This page has been archived and commenting is disabled.
Richard Koo On Why Europe's Austerity Will Cause Deflationary Spiral
While not new to our thoughts, Richard Koo, Nomura's Balance Sheet Recession guru, has penned a lengthy but complete treatise on why governments need to borrow and spend now or the world faces a deflationary spiral. The Real-World Economics Review posting makes it clear how his balance sheet recessionary perspective of the deleveraging and ZIRP trap we now live in means bigger and more Keynesian efforts are needed to pull ourselves out of the hole. While we agree wholeheartedly with his diagnosis of the problem, his belief in the solution...
At such times and at such times only, the government must borrow and spend the private sector’s excess savings, not only because monetary policy is impotent at such times but also because the government cannot tell the private sector not to repair its balance sheet.
...is flawed in so much as the size and scale of additional government borrowing at this time of smaller and more risk averse balance sheets leaves the governments (of currency issuers and users alike) more anxious of bond vigilantes than ever before. Furthermore, the impact of a much-bigger-than-previously-believed shadow banking system deleveraging and de-hypothecating and the historical precedents now engraved in manager's minds leaves them thinking 'fool me once...'. His discussion of the cause and cure of the deflationary abyss we now stare into is useful for completeness but his thoughts on the political difficulties of such a borrow-and-spend solution and the 'when to exit this solution phase' is noteworthy in its timing (and cyclical perspective):
There will be plenty of time to pay down the accumulated public debt because the next balance sheet recession of this magnitude is likely to be generations away, given that those who learned a bitter lesson in the present episode will not make the same mistake again. The next bubble and balance sheet recession of this magnitude will happen only after we are no longer here to remember them.
He warns that perceptions of the recovery from the Lehman shock is NOT recovery from the balance sheet recession and has an interestingly xenophobic approach to solving Europe's problems.
In case you have not heard of balance sheet recessions before:
The key difference between an ordinary recession and one that can produce a lost decade is that in the latter, a large portion of the private sector is actually minimizing debt instead of maximizing profits following the bursting of a nation-wide asset price bubble. When a debt-financed bubble bursts, asset prices collapse while liabilities remain, leaving millions of private sector balance sheets underwater. In order to regain their financial health and credit ratings, households and businesses are forced to repair their balance sheets by increasing savings or paying down debt. This act of deleveraging reduces aggregate demand and throws the economy into a very special type of recession.
which inevitably leads to:
More importantly, when the private sector deleverages in spite of zero interest rates, the economy enters a deflationary spiral because, in the absence of people borrowing and spending money, the economy continuously loses demand equal to the sum of savings and net debt repayments. This process will continue until either private sector balance sheets are repaired or the private sector has become too poor to save (i.e., the economy enters a depression).
Its important to note that at all times, in our view, a deflationary shock will be met with an increasingly more powerful currency devaluation, no matter how many Japanese economists scream, after all its never been easier just to add a few zeros.
»
- 25572 reads
- Printer-friendly version
- Send to friend
- advertisements -
So, free cars for everyone?
I guess I'm not following the logic. Is this JUST for the US? Or, perhaps for all the countries in the West? But then what about all those Chinese? Or, the majority of the world's population (that lives on $3/day or less)?
Yeah, we can grow our way out of this mess. Oh, yes, it's worked for ALL big cities!
@Seer
I was never a fan of the car thingy but there is such a thing as technological development / capital investment that counters the depletion game.
Be it a villager using a wood gas stove to reduce fuel wood expenditure or a nation investing in Nuclear to reduce the opportunity cost of using NG as your base load electrical power as happens in Ireland I am afraid.
You are just looking at the depletion angle - but lifes more complicated then that.
PS class A cars still has a 14% VRT, a road tax of 104 euros which has moved to 160 euros now and petrol at something like 1.45 Euros a Litre.
Meanwhile class G - the Hummers of this world have 36% VRT and a yearly car tax of 2100 euros moving to 2258 Euros.
Americans really crack me up.
"technological development / capital investment that counters the depletion game."
Ugh! "capital investment" and "technological investment" ARE NOT PHYSICAL RESOURCES, these things cannot CREATE MATTER!
