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.
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: