Richard Koo: American Politicians Know Nothing About Balance Sheet Recessions…

In his latest note, Richard Koo of Nomura shreds US politicians for their lack of understanding regarding the current macroeconomic situation. In a few paragraphs he says Krugman, Summers, Obama and the entire Republican party have misunderstood the crisis and its necessary fix.  Of course, Koo is best known for the idea of the Balance Sheet Recession.  Here’s where he say virtually no one has understood the macroeconomic landscape and grades President Obama as a solid D for understanding:

Summers also unable to break out of “yang” mindset

Like Princeton Professor Paul Krugman, Mr. Summers had high expectations for the Fed’s monetary easing measures. But monetary accommodation has had a limited impact because the US economy is in a balance sheet recession, and the Fed has been unable to spark the kind of recovery they envisioned. That, in turn, led to more disappointments.

Although both Summers and Krugman have argued strongly for the need for fiscal stimulus, their inability to give up on
monetary accommodation suggests an inability to break away from the orthodox mindset that private-sector agents always seek to maximize profit.

All in all, I would rate the Obama administration a 6 (out of 10) on its understanding of balance sheet recessions today, compared with a 2 when Mr. Obama took office in 2009.

Republicans have zero understanding of balance sheet recessions

That said, the Obama administration has provided as much fiscal stimulus as it could and has kept the US economy out of a deflationary spiral.

The Romney camp, in contrast, appears to have almost no understanding of balance sheet recessions. The team’s policy prescriptions are based on the orthodox view that smaller government will spur private economic activity.

Paul Ryan, Mr. Romney’s running mate and a strong believer in fiscal consolidation and small government, is expected to have a large say on economic policy in the event the pair win the election. His statements are closely watched because Mr. Romney’s views seem to change so frequently, making it difficult to determine what he really believes, whereas Mr. Ryan has an extensive congressional record and his statements are consistent.


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Barak

    and what Koo dooesn’t say: the american public has even less understanding than the republicans, since a majority think romney has a better economic plan than obama. what surprises me is that there is such a heated debate over two candidates with a rather similar economic world view.

  • Johnny Evers

    OK, let’s put some meat on the bones. Specifically, what kind of fix is required.
    How big is the fix required? What amount of deficit spending is needed? And for how long?

  • BJM

    Romney is not stupid – he knows exactly what the BSR is, he just is not discussing it b/c you can’t get elected by outright stating we need 10% deficits for the next 3 to 5 years. He’ll slowly balance the budget over 8 to 10 years, and likely will do so primarily via growth…

  • JimG

    Why can’t someone get elected by saying “The debt and deficits are beneficial to the economy, not dangerous, and balancing the budget is not on my agenda”?

  • jaymaster

    So Koo is saying that a tax cut isn’t fiscal stimulus?

    That would go counter to MR and even MMT thinking, as I understand it.

  • whatisgoingon

    Cullen it always surprises me how people can not understand how things work and still survive. Here are three general groups that have a theory and all seem to do well in their own books – hyperinflationist gold bugs, bond loving deflationist and muddle through realists.

  • Barak

    i think the best example is bill Gross. he’s comments put him in the “debt is a danger” camp but he’s not trading his macroviews, but what he sees in front of him (and fron running the fed, which he does best).

  • Romeo Fayette

    As I understand it, Mr. Koo recommends public sector fiscal accomodation to offset the household fiscal consolidation that emerges in the wake of a balance sheet recession–based upon his observations of the Japanese lost decade(s).

    You’re right though, I’d appreciate specific remedies & solutions from Mr. Koo. Identifying the problem is one thing, prescribing a specific remedy is the more important thing. This is something that frustrates me about a lot of blogs & even the presidential elections. Anyone can be critical of that which hasn’t worked, but the real genius is the guy who has solutions. I’d love to read a white paper by Koo; I’d love to read white papers by Obama & Romney too: don’t spew vague, fuzzy math; put it in writing.

  • Trendless

    To disclose an understanding of the BSR is to forego a powerful election tool, namely that of whipping the public into a fear of indebting ourselves into becoming “like Greece.”

    Even if you give the politicians more credit than they deserve and assume they all know better, it’s much more advantageous for them to appear ignorant.

    Hey, if it plays in Peoria……

  • ES71

    I tend to agree with this. Anyone who tries to explain how money and banking really work will lose the election. Public cannot handle the truth.

