Richard Koo Explains It's Not The Fed, Stupid; It's The Fiscal Cliff!
While Koo-nesianism is only one ideological branch removed from Keynesianism, Nomura's Richard Koo's diagnosis of the crisis the advanced economies of the world faces has been spot on. We have discussed the concept of the balance sheet recession many times and this three-and-a-half minute clip from Bloomberg TV provides the most succinct explanation of not just how we got here but why the Fed is now impotent (which may come as a surprise to those buying stocks) and why it is the fiscal cliff that everyone should be worried about. As Koo notes, the US "is beginning to look more like Japan... going through the same process that Japan went through 15 years earlier." The Japanese experience made it clear that when the private sector is minimizing debt (or deleveraging) with very low interest rates, there is little that monetary policy can do.The government cannot tell the private sector don't repay your balance sheets
because private sector must repair its balance sheets. In Koo's words: "the only thing the
government can do is to spend the money that the private sector has saved and put that
back into the income stream" - which (rightly or wrongly) places the US economy in the hands of the US Congress (and makes the Fed irrelevant).
DEIRDRE BOLTON, BLOOMBERG NEWS ANCHOR: Based on the data points, the economic data points we've got in the past month, how likely is it that the U.S. is heading towards a lost decade? Is it more or less likely than what you told us about four to six months ago?
RICHARD KOO, CHIEF ECONOMIST, NOMURA RESEARCH INSTITUTE: Well, it is beginning to look more like Japan. The amount of house price declines, the commercial real estate price declines there, all following the Japanese pattern very precisely and very slow GDP growth, even with all this monetary easing, QE2, possibly QE3.
So yes, to me, the United States is going through the same process of what I call balance sheet recession, that Japan went through 15 years earlier.
BOLTON: You mentioned the possibility of QE3. What should Ben Bernanke do today in his speech and then what should he do as a follow-up action?
KOO: Well, actually, the Japanese experience told us that when private sector is minimizing debt or deleveraging with very low interest rates, there's very little monetary policy can do.
In fact, Chairman Bernanke has been saying, since the middle of last year that this is no time to cut budget deficit. The fiscal stimulus should be in place because I think he also understands that under the circumstances, there's so little that monetary policy can do.
But there's a lot the fiscal policy can do to keep the U.S. economy from losing its bottom.
BOLTON: Richard, how.
KOO: And so I think he should continue to push that line. Yes?
BOLTON: Continue to push that line and maybe try to subtly encourage Washington to take a little bit more control. Sounds like you think that Congress should do something.
KOO: Yes, because when people are deleveraging even with zero interest rates, that means they are very sick. The private sector is very sick and in need of help because their balance sheets are under water.
And then that's the case, even if Federal Reserve lowers interest rates, puts liquidity into the market, the private sector cannot really respond because they have balance sheet problems.
And the government cannot tell the private sector don't repay your balance sheets because private sector must repair its balance sheets. So the only thing the government can do is to spend the money that private sector has saved and put that back into the income stream.
And that, I think is what the U.S. has to do. And that means this is no time to cut budget deficit. You have to maintain the fiscal stimulus until private sector is healthy enough to start borrowing and spending money again.
And at that point, Federal Reserve will become all very irrelevant. But at the moment, I think the control of the U.S. economy is really in the hands of Congress.
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