On Jevons Paradox (http://monthlyreview.org/2010/11/01/capitalism-and-the-curse-of-energy-e...):
Most analyses of the Jevons Paradox remain abstract, based on isolated technological effects, and removed from the historical process. They fail to examine, as Jevons himself did, the character of industrialization. Moreover, they are still further removed from a realistic understanding of the accumulation-driven character of capitalist development. An economic system devoted to profits, accumulation, and economic expansion without end will tend to use any efficiency gains or cost reductions to expand the overall scale of production. Technological innovation will therefore be heavily geared to these same expansive ends. It is no mere coincidence that each of the epoch-making innovations (namely, the steam engine, the railroad, and the automobile) that dominated the eighteenth, nineteenth, and twentieth centuries were characterized by their importance in driving capital accumulation and the positive feedback they generated with respect to economic growth as a whole—so that the scale effects on the economy arising from their development necessarily overshot improvements in technological efficiency.33 Conservation in the aggregate is impossible for capitalism, however much the output/input ratio may be increased in the engineering of a given product. This is because all savings tend to spur further capital formation (provided that investment outlets are available). This is especially the case where core industrial resources—what Jevons called “central materials” or “staple products”—are concerned.
Sure the sun will die eventually but the human mind is capable of something beyond primate rock breaking.
www.youtube.com/watch?v=fd1IFjBNNVo
You seem unaware that there was a movement towards deindustrialisation for the first time ever after the club of Rome days.
This entropy takes time to work down the tech ladder.
Freeman Dyson has stated as such with regards to Project Orion - it was the first time that politics stopped applied technology with such force.
Your mind is a product of the Silent Spring & on the Beech cultural movements of the fifties - very valid arguments but just a moment in time when it comes to humanity.
www.youtube.com/watch?v=FRp3S8OOeZc
koo koo ca choo
I am the Pigman... (well, so I took liberties?!)
I thought we were beyond the point where the painfully obvious needed a 19 page expose. Don't we have better things to do with our time?
There will be plenty of time to pay down the accumulated public debt because the next balance sheet recession of this magnitude is likely to be generations away, given that those who learned a bitter lesson in the present episode will not make the same mistake again. The next bubble and balance sheet recession of this magnitude will happen only after we are no longer here to remember them.
Sure am glad I read this article. Pay down accumulated debt?
BWAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHA
Wall Street controls the dialogue. A falling dollar means that US multinationals of the DOW get to book more dollars back home resulting in higher revenue, profits and stock prices. However, this means higher economic input costs for US domestic small business which employs most of the working force. The dollar understandably hasn´t liked this intolerable situation which is why we´ve repeatedly seen it deny its own demise in recent years. Presently it´s rallying off a cyclical low and seems set to reach the top where it has been for 3-4 times in the last 5 years or even better that. It´s an absolute economic necessity for the USA and its labor force.
I could use some deflation in gas prices. and milk. and bread. and butter. and heating oil. you know... stuff I use.
Absolutely.
In a world that is drowning in oversupply, overcapacity, overindebtness and demand failure and endless armies of cheap labor wage increases are far fetched to say the least. All this screams for reduction of expenses obviously and I believe that the marketplace has begun to reflect this. Most commodities bubbles are collapsing and the dollar is perky. Crude seems to cling to hopes of major war which I find very unlikely due to the very weak strategic position of Govt./Wall St. in their flanks and current wars in the desired war area. It´s bark but it will be no bite.
"Most commodities bubbles are collapsing"
I think that your view is missing a key data point, and that's that collapse in production will just cause the prices to go back up. This is what I've been referring to as "economies of scale in reverse."
Plants, land and equipment just can't sit there ready to leap back into full production at the drop of a pin. If you don't have enough market-share to maintain razor thin margins then you're going to be toast, doesn't matter how big you are, or whether you're an oil producer or whatever.
All of this shit ONLY works when the pedal is pushed down. Unfortunately that pedal has been pushed to the floor and there is no MORE. The only direction that it can go is to back off. And, all the while, as resource depletion continues, the floor is moving UP on us: push back!
A mere percentage points is all it takes for this thing to swing violently to its death.
I guess I might be asking for too much if I asked that whoever gave me a red arrow were to present an alternative view.
And, just what do you think will become of this?