  • Dave

    As I alway claim the govt intervention will just shift problems from the private economy to the govt. At the end of this shift is the taxpayer which has to pay. In contrast to some believe the govt can’t do anything for free. So it can’t fix the economy by spending without creating costs that have to be payed in some way (through inflation or taxes).
    Japan tries to jump start its economy since more then two decades with govt stimulus. The case is different to the US but it is a good example. Corporations are by now net savers and the govt is most indebted of all industrial countries. The shift happened but it didn’t help anything.
    Of course for many people this shift is considered a solution. I would argue against this believe.

    The only thing that would help the US is to boost liquidity by restructuring the debt. But this will be painful as well and govts prefer the long way where pain is stretched over years.

  • ES71

    > The Romney camp, in contrast, appears to have almost no understanding of balance sheet recessions. The team’s policy prescriptions are based on the orthodox view that smaller government will spur private economic activity.

    Where I have an issue with Obama’s policies is that he tries to provide fiscal stimulus to the 95% at the expense of the other 5%. And not only that, he also paints the top 5% as good for nothing stealers of wealth, which might be only true for a tiny sliver of that 5%. The reast are honest hardworking people. At some point , if you belong to the top 5% the self-preservation instinct kicks-in.

  • David

    I have never had a problem with government or gov stimulus for that matter. Stimulus is important right now to plug the gap, the problem with gov stimulus is they are such poor allocators of capital. Anybody who has ever worked on a government contract in construction or any other industry can attest to their poor execution. For every Moon Landing and DNA sequencing, great use of government funds, there are 10 bridges to nowhere. If your going to spend it, then spend it on something that will make society better.

  • ES71

    I honestly think govenment spending is big enough already. US standrd of living is very high. I don’t see why government needs to spend even more to keep it even higher, at the level of bubble years
    At this point, after 4-5 years the real issue really is lack of growth. There is no growth and we are stagnating. But I think it has more to do with US high costs of labor and extremly arcane tax code which bascially pushes jobs out of the US. Fiscal stimulus helps us to stay afloat but doesn’t solve structural issues.

  • BHB

    Read The Holy Grail of Macroeconomics by Koo. Excellent book! More details on how to get out of balance sheet recession.

  • SBG

    Which is a trip since Obama would land squarely into that 5%.

  • hangemhi

    Lots of people like to say “I think” this or that, but can’t or won’t back it up. I’m guessing either they don’t understand what Koo is saying, or what a “balance sheet recession” means.

    Since banks create money out of thin air an increase in private sector lending leads to economic booms – we had that in spades during the real estate bubbble. When they reduce their leverage money is destroyed and that leads to recession/deflation. We do indeed have the further problem of leaking money in our trade deficit. So if you add up the destroyed and the leaked money, it requires some other source of new money to keep the economy from collapse. Enter Gov deficits.

    IF you don’t “think” the above is true, then state why or how, because otherwise you’re just like everyone else who has an opinion based on nothing

  • El Viejo
  • hangemhi

    I keep hearing the “our taxes are going up” argument as the current, or inevitable, result of the debt. But taxes have not gone up, and aren’t going up, and have more or less done down in a straight line for 5 or 6 decades. This seems like just another non-factual fear mongerer statement that gets the know-nothings riled up.

    When the deficit and debt “get too high” it will mean the private sector will have “too much money” in which case we’ll be booming and then we can raise taxes. Or just keep tax rates the same and reap the increasing revenue from the expanding tax base, combined with lower automatic stabilizer spending (lower food stamp/welfare/UE benefit rolls, etc) and the deficit naturally shrinks.

  • jaymaster

    Well, that is kind of a bummer.

  • ES71

    I understand what balance sheet recession means. It means people are in debt and cannot borrow anymore to keep consuming and therefore there is no demand.
    My point was that we had a lot of stimulus over the last 4-5 years. Yet people barely deleveraged during that time. So obviously stimulus alone is not working. We also need something in addition to it. UNless we are prepared to keep this extraordinary level of stimulus for the next 50 years. And that was my point, we have to look at our structural issues which date all the way back into 80s and 90s. I don’t know why you get mad at me for stating the obvious by now. Stimulus alone is not enough. US tax structure and labor structure are arcane and uncompetitive. It is extremly hard to create a business here unless it is something completely virtual like financial serivces or some osrt of a web site. These types of businesses don’t employ many people , however. In short, we need to look at structural problems that inhibit our economic growth.

