Economists and business commentators have always assumed that the majority of companies in any economy are forward looking and are trying to maximize profits. They never considered the possibility that a vast majority of companies may be placing their highest priorities on minimizing debt in order to repair their balance sheets.
Richard C. Koo
Wiley, John & Sons, Incorporated, May 2003
Synopsis
In this groundbreaking book, leading international economist, Richard Koo argues that far from being the sick man of Asia, Japan is suffering from a temporary but highly unusual economic aberration.
Economists and business commentators have always assumed that the majority of companies in any economy are forward looking and are trying to maximize profits. They never considered the possibility that a vast majority of companies may be placing their highest priorities on minimizing debt in order to repair their balance sheets. But that remote possibility has been the reality in Japan for the past decade, and more recently in many other countries including at least a part of the US.
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.
Richard Koo's experience in dealing with both the US banking crisis of the early 1980s and the Japanese balance sheet and banking problems of the last ten years makes him unique qualified to comment on this situation. He clearly explains how such a recession can happen in any economy following an asset price bubble, and how best to deal with it.
Foreign Affairs
The poor performance of the Japanese economy is troubling for Japanese and foreigners alike. Koo, an economist at the Nomura Research Institute, advances a clear, plausible explanation for Japan's lackluster performance since 1990: excessive corporate debt and the resulting preoccupation with paying down debt to improve corporate balance sheets and reluctance to borrow for new investment. In Koo's view, the correction of this imbalance still has time to run, so the Japanese government should relax regulation, particularly of land use and construction contracts, and end archaic practices that have prolonged the stagnation by stifling both investment and household consumption. Koo also offers illuminating discussion of aspects of the Japanese economy not often evident to nonresidents — such as how heavy weekend traffic combines with corporate pressure to give up paid vacation time to discourage the purchase of second homes.
Excerpts
Had there been no fiscal stimulus, the Japanese economy today would have contracted by 40-50%, if the U.S. experience during the 1930s is any guide.
Indeed, the policy worked so well for so long the the general public, including most commentators on the economy, never learned that the economy was on the verge of entering a dpression troughout this period.
After all, this economy needs a budget deficit of over 6%of GDP just to stay at 0% growth.
It is interesting to note that exactly 60 years earlier, President Frankloin D. Roosevelt made the same mistake that Prime Minister Hashimoto made in 1997. (...) Believing that the economy was well on its way to recovery, and that a budget deficit is a bad thing, Roosevelt made the mistake of trying to reduce the deificit for fiscal 1937. (...) Indeed, it took an enormous amount of time an energy to heal the wound for the second time, and the US economy did not begin its recovery in earnest until 1941, when the Japanese attack on Pearl Harbor and World War II pushed the US government to increase its spending several-fold.
...the household sectors is saving, but the corporate sector is not borrowing.
...during the early 1980s, Japanese companies were leveraged almost five-times as highly as their US counterparts.
In modern history, Japan is the only country that has not fallen into a depression despite a loss of ewalth greater than the loss experienced by the US during its Great Depression.
Losing this much wealth and maintaining zero growth is a remarkable achievement.
...it is not lower interest rates per se that improve the economy rather, it is the people's reaction to lower interest rates (that is, borrowing money to spend or saving less) that improves the economy.
If the bottleneck is on the demand side, no matter how well the supply problem is resolved, the economy will not recover unless the demand problem is resolved.
Of all the transmission mechanisms between the monetary authorities and the real economy, the role of the construction and real estate sector is the most important.
Contrary to the beliefs of monetarists, therefore, monetary policy is not only not almighty, but also heavily dependent on fiscal policy during a balance sheet recession.
Borrowers are behaving correctly. So are the lenders. Everyone is behaving appropriately. Yet, when this is all put together, it results in the fallacy of composition.
It is the yields on government bonds and the strength of private sector fund demand that send the signals as to whether the fiscal stimulus should be increased or decreased.
War overcomes balance sheet recession (...) because it forces government to resond to the existential threat by placing huge orders for military wares with very strict delivery times.
For without asset prices stabilizing people cannot plan ahead.
No one noticed that Keynesian policies are really only meant for balance sheet recessions.