Australia Cuts Estimate for Agricultural Exports on World Economic Outlookhttp://online.wsj.com/article/SB126102247889095011.html
Think about it! Lowered output will result in higher production costs. And, those who would be the consumers? I seriously doubt that their capacity to ramp up consumption is going to pick back up: the higher things cost the less they will be able to afford to spend on any one thing. If I knew how to form this as a bet I'd consider doing so (though, when it comes to food I'm a bit leary of doing anything that would harm those needing it).
It must be me, but whilst I can see Koo's point - I only see it up to a point. Just what private sector savings are we talking about here?? If you follow Steve Keen, his view is that we have the largest private sector debt bubble in HISTORY. Cash on the balance sheet is not the same as savings. So whilst corporates may have cash, I am not aware that they have savings to be spent. My understanding (as shite as it is!) is that corporates have been raising cash because they can raise it cheaply, but have been doing this by selling bonds (which are a liability).
Maybe I have all this stuff back arsewards! But I can have a pile of cash and fuck all savings!!!!
I cant get my head around the ideat that 'the govt cant stop the private sector from repairing their balance sheets' from the idea that they wouldnt need to do so if they had loads of savings?
Debt saturation bitchez!!!!
I am going to stop now!!!!!!!!
WTF!!!!
K@
At such times and at such times only, the government must borrow and spend the private sector’s excess savings, not only because monetary policy is impotent at such times but also because the government cannot tell the private sector not to repair its balance sheet.
Seems like the messaging is now that the evil corporations are sitting on money and not spending it the way they should. If only they would spend trillions of dollars it would solve the problems of the world.
Thank God the governments of the world know how to spend money the right way...hand over fist with no expected returns.
http://www.huffingtonpost.com/2011/12/06/corporate-america-is-sitting-on...
Koo: "After us, the deluge."
Economists and pundits dress up simple issues in high-falution language, talking about the government must borrow to spend the citizens excess savings.
The simple truth is that if you have raised your living standards by borrowing "X"amount from the TMA, credit card or whatever, for a few years then when you go into reverse your living standard must decline by X" per annum until your income lines up with what you can earn.
Its the other side of the coin. Just don't borrow endlessly if you want to avoid this.
Nothing is achieved by the State stepping in to "spend" the "excess savings" (what excess?) because all the borrowing created a massive misallocation of REAL resources and the real economy really was not creating the wealth they thought it was. The borrowing borrowed from the future and drew EXCESSIVE resources from the future.
This is the fallacy in the idea that State debt is not the same as personal debt which economists keep harping on about and parading themselves as very clever dicks when in truth they are quite the reverse -- they completely ignore the impact on the real economy. State debt is the same as personal debt and it has the same effect.
Economics is really the study of the allocation of scarce resources among competing ends. Never forget that. It is not about fancy manipulation of accounting identities and aggregates like "effective demand" and "Savings and Investment".
We are entering a period when this hard lesson will be driven home with a vengeance. Your average businessmen knows what it means: your average Phd economist who couldn't run a whelk stall does not.
"Economics is really the study of the allocation of scarce resources among competing ends."
This needs to be stated over and over and over!
And, lest anyone need reminding, those scarce resources aren't getting any more plentiful. This kind of puts a bit of a bind on that growth paradigm thing we've been working with for, oh... thousands of years!
Economic theory is absolutely bankrupt, this is the point I never tire of pushing. It´s a terrible idea to chase falling prices due to technological revolutions by going into debt on false interest rates. This has been a very manipulated marketplace. But the manipulators can only fight market forces for so long. It´s a tsunami of supply out there. Demand is limp and overindebted. While the scam was defrauded through the mantra was don´t fight the FED. Now the FED isn´t really worth your punches. It´s bankrupt, only its bankruptcy won´t be its problem but the Treasury´s. So they won´t print themselves to a 100-1 leverage but rather will stand down and let the market have its course. Bubbles will have to burst and there will be short squeezes but if the market is allowed to sort it in peace out I hope we can muddle through somehow.
richard koo is the dick bove of economics...i would sooner ask paris hilton for her economic prognostications than i would koo,,,
koo-koo koo-koo
What is this zero percent interest you speak of? I'm paying 6 percent per annum.
I bought a Blackberry PlayBook and a new TV for Xmas. I'm saving Canada.
The level of technology and its pace these days is astounding.