  • ES71

    Obama will be retired with his millions in Hawaii by then. What does he care?

  • Wantingtoretire

    It isn’t that the public cannot handle the truth. Its a difficult subject to convey simply because it’s not part of everyday language.

  • Johnny Evers

    The economy could not sustain itself even with massive deficit spending by the consumer and the banks and now is facing long-term deleveraging with the handicap of a low-growth economy.
    How then can we count on massive deficit spending by the government to sustain the economy?

  • krb


    Hangem, es71 has made legitimate points. Those of the view that we can just continue to “fake it” through more “stimulatory” largesse to the favored constituency of the day are no more serious than those they mock. krb

  • Mike Bell

    “and the entire Republic party”. I believe you meant Republican party.

    Here is the way I see it. We’ve tried one way. It hasn’t worked. Therefore, we should try a different way. And nobody should be so arrogant as to think they have “THE solution”. We don’t know unless we try. Theories must be put into practice – and then we can judge them by the results. Science.

    You can’t blame the average American for not understanding MMT etc. It is counter-intuitive. They view the country’s economics as if it’s just a much larger scale of their personal financial situation. It’s not their job to know. That’s one reason the USA has representative government. The average citizen is not an expert on most things. We elect politicians to hopefully (haha) represent us. To inform themselves and then make good decisions for society.

    I know Obama is clueless. But I wonder if Romney, given how smart and adaptable he is, wouldn’t be able to wrap his head around this stuff? Ryan is locked and loaded. Forget him. But Romney might surprise you in his flexibility. He is a solutions guy. He has a history of being dynamic. Some call that flip-flopping. Depends on the situation, I guess. But it can be a good quality to have when you start off with an erroneous assumption and need to correct your course or go in the other direction.

  • El Viejo

    Whada-U-Think? Would military credit unions be a safe haven in such a scenario? In dire scenarios like that FDIC SIPC and others will only pay out a % on the dollar. Even Social Security has a clause that says if the Trust Fund runs dry all recipients will take an automatic 25% cut in benifits.(I have not verified this)

  • Wantingtoretire

    In my walk of life it is exactly the same. People often do not understand how things work but that doesn’t stop them becoming prominent. I’m talking about engineering. Being “successful” in America is not about technical stuff its about making deals.

  • Dismayed

    “I honestly think govenment spending is big enough already. US standrd of living is very high”

    So the hell with the 22 million peolpe who are unemployed or under-employed? Ridiculous comment. We’re under-producing when millions sit idle instead of engaging in productive work. Look at the state of our roads, power grid, and water systems. There’s plenty of work to be done.

  • Dismayed

    A tax cut is more likely to go to debt repayment thn to consumption during a BSR. So, no, it doesn’t take the place of direct job creation.

  • Michael

    Sounds like you want to give Romney a chance the same way people wanted to give Obama a chance four years ago – based on “hope” and “change”. This is no way to run a country, and it is no way to vote.

  • El Viejo

    That was the psychological thinking behind the payroll tax cut as opposed to one lump sum rebate. (The lump sum goes to debt repayment while a little extra each month gets spent)

  • Wantingtoretire

    It is difficult to understand why you consider Obama to be clueless other than political rhetoric. Obama inherited Bush economics. These crippled America. Remember TARP was a Bush stop gap measure. America was so crippled when Obama took office that I think it is amazing that he managed to stabilize the situation. That is what he did stabilize the situation by spending money the government did not get directly from tax payers.

    The current deficit spending is in directly related to the mess that Bush economics created. There are many people who want to go back to that. These people have a vote. Isn’t that highly dangerous.

    The issue with Romney is that he is a complete unknown as far as this situation is concerned. He may take action which could further depress the American economy due to a misunderstanding of the situation. The household balance sheet recession has to play out. The consumer has to become viable again as a consumer.

  • Mikael Olsson

    “Paul Krugman [...] had high expectations for the Fed’s monetary easing measures.”

