Balance Sheet Recession - Richard Koo

[txlaw]

[amazonsearch]Balance Sheet Recession[/amazonsearch]

 

Explains Koo's concept of a balance sheet recession and how he believes that Japan's lost decade essentially represented the avoidance of a monumental depression in Japan, especially given the peak to trough decline in Japanese real estate asset prices of about 85%.

 

Parts of the book that are fascinating:

 

-His discussion about how his view is different from Irving Fisher and Keynes.  With respect to Keynes, for example, he disagrees against using fiscal policy as way to "stimulate" the economy except when there is a balance sheet recession, which is a rare occurrence.  In normal times, Koo believes that there is a crowding out effect, which means that fiscal policy shouldn't generally be used.  He also talks about why he thinks monetary policy doesn't work during balance sheet recession times, though he may have changed that view with respect to recapitalizing the banking sector after our most recent financial crisis.

 

-His detailing of the steps that the Fed and other US policymakers took during the Latin American debt crisis, which never blew up into a crisis of the same magnitude as this financial crisis, partly because of the heroic policy directives of Paul Volcker.  Extend and pretend today is explained by this.

 

-His take on the Asian currency crisis that resulted from unchecked capital flows from Western investors who hadn't done due diligence prior to piling into the Asian tiger economies.  The resulting balance sheet recessions were devastating on those economies, but they recovered because of the collapse in their currencies.  He quotes Lee Kuan Yew in a couple of circumstances, who admonished the West for failing to warn Asian countries about the problems with relaxing capital flows prior to making structural reforms, while scolding those same countries after shit hit the fan.  Explains why Brazil, China, and India are wary today about completely opening up the borders to foreign capital right now because they don't want dumb money flowing in.  Also explains why the Chinese are very hesitant to cede control of the yuan-dollar peg.

 

-Koo also talks about how he believed the bursting of the Internet bubble put the US into a balance sheet recession.  Interestingly, his take on that bubble was similar to Jeremy Grantham, in that Koo seemed to believe that the bursting of the Internet bubble would start the deleveraging process (which it did not).  Koo also talks about how Chairman Greenspan was really worried about cataclysm occurring and so supported the Bush tax cuts, advocated for stimulus, and kept interest rates very, very low.  Greenspan was aware that real estate was the only asset class that was not tanking after the bubble burst and that was the most interest rate sensitive asset class, so Greenspan specifically kept interest rates low to offset the destruction in capital markets wealth with real property wealth.  Koo actually warns that this potentially was creating a bubble in real estate.  Just like he warned recently that QE has possibly created an asset bubble in commodities and emerging market stocks.

[Edit: added another part in Koo's book that I remembered after reading a post in another thread about Greenspan.]

 

All in all, an excellent book.  The type that people who are interest in macro should have on their shelves.

[PlanMaestro]

http://marketmonetarist.com/2013/05/25/two-cheers-for-higher-japanese-bond-yields-in-the-spirit-of-milton-friedman/

http://marketmonetarist.com/2013/05/27/a-few-words-that-would-help-kuroda-hit-his-target/