My computers have been shrinking for years and now I have a small netbook and an Ipod (a fantastic palm computer once you have it jailbroken). Now I can be on the internet pretty much everywhere out of my pocket. This is the escalating technological bubble which will inflate for decades to come. There are also extreme productivity increase bubbles ahead as well.
These are extremely strong deflationary forces. The price is steadily going down. The price of money (debt) is understandably close to a 100-year high. Money anticipates these huge waves in advance,
Take a look here:
http://dbooth.org/guat2000/small/day3_1.htm
R-E-A-L-I-T-Y!
You're talking a bunch of shit. You're one of the elites and you don't even fucking know it. That "technology" that you're giddy about keeps you above folks like these. But when it falters, and it WILL, well...
Koo mentioned war two times as the spur for stimulus action, stressing that "peacetime" did not stimulate the politicians "in a democracy" enough to expand borrowing.
War Bonds, yeah!
And , oh yes, there will be plenty of time (generations, in fact) to repay the savers in worthless currency. Their children need no stinkin' pensions. We'll just work them to death.
After enough propaganda, those who prefer an honest depression will probably be outvoted by the war mongers.
We are entering the exit of the deflation through the situation "people become too poor to save", which is one of the exits of deflation into hyperinflatioj . The consumer credit increasing while income growth becomes negative tells that people become too poor to save. That is the scraping the bottom effect, we are there now, if you see income continue to be flat and savings rate be negative the US are in Big Big Big trouble.
It might not be Big Big Trouble because being too poor to save doesn't mean much in a country that hasn't saved in decades. Whatever The Bernank and Timmay are doing, doesn't mean diddly to the peons.. We can scrape the bottom for 20 years as TPTB try to stuff everyone in a drab, grey, wretched world of zero job growth, cheap goods, and mtv/reality-show ignorance. I see no path to hyperinflation in this scenario.
If this is now a 'service-based' economy as it touted constantly - I'd like to hear how deflation is actually a negative. Lower commodity prices and higher margins don't sound bad. As I've read it, what made deflation so bad during the Great Depression was that many many more people were farmers. Crops spoiled and couldn't be shipped due to low prices and people lost their land. These days when all Americans do is buy shit, I don't see how buying shit made overseas and filling up their gas tanks for less, is a bad thing (it's 'stagnant', as opposed to buying local or Made in USA - but not 'bad' per se). I doubt restaurant prices would decrease or any of the services people pay for now.
Deflation is bad if you're a multi-national that needs to constantly hedge or an industrial farmer of commodities (as opposed to real 'crops' for consumption, which is paying a premium currently). If deflation takes hold, wage moves lag (stay higher), spending is spurred, and prices stabilize to 'value' not 'speculation' - savers win... and blah blah blah. Never heard anything from the bitchez in finance or government that prove these points false.
Just like globalisation and NAFTA would create jobs..... These people will go down in history as complete and utter failures - yeah I'm speaking to you Greenspan, you walking smelly corpse.
Hyperinflation comes along when people lose total confidence in the currency.
At what point is there critical mass, how many people?
As wealth concentrates in fewer hands it alienates itself from the bulk of people.
Deflation is bad for people holding wealth. It's the receding tide that expose who isn't wearing shorts. The rich do everything in order for it to not happen. Problem is, in this case their measures of avoidance only increase the likelihood of eventual hyperinflation.
Because of the reversal of economies of scale and diminishing resources goods will become increasingly harder for people to obtain. Abilities will be DEFLATED. Meanwhile the means for exchanging goods -common currencies- will become more meaningless, they'll be eschewed by the masses, and, eventually, hyperinflated in to oblivion.
We are entering the exit of the deflation through the situation "people become too poor to save", which is one of the exits of deflation into hyperinflatioj . The consumer credit increasing while income growth becomes negative tells that people become too poor to save. That is the scraping the bottom effect, we are there now, if you see income continue to be flat and savings rate be negative the US are in Big Big Big trouble.
Wtf?? People have no money therefore hyperinflation? Ludicrous.
Tell me how excess reserves make their way into the public's hands? How does velocity increase when wages are declining and real unemployment is approaching 20%? We've already "printed" gobs and frigging gobs of $, right? So why are we still getting sucked into the deflationary black hole?