    I’m sorry but that’s just false. Krugman is on record on his blog saying several times that fiscal stimulus was needed – even critiquing the Obama administration for not doing enough. (well before election times, mind you, he is of course solidly Dem over GOP)

  • Mikael Olsson

    (He’s said it plenty more times, those were just 2 random links i googled)

  • Mikael Olsson

    A tax cut with unaffected spending is a stimulus. I’m pretty sure that’s not what Romney is suggesting.

  • Mikael Olsson

    Paying workers is about as good as it gets. The money isn’t destroyed, it is redistributed according to thousands of individual wills towards what they want in life.

  • Johnny Evers

    If we send a check for $10k to every man, woman and child in America, that would be $3.5 trillion. I think my math is right on that?
    What would that do for the economy? Would it create inflation?
    Sincerely curious here.
    Can we print money?

  • csodak

    The only stimulus that occured was bailing out the banks and the stock market. No stimulus for capital formation be it publicly or privately created. Little infrastructure spending.

    1) If I enherit x $’s I can either retire my current debt thus freeing up future consumption capacity or if I invest in a productive asset which generates net free cash flow I can invest this cash into future investments or spending.

    2) If I spend my inheritance receiving the services of those who work at a whore house I will 1) have no inheritance 2) increase my likelihood of contracting venereal disease.

    This country, indeed the EU and the US executed option 2.

    What remains is too much consumer and gov’t debt chasing to few consumers and taxpayers = deflation.

  • jaymaster

    I am not saying that I DON’T believe in temporarily increasing government spending. So you can take that discussion to another thread.

    But I have a hard time believing the claim that “a tax cut is more likely to go to debt repayment than consumption during a BSR”. In fact some tax cuts, like the 100% bonus depreciation write off, and possibly the elimination of the AMT, are arguably more likely to increase consumption, and even increase debt.

    And even if “tax cuts go to reduce debt first during a BSR”, well, how is that not a good thing? You can fix a broken balance sheet from either side, or ideally, from both.

  • ES71

    > So the hell with the 22 million peolpe who are unemployed or under-employed?. Look at the state of our roads, power grid, and water systems. There’s plenty of work to be done.

    And you are sure that these 22 mil are the exact match for building a power plant or a road? We have a skill mismatch in this country. Most people without jobs were doing jobs that were automated or lost in housing. These jobs are not going to come back. Housing will come back some but not in the full swing.
    Another big unemploytement category is young college graduates. They are not going to go into road building.
    We need to stop generalizing our issues and actually look into details if we want any kind of a solution. Analyze who is underemployed, why, can they retool? You cannot retool a former mortagage clerk into a power plant operator.

  • Mikael Olsson

    One single $10k check to everyone might distort things (depending on what people do with it – if they just pay off debts with it the answer is no)

    $10k spread out over a few years.. nah.

  • Tom Brown

    The scary part though is that politicians probably BELIEVE their understanding is superior to the public’s because they probably spend a lot of time listening to BS from financial service industry lobbyists, who’s job it is to simultaneously flatter and snow them.

  • Tom Brown

    So why not do an experiment somewhere. Pick a smaller dollar amount, and a smaller geographical region than the whole US. Also, we might want an age limit (on the low side).

    Economist Steve Keen has proposed EXACTLY that. He’s famous for advocating what he calls a “modern debt jubilee” but I thought exactly the same thing… that’s a BIG risk to take, and what about the inflation?

    In an interview Keen proposed doing a small scale experiment with this debt jubilee bit. I should say that Keen adds a provision to the “gift”… namely that the funds MUST be used to pay down debt, if the recipient is in debt.

    Thus the effect is debtors are probably just a little less in debt (or a lot less, depending on the size of the check) and savers are NOT punished: They just get cash!

    I think this could be done w/o upsetting the economy too much. The reason? Those funds used to pay off debt, do exactly that. They DO NOT start circulating in the economy themselves. If the checks are small enough, say your $10k, then almost EVERYONE will be required to use it to pay down their debt.

    Who gets hurt? Banks and bank investors (which include pension funds, etc.), because paying down debts directly reduces the size of their assets. But the damage may not be as bad as it seems since it probably also improves the quality of their balance sheets somewhat. If, for example, a husband and wife use their combined $20k to pay down their mortgage by that much, and their house was under water to begin with, then that may improve the bank’s balance sheet overall.

    And of course now the couple can use a bit more of their take home pay to pay for something other than interest to the bank.

    I think it may well be a good idea.

