When confronted with a balance sheet recession the math regarding economic growth gets relatively simple – either the government spends in times of below trend private sector spending or the economy contracts. For several years now I have maintained that we are in a balance sheet recession – an unusual recession caused by excessive private sector debt. Although this balance sheet recession created the risk of prolonged weakness I have been quick to dismiss the persistent discussions that compare this to anything close to a second great depression - as I showed in 2009 the comparisons were always ridiculous. The much closer precedent was Japan, where the economy actually expanded throughout their balance sheet recession, but a persistent malaise left a dark cloud over the private sector as they paid down debts.
Over the last year I have consistently expressed concerns that the USA was going to suffer the same fate as Japan, which consistently scared itself into recession due to austerity measures. At the time, most pundits were comparing us to Greece and attempting to scare us into thinking that the USA was bankrupt, on the verge of hyperinflation and general doom. I wrote several negative articles in 2009 & 2010 berating public officials who said the USA was going bankrupt and that the deficit was at risk of quickly turning us into Greece, Weimar or Zimbabwe. Nothing could have been farther from the truth. The inflationists, defaultistas and other fear mongerers have been wrong in nearly every aspect of their arguments about the US economy.
US government default was never on the table, the bond vigilantes were not just taking a nap and now, with the passage of the most recent stimulus bill it’s likely that we’ve (at least temporarily) sidestepped the economic decline that was likely to accompany a decline in government spending. Richard Koo, however, believes we are repeating the mistakes of our past. In a recent strategy note he said:
“The situation in Europe is no different from that in the US. I therefore have to conclude that the western nations have learned nothing from Japan's lessons and are likely to repeat its mistakes.”
I have to disagree here. The most important factor impacting economic growth in the prior year was the USA’s ability to avoid talking ourselves into austerity measures. Unlike Japan in the 90′s, we have not convinced ourselves that recovery was here before it was truly sustainable. This was the single most important contributing factor to Japan’s rolling lost decades. They suffered from a persistent economic malaise as the government withdrew aid just as the private sector appeared to be gaining some traction. And every time this occurred the economy sunk back into recession. Thus far, the USA has avoided this trap.
Mr. Koo is unhappy with the passage of tax cuts, which he believes, will prove far less impactful in boosting the economy. He also compares the USA to Europe, which I currently believe is inaccurate. With regards to the tax cuts, the key during a balance sheet recession is paying down debt – not propping up the economy via government programs. Whether this debt repayment is done through unemployment insurance, jobs programs or tax cuts is relatively semantic. The end goal should always be the same – to fix the balance sheets. I think the recent tax proposal is an adequate policy response given the current state of the US Congress. It’s not nearly as large as the USA needs and it’s not nearly as well targeted as it needed to be, however, it’s one of several things I have asked for in recent years so it would be entirely unreasonable to sit here and stubbornly say that it is a waste just because it’s not exactly what I wanted. Speaking of being reasonable, it is only fair that I admit that several of my pleas have come to fruition in recent months:
That’s 3 for 3 in terms of several of my big picture requests – not ideal, but it’s not as bad as it could be. I think things could be far worse than Mr. Koo makes them out to be. As for Koo’s concerns that we have not learned from the lesson of Japan and are increasingly comparable to Europe – I think that’s a bit off the mark. Europe is forcing widespread austerity on the periphery nations and the UK has willingly implemented austerity measures. This is far different from what the USA is doing. The recent tax proposal all but guarantees that true austerity is not in the near future in the USA. His argument regarding Europe’s response is exactly right, however:
“In Europe, unfortunately, both governments and the private sector seem to be focused exclusively on fiscal consolidation. Particularly for the orthodox individuals in charge of the ECB, the EU and the OECD (by "orthodox" I mean they do not understand the mechanisms of a balance sheet recession), fiscal rectitude has become the "only game in town." They are oblivious to the fact that austerity is a fundamental policy mistake during a balance sheet recession.”
