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Thursday, May 14, 2009


the condensed richard koo

from april, a 15-minute interview with the globe and mail. koo's comments on the policy receptiveness in china toward the end are also quite encouraging.

it is particularly important, i think, to reiterate koo's points as loudly as possible -- particularly considering that there are loud voices with considerable influence who apparently misunderstand the crisis, perhaps quite profoundly.

It is of course sensible to use fiscal stimulus to offset a fall in private demand, and to some extent this can be effective – with a lag. But if you lose control over public spending and borrow too heavily (helped by the fact people like to hold your currency), it ends badly.

From the beginning, we’ve expressed concern here that the entire Summers Plan was overweight fiscal, i.e., not enough resources for recapitalizing banks and addressing housing directly (for the context of this assessment, see our full baseline view). Back in December/January, this was a strategic choice worth arguing about; now it’s a done deal and following the (very) limited recapitalization outcome of the bank stress tests, it seems likely that household and firm spending will remain sluggish. If that is the case, the Administration’s logic implies throwing another big fiscal stimulus into the mix – and the Summers’ team is already preparing the groundwork.

The IMF is now warning against the risks of this approach, albeit using carefully worded language.

In a 20 minute presentation at the Carnegie Endowment on April 30th, Olivier Blanchard made statements that are striking coming from the IMF’s chief economist (webcast; slides; fan chart for growth forecast).

i'm unlikely to teach either simon johnson or olivier blanchard much about economics, and i've certainly entertained johnson's points on multiple occasions. nevertheless, the presumption that repairing the banking system through a monster series of writedowns will resolve the economic downturn does not seem to me to have much if any foundation, as it presumes the will to borrow remains intact in the aftermath. moreover, the notion that government fiscal deficit spending must be problematic beyond some arbitrary level does not seem to rigorously analyze the nature of that borrowing in a useful way. (though it may be problematic nevertheless.)

the potential of a national government to finance stimulative spending to replace demand lost to debt reduction is one of koo's critical policy insights, and it does not seem that either johnson or the IMF employ it. johnson is not a fan of larry summers, but as i've earlier commented johnson himself seems to be at a loss for practical and credible ideas beyond bank recapitalization and voiding by fiat a significant part of the country's $11tn mortgage debt, all delivered with a rather liquidationist tint which extends to banks in spite of some semantic obfuscation wherein we are asked to believe that gutting the creditors is not in fact nationalization simply because the government would not operate the banks.

to be sure, some failures will and must occur. but i daresay such steps as johnson has advocated may run the risk of not only not fixing the problem, but potentially decapitalizing the american insurance and pension superstructure with the likely undesirable effect of plunging the world into depression. i don't wish to impugn motives, but this does strike me not as a real plan so much as a concession to mythic fantasy which satisfies an ancient human desire for punishment -- a natural desire that johnson clearly feels strongly to judge by the writings which brought him to my attention in the first place.

UPDATE: nor should i single out simon johnson, obviously. nouriel roubini gives what i find to be a wholly unsatisfactory explanation of how bank losses can be foisted onto the insurance and pension sectors, forcing the government subsequently to come to their rescue as well.

UPDATE: i fear, as regards the insurers, barry ritholtz may similarly be allowing a very natural anger overrule a proper analysis of the problem. this is obviously good company to keep, but i do think they're collectively quite wrong.

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Thanks I will check out this video later.

You might be interested to read Steve Keen's comments (below the post itself) here. While he's said in the past he's "not keen on bailouts", he does seem in these comments to be supportive of monetization of government deficit spending in special circumstances like this crisis. And the reason he believes we cannot avoid a depression no matter what the government does appears to be because we have nothing to replace the loss of income from the collapsing FIRE sector of the economy. (The comments apply to Australia mostly but US by extension I think). While I'm not certain I fully grasp all the theory yet, this also seems related to the problem of specialization of labor thwarting keynesian stimulus spending. I wonder what Koo thinks about that. I know he emphasized that the most unproductive work is actually the best place for government spending during a balance sheet recession as it will not crowd out the private sector, but I dread the thought of what thousands of financial sector specialists etc being paid to stack paperclips would do for fulfillment/happiness of the population. Perhaps that's one reason why the Japanese have such high levels of depression?

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"the potential of a national government to finance stimulative spending to replace demand lost to debt reduction is one of koo's critical policy insights."

Actually, I think that belongs to Keynes.

Johnson's piece was good for one reason, I thought, and I might add something Gaius Marius, might be familiar with in the Roman republic's final decade, that is, the grabbing of power by a tiny oligarchy. Otherwise, Johnson's prescriptions are pretty standard IMF.

I find KOO's piece interesting. I think he underplays coming to terms with the problems of the banks. Also there's large differences between the US and Japan, first and foremost much of the debt in the Japanese system was carried by the corporations, which in Japan the banks hold great chunks of, making it the banks problems. The corporations retrenched in Japan, more so than the banks, here we have the banks retrenching. So, the banks tightening credit ends up with a similar end of no one wanting to borrow in Japan, though here we have banks, corporations, and consumers tightening up.

I do agree with him about fiscal stimulus and in fact that will be where the growth comes from for some time. However, I'm much less convinced of the argument to give the banks time, in the sense that we then end up like Japan, but that may very well be the best we can hope for.

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sorry, joec -- my misphrasing -- koo articulates (i think) how countries can do so without concern for interest rate difficulties, giving a mechanism for state demand support. he also explains why such keynesian stimulus does not similarly work outside the auspices of a balance sheet recession.

you touch on one of the big differences between 1990 japan and 2008 america -- japanese corporations didn't have non-recourse loans, for example.

but although US banks landed in a credit crunch much sooner than japan's banks did (not until 1997), i suspect the ultimate dynamic will be very similar as the private sector delevers longer term. the problems of the banks' balance sheets will (if things are well handled) eventually be seen as something of, if not a footnote, then perhaps a sidelight of the crisis in the academic treatment. it's the drying up of loan demand that will be the main storyline instead.

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