  • Tom Brown

    Also, that couple may be able to refinance their home at a competitive rate, whereas before the “jubilee” they couldn’t, so it could have a compounding effect.

    As someone who has investment properties that are under water, or close to it, I can tell you it’s awfully frustrating seeing rates so low, but knowing I can’t take advantage of them. I was able to refinance through a special offer from the lenders, but ONLY the bank holding the mortgage would offer it, and it was not a competitive rate: I still paid a premium compared with new loans.

  • jaymaster

    How is that different than a a tax cut,other than forcing debtors to pay off debt?

    But as others like to claim, they’ll do that with a tax cut anyway.

  • Tom Brown

    Good point… perhaps through the requirement that the money be used to pay down debts first. In other words, perhaps the gov could actually just check, and directly credit your highest rate debts FIRST and then send you whatever is left over.

  • Mikael Olsson

    A % tax cut is best for those with high income. A fixed sum benefits the economy at large the most – lower income people actually USE it. (Paying off loans leading to lower future interest payments is totally valid)

    Of course if you can figure out a tax cut that ends up being the same $ for everyone – yes, 100% the same. Deduction on federal taxes doesn’t work though, not everyone pays them.

  • Jason H

    Millions were/are in construction/real estate & huge part of the unemployed..

    Construction of power plants is related to that (as is constructing windmills, solar panels, dams, bridges, buildings,homes).. anyone including mortgage/finance people can be taught to be a power plant operator (engineers design but physical labor/constructon/operations is teachable/trainable)

    Right now the US has a shortage of medical personnel & power… it can hire/train all millions of unemployed as as nurses, respiratory therapists, x-ray techs, etc (1 to 2 yr vocational schools or 4 yr for some) to increase supply of medical personnel & decrease spiraling medical costs

    It can hire/train millions to construct hospitals, cliniics as well as power plants, oil drilling, build oil wells offshore, etc

    All via money creation

    BTW, this was already done under Eisenhower who doubled medical schools, hospitals, etc hmmm, I recall a ‘booming’ 1950s

  • Mikael Olsson

    Also you might want to check out Australia’s stimulus in 2009 and 2010. 2 rounds of $1000 straight into the bank accounts of the less-well-off.

  • MJJP

    I don’t think wages are too high if you factor in the higher quality of life we experience. Sure wages are lower in third world countries which don’t have running water, paved streets, benefits etc etc etc. We should not even try to compete unless we want to become like them. We should trade with them when they rise to our standards not the other way around.
    Another issue why I think the cost of labor is not the issue is the fact we have millions of people not working . As such they don’t or can’t play at the table. The millions of people that are unemployed and underemployed if given money to spend would stimulate the economy like nothing else.
    As far as the tax code being an issue the US was at its highest economically when the tax rates were much higher. In the old days when a business had profits and wanted to shield it from taxes it invested in the business by buying buildings, equipement and hiring. Today with our tax code if a business has a profit it just does what it wants to include spending it on vacations or putting it in the bank. Way too much money was taken out of the economy and continues to sit in very deep pockets. Finding a way for business to empty the pockets is the solution to the economic mess we find ourselves in.

  • Colin, S.Toe

    This site has done much to convey the basic relativity of ‘money’. Bringing the average debtor to zero, while increasing savers by the same amount would basically maintain the relative standing of households, although the devil might be in the details of how to get there.

    The IMF paper’s ‘Chicago Plan Revisited’ which includes sophisticated modeling, appears to be a way not only to get there, but stay there.

    Such a measure would mean radical change for the banking/financial sector, but it seems to me that the justification for its existence is to allocate credit efficiently to support productivity and innovation.

    I don’t understand how forcing households to go into debt (via credit/debt money creation by private banks) in order to meet basic needs (or worse, to acquire imported stuff they don’t need) contributes to this role.

  • Old Dog

    The most important things Koo doesn’t say is that Romney is both very smart, a realist and highly pragmatic.

    He is not an ideologue. Anyone who can succeed as a Republican governor of a liberal state like MA should not be painted into box. He picked Ryan for political reasons NOT to limit his options to govern.

    If the deficit needs to be tripled – Romney will do it.

  • Mikael Olsson

    That article… seems a bit confused on some topics. They threaten hyperinflation for club med for defaulting on loans? Well, Iceland is calling and wondering when it’s going to see that happen.