Austerity in periphery nations will continue to drag these countries into economic depression and create extreme risks for the global economy. The lack of austerity in the USA has been soundly backed by recent data trends in the USA. The most notable improvements have been consistent strength in regional manufacturing data & the ISM data. If we look purely at a comparison of ISM Manufacturing with GDP the current levels are consistent with historical GDP growth of just under 4%. This is still largely government/inventory driven, however, it’s a continuing positive development for a country facing economic headwinds.
The ISM data can be particularly volatile and recent leading indicators have shown some marginal warning signs. It would not be surprising to see some moderation in the ISM data in the coming quarters and GDP growth that is below trend. While all of this is fairly good news we are not quite out of the woods yet.
The bad news is, we are Japan, but the good news is we are Japan on “fast forward”. As I described in mid-2009 everything in the USA’s balance sheet recession appears to be occurring much more quickly than it occurred in Japan. So, the good news is that we won’t need government aid as long as the Japanese needed it. In the meantime we must remember that stimulus is not self sustaining recovery. Ultimately, the USA will not be out of the woods until the private sector begins to meaningfully expand, contribute to closing the output gap and help reduce the 9.8% unemployment rate. Based on many macro trends I have said this could be occur as early as 2012, however, any number of exogenous risks could set us back by months or years. Thus far, there are some relatively positive signs coming from the private sector, however, we are still a long ways from sustained private sector recovery.
For now an accommodative Fed, a $1.3T deficit, a general lack of austerity and a tepid private sector recovery is likely enough to sustain economic growth, but not enough to meaningfully close the output gap. This all continues to point to a period of very high unemployment, tepid economic growth and a recovery that feels like a recession. As I said in early 2010 we might be in a technical recovery, but it still very much feels like a recession with a 9.8% unemployment rate. The good news is we’re not talking ourselves off the edge of the cliff. The bad news is the recovery remains tepid and highly susceptible to exogenous risks.
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I could just puke. I can’t say I disagree with the assessment but it’s like being happy over receiving a D instead of a D-.
I know, it’s sad that we have come to be so bullish about an environment in which we have near double double digit unemployment. Talk about low expectations.
Your phrase,”given the current state of the US Congress”, aims at the most potent factor in limiting our proper response. Please tell us your thoughts on where the new Congress is likely to act and the consequences of such acts.
Great post TPC. It would be nice if all Americans read this and understood it, but of course we all know there may be .1% that does understand it.
I’m not sure we will ever get back to full employment in this country. There is just not the need for labor like there used to be. Technology and cheaper overseas labor will continue to put pressure on the jobs market. In the past, there has always been an industry that picks up the unemployment slack. Now, I have a hard time seeing where the growth will come from.
What I expect we will see is a similar economy to what you predict. But what I think we will see in the years ahead is the inflation that we have historically exported overseas will turn full circle and begin to be imported as the emerging world gets stronger and stronger. It will be interesting to see how the bottom 90% of our country gets by when everything costs more and wages stay stagnant. Again, this leads to a slow moving economy just like you predict.
this is why you remain one of the top 5 guys to listen to…..and your short timing, when i can find it…..guess i’m gonna have to do twitter.
Yes, we are Japan on fast forward. What I do not understand is why you are call it “good news”. We still have not seen the final outcome of Japan situation, and it, i would say, is quite debatable. If you believe it will not be catastrophic, please, provide your rationale.
In 2009 Debt to GDP was at 350% in the US; it’s higher now. To say that we have avoided a Japan situation is premature to say the least. The Fed’s solution to this is the same approach tried during the 1930′s, monetary debasement. One can argue that without a gold standard, Bernanke will be far more successful this time around than his depression counterpart. Monetary contraction in the form of money velocity shrinkage is still strong, and despite the flow of QE going to commodity speculation, the demand is beginning to tank again. I know it, my commodity based small business is still down 18% FROM the 2007 peak. For people like me holding business debt, the future is very bleak indeed, even with my debt ratio (180% to cash flow) being far less than the precipitous national number. Small business will not lead this ‘recovery’ that’s the main problem.
