investment = no growth.

Malaysia is different cos Malaysian government (used to anyway) get its money from Petronas et all rather than direct taxation. In the West, any deficit spending means delayed taxation and some people will adjust accordingly for the 'bad time' and business will plan accordingly against anticipated future taxation.

yauwenchin said...

wonderful analysis. it would be great if we have Richard Koo does a piece on Malaysia economics, perhaps Sali can consider the vacancy and write about the Holy Grail of Malaysia NEM, Not Enough Money scheme.

SmokingGun said...

Thanks Dali

Jeremiah said...

My feedback to Mr Koo's well written albeit repetitive book:

There is a huge difference between the corporate balance sheet recession of Japan and the recent consumer balance sheet recession of the US.

When the government steps in to spend money on infrastructure, it will encourage businesses to repair their balance sheets and eventually expand their investments and borrow more from the banks. But in the US case, consumers will not be induced to borrow more even if the government raises spending. There are simply no new jobs created by the private sector.

The only solution is for the US economy to restructure itself to become more investment-driven rather than consumer-driven. A technological breakthrough is the catalyst for the former.

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