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Friday, April 03, 2009


second presentation by richard koo

following on the first talk given by richard koo of nomura bank at the center for strategic and international studies dated late october 2008, the same folks at CSIS have kindly offered a second from late march 2009. (UPDATE: new link)

there are significant and important updates in data and outlook, and koo is only further convinced by events in the intervening five months that we are in fact facing a globalized balance sheet recession spanning several developed economies more serious than the isolated example of japan 1990-2005. his analysis of the collapse in demand for funds -- something rarely or never commented on in the public discourse, which focuses on the concept of a credit crunch centered on lenders and the supply of funds -- is in my view absolutely essential to understanding what is happening today.

his comments around 28 minutes on the multiplier of government spending in a balance sheet recession and the misleading nature of macroeconomic equilibrium modeling in assessing those multipliers heretofore is essential.

i think koo is just a bit optimistic about the galvanizing effect that public acknowledgement of the nature of the depression and the need of a fiscal solution would have. large swathes of the american public, with zero understanding of macroeconomic concepts, are convinced as a matter of religion that government deficits are bad and will vote accordingly. that won't go away soon, regardless of public proclamations or for that matter clear evidence. koo specifically warns against the counterproductive role of ratings agencies in uselessly trying to frighten bond market investors around minute 42.

watching this presentation has furthermore changed my expectations of the efficacy of "fat spreads" (ie a wide and profitable gap between cost of funds and retain lending rates) alone in recapitalizing american banks. koo rightly points out following minute 52 that, with effectively no new borrowers, banks will ultimately be unable to utilize fat spreads to recapitalize from extremely serious damage in a reasonable timeframe -- a critical observation.

particularly engrossing are his comments from that point forward. fixing the banks and ending credit crunches are contradictory goals. things can and should and must be done slowly, not quickly. the idea that moderately-impaired banks cannot and will not lend is nonsense -- both japanese banks post-1990 and american banks post-1982 lent vigorously. these are views very contrarian when set against the current american policy discourse.

in response to the first question, koo relays his experience with global concern over the use of the fed balance sheet as a trigger to a dollar collapse. this is important information from someone as wired in as koo is in east asia -- many international parties believe treasury must take obligations (eg maiden lane) that the fed has adopted to safeguard fiat currency.

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The two most important points I haven't seen Koo cover that I wish I could hear his take on are:

1. Whether this being a significantly larger crisis (US has double Japan's 1990 debt to GDP ratio) as well as significantly more global could create significant barriers or tipping points in the ability to play out how Japan's has and how he recommends now, and

2. He mentions in the October video in abstract terms that the government sector should heal its balance sheet after the private sector has healed theirs, yet he doesn't explain how this can be done without adverse effects when total debt has not decreased (just shifted to government) nor why Japan has not even begun to make progress on that front... In other words Japan's "success story" has no proven exit strategy.

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the latter is an important observation too, hbl, but there might be other cases to study.

it seems clear to me from his analysis that the alternative to supporting demand is bigger government debts, not smaller, especially as a ratio of (crushed) GDP. but that does not mean that there is an exit.

but i can imagine that, once private sector balance sheets are repaired, real private sector growth can resume. government can then use the resulting increased receipts to pay down debt -- in effect, bleeding savings stored in treasuries back into the economy to be allocated microeconomically. it should serve to keep interest rates low well into the nascent boom by providing a steady stream of funds.

this was something of what happened in britain and (to a lesser extent) america post-ww2, where british national debt was almost all sovereign and sovereign debt was 250% of GDP. likewise the US, except at 130% sovereign-debt-to-GDP (and with total debt around 170%, the american private sector was extremely lean). sovereigns crushed their debt loads quickly in the aftermath.

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"no new borrowers" ? i wouldn't worry too much about that in the U.S. context. in addition to the "fat spreads", as you say, the banks and hedge funds will be earning fees and government subsidies by lending and borrowing "toxic assets" to and from one another thanks to TARP and TALF.

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