I think it’s wrong to focus on the govt debt issues. This isn’t a govt debt problem. It’s a pvt sector debt problem. The govt intervention will leave behind a nasty trail of moral hazard, remorse and malinvestment. The imbalances continue which is why we can likely look forward to the next big crisis in coming 5-10 years. We’ll all look back and talk about this last crisis like it was a separate event, but it won’t really be….So in short, enjoy the economic strength. The recession is technically over, but it’s aftermath will be felt for years.
This is were I get cofused, after reading this over at the mises institue:
“Between 1992 and 1995, Japan tried six spending programs totaling 65.5 trillion yen and cut income tax rates during 1994. In January 1998, Japan temporarily cut taxes again by 2 trillion yen. Then, in April of that year, the government unveiled a fiscal stimulus package worth more than 16.7 trillion yen, almost half of which was for public works. Again, in November 1998, another fiscal stimulus package worth 23.9 trillion yen was announced. A year later (November 1999), yet another fiscal stimulus package of 18 trillion yen was tried. Finally, in October 2000, Japan announced yet another fiscal stimulus package of 11 trillion yen. Overall during the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession. What the spending programs have done, however, is put Japan’s government in poor fiscal shape. The “on-budget” government spending has caused public debt to exceed 100 percent of GDP (highest in the G7), and even more debt is apparent when the “off-budget” sector is included.” http://mises.org/daily/1099
So if it Govt spending and lower taxes were not an imidiate elixer for Japan, why should it be one for us?
Americans are exceptional? :p
As Koo suggests, their balance sheet recession is only just ending. It took their pvt sector this long to pay down debts. And that’s in large part due to the fact that they had simultaneous twin bubbles. The price declines were also worse. I still expect RE to fall in the USA, but I would be surprised if prices fell more than 15-20% more. Our problem is at the consumer level and while the problem looks bad it’s become more manageable. De-leveraging will continue for years in all likelihood. But that doesn’t necessarily mean we’re facing another lost decade. Don’t get me wrong, I still think there are big risks out there….
“This time is different” /s
The problem is the debt level. Neither the tax cuts nor the stimulus will help much. Austerity will make it worse. Currency debasement and inflation are helpful since they do reduce the debt burden.
The only positive example is Iceland. They defaulted (reduced debt burden) and are out of the woods. Ireland and Greece on the other hand are way worse.
It is not a matter of coming up with path or solution. The answers are there, but the will to implement them is not.
poke, you have to understand they withstood the popping of a credit bubble in which writedowns were on the order of 3x GDP — larger than the american great depression — without suffering the debilitating sustained spiraling loss of income that has been the hallmark of every similarly-scaled bust in the historical record that i’m aware of. that was and is the major achievement of government deficit expansion in japan.
i don’t think anyone at mises.org really understands what happened in japan, and really couldn’t given their dogma.
Hey congrats on picking the #2 word of the year…pragmatic.
Here’s the killer tho…number one is austerity!
http://www.merriam-webster.com/info/10words.htm
Happy Holidays, thanks for an excellent site!
“[Koo] also compares the USA to Europe, which I currently believe is inaccurate. ”
In a way you may say he is correct. The US government can print and devalue the USD, but so can the ECB, right?
The US states can receive help from the government, same is true for the EU sovereign nations.
What I mean is it is all a matter of political will. If the US government stops supporting the states they will … cut spending, raise revenues (taxes) until they fix up the mess or default. Same as in Europe.
If there is political will in Europe to help the struggling nations and devalue the euro, the situation will be no different than in the US.
Yes, but he is implying that the USA is repeating the mistakes of Japan, and while he may not be satisfied with the type of spending, this is far from austerity.
Spending equals income, but income does not equal spending.
Tax cuts do not equal spending. It is a fact.
Does a tax cut help alleviate balance sheet pressures?
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