UNDERSTANDING THE GREAT RECESSION BY RICHARD KOO
6 November 2009 by Cullen Roche
5 Comments
This is a must listen presentation here by Richard Koo. He describes the similarities between the Japanese de-leveraging and the current de-leveraging cycle in the U.S. Readers can find some of my work on Koo and de-leveraging here & here. (Thanks to reader DanH for sending this our way).
Source: CSIS
Long but EXCELLENT presentation. Some of my takeaways:
+ Government must be the borrower and spender of last resort when everyone else pulls back.
+ Premature withdraw of fiscal stimulus before consumer/bank balance sheets are repaired (many years) will tank the economy, raising the cost and duration of the crisis.
+ Interest rates will stay low for a long time.
+ Don’t worry about who will buy the government’s bonds, the banks have no good borrowers and will be the buyers.
+ The amount the government needs to borrow and spend to keep GDP from contracting is the amount of debt paid down or saved elsewhere in the economy; this is the source of government funding.
+ Paradoxically, the best kind of spending is wasteful (e.g. military) spending, as it does not produces assets which compete with existing assets and further impair existing balance sheets. It worked for Hitler and Roosevelt.
Investment implications were not mentioned. One is apparent (if he is right) –T bonds are a buy on a rise in rates as we would probably see 10 year notes at japanese rates, 1-2%.
I think things are going to be grim for a lot longer than most people can possibly imagine.
It’s a really spectacular presentation. My problem with Koo’s response to the crisis (spend spend spend) is twofold:
1) how long can we continue to devalue the dollar?
&
2) It goes against common sense that you can spend your way out of a debt crisis.
My solution? Downsize the banking sector and reduce their influence while also de-leveraging the private sector and public sector. The consumer and government de-leveraging has to and WILL occur no matter what at some point. In the meantime, we must crush the banks that have helped cause this mess. They must be downsized, their power must be reduced and their debts must be extinguished. I fear we have added several years to the crisis by trying to spend our way out of this mess.
The banking system just got “reduced” by 10 more failures Friday, with the good assets being cherry picked by another bank, and the bad being taken up by the tax payer. I know that this isn’t what you meant, and I hope Congress has the cojones to go after the biggies, but I wouldn’t hold my breath.
I agree with what you say, TPC.
I think another good investment class for the rough times ahead is dividend paying stocks with rising dividends and bullet proof balance sheets. Example: ADP, which has no debt and a 3.1% yield. Hedge funder Bill Ackman has this one right.
This was Awsome!
I have been reading Steve Keen’s work (highly recommended: debtwatch.com), and this filled in some blanks.
Keen made it clear how “balance sheet” recessions operate. Keen just calls it debt deflation.
So when nobody want to borrow, and is actually paying down debt as fast as possible, and the banks can’t and don’t want to lend, the government can step in a be the borrower of last resort. This keeps the money supply high enough to keep GDP from being cut-off due to a lack of money.
Debtors are paying down debt, which reduces the money supply, wihich was just debt floated by the banks in the first place. The banks are getting all this money back, but can’t lend it to anybody, so it just sits there. So the government borrows it, and puts it back into the economy, which pays wages etc and allows some people to continue paying their debts instead of defaulting.
Eventually, the debts are paid down to a tolerable level, and businesses can begin to grow and consumers can begin to spend. GDP takes a nice jump upward, and the government can take 30 years to pay the moeny back (with a little inflation thrown in to ease the burden).
However, we see that this situation depends on certain money flows not getting out of hand. The asset bubble that created this mess is shrinking which causes defaults. But the asset bubble allowed the money supply to get too big in the first place, so defaults reduce it to a more balanced level? The ideal situation might occur when the government borrows just the debt that is being repaid, while defaults further reduce the moeny supply becasue it was too big. In the end the money supply shrinks to a level supported by people paying back their loans.
Obvisouly, if defaults are too many or come too fast, the banks won’t have any money to lend for stimulus, and this strategy doesn’t work.
So when the economy gets going again, at reduced asset prices, the money supply is about right, so no big shock of inflation occurs, which happens when a bloated money supply comes into contact with reduced asset prices.