A long, shaky bridge to recovery

By J Saft
November 14, 2008

jimheadshotsmall– James Saft is a Reuters columnist. The opinions expressed are his own –

The lessons of Japan’s stumbling path out of deflation and recession suggest that government spending can help stave off an extended recession, but it may take years not months and require an unlikely combination of political will and consensus.

That’ll be a lot of bridges to nowhere.

The particular type of recession the United States faces, a balance sheet one, means that cutting interest rates will be really pretty ineffective, and while you can throw everything you have at saving the banking system, you can’t make people and businesses borrow and put the money to work. They too have their own balance sheet problems, having loaded up on debt and holding as they are assets like real estate and stocks that have fallen in value.

Banks too are about to get whacked by another hit to their assets, as corporations respond to newly lousy economic conditions by, well, defaulting.

In short, it’s a negative self-reinforcing cycle that low interest rates do little to break and that is bigger, though related, to the problems in the financial system.

Government spending can break the cycle. Not tax cuts, which will only go to pay down debt or are saved into a banking system that isn’t working, but actual bricks and mortar. Think the New Deal’s Works Progress Administration super-sized or Japan building highways and bridges over seemingly every river, stream and rivulet.

“It was the fiscal stimulus that actually helped end the Great Depression, not the monetary policy,” said Richard Koo, Tokyo-based chief economist at Nomura Research Institute and author of The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession.

“I don’t think it will be over quickly. I am recommending at least three to five years seamless medium-term fiscal stimulus measures to give enough time for the private sector to repair its balance sheet.”

Three to five years is an eternity in political life. It is an absolute sure thing that incoming President Barack Obama will design and implement a pretty chunky fiscal stimulus package even if President Bush does not pass one in his waning days in office. But think about how difficult it will be to maintain both the will and power to maintain a huge borrow and spend program for several years.

Koo thinks that Japan, which was facing a far more serious destruction of assets, derailed its recovery with premature fiscal reform. “If we had known in advance that this kind of recession will never be over until private balance sheets are repaired and fiscal stimulus is needed to keep the economy growing, we could have done it in seven or eight years perhaps instead of 15,” he said.


Between 1998 and 2007 credit extended to the private sector in Japan dropped by about 100 trillion yen, but massive government borrowing from banks of 106 trillion yen kept money moving in the economy.

Near zero interest rates were ineffective in Japan because people and business refused to borrow, continuing to pay down debt to repair balance sheets that had been hurt badly by the fall in the value of assets like stock holdings and real estate.

Very low interest rates are needed, certainly, but what they do is to keep the banking system and debtors on life support, giving them the time they need.

Of course, resolving to borrow multiple hundreds of billions of dollars is one thing, finding someone to lend it to you can be quite another.

China approved a huge stimulus package worth 4 trillion yuan ($586 billion) through 2010 to boost domestic demand. China will plough money into infrastructure and social welfare as well as other key sectors. This has raised some fears that China may become a less avid buyer of Treasuries, or even a seller.

But that ignores the fact that in both countries people will be forgoing investment or paying down debt. In other words there will be a new pool of money available domestically to finance increased government borrowing on both sides of the Pacific ocean.

“China’s fiscal stimulus will offset a fall in domestic investment more than it reduces China’s purchases of U.S. debt,” economist Brad Setser, who follows central banks at the Council on Foreign Relations, wrote in his blog. blogs.cfr.org/setser/

“Chinese banks that previously were lending to China’s property developers will be lending to China’s government instead. And the rise in the U.S. fiscal deficit will offset a fall in borrowing by American households and firms. As a result it won’t need to be financed as heavily by the rest of the world.”

Even so, there is no doubt that the United States remains dependent on China’s continued desire to buy and hold its debt.

But the bigger job for the U.S. will be at home. If what is needed is several years of stimulative spending, the U.S. is going to need a level of consensus and resolve that to me just doesn’t seem likely.

— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –


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Interest rate cuts will not help in this recession because the financial problems are so large due to the fact the western governments refuse to let large corporations fail which in turn creates a environment in which failure is rewarded, the fact of the matter is big business has became ingrained in the political processes and the very people who are making important decisions such as the $700 billion bail out ie MR Paulson and co should be checked to see if such persons have a interest in companies in which are being bailed out.

Posted by SircolinjamesOBE | Report as abusive

We have lived in Europe and Asia when our family was young, and have visited all of europe, north africa, some of asia, every province in canada because we enjoyed travelling. We always thought it was a priviledge to meet people from everywhere and see new places. We budgeted to travel and have many many happy memories. Never did realize how much everyone didnt like americans – but it has become pervasive enough in the media that we have cancelled two trips last year and are visiting the states this year. Hopefully tourists from other countries will visit all these places and be better liked.

This country cant go on spending money it does not have. A program like the CCC or American Peace Corp for Americans would be great. And stop the BS on cars. A 1953 Ford 6cyl std shift with overdrive got way over 30mpg. Lets stop making throwaway cars and make cars we can rebuild and re-new. John

The headlines read “World leaders unite to restore global growth” or similar reactionary stuff. Don’t we realize that the time for “growth” is over and that we need to learn to do with what we have got? Yes, the learning process will be slow and painful, and not only the dwellers in the slums will die. But at the root of our problems is “growth”, uncontrolled growth for several hundred years gaining momentum as growth grew to include a free lunch and soap bubbles that lasted long enough to seem for ever. With such a growth philosophy there comes a time when in the name of sanity one has to welcome its total collapse.

Near zero interest rates which discourage savings is exactly the wrong way to go in a world that is trying to recover from a decade of excessive debt creation. Acceptance of lower living standards is unavoidable if there is to be a return to economic stability. The medicine – a recession – is bitter but without it, the patient will not recover.

Posted by john richards | Report as abusive

So far, our government has failed to heed the first rule of economics. When you find yourself in a hole, you must first STOP DIGGING the hole DEEPER !!

That’s exactly what Congress and WH has been doing for the last ten years.

1. Offshoring or manufacturing to countries with little or no social reforms is a recipe for disaster.

2. Importing foreign sci&tech workers to the tune of 200K per year. (P.S. another 140K new imports were given the go ahead as of Oct 1, 2008.) This year we’ve seen more than 140K layoffs in these fields, the H-1B and L-1x visa programs effectivily doubles the economic damage and depresses wages across a wide range of fields. Resulting in several million mortgage defaults.

3. Allowing illegals to work and live in our country taxes our social support systems while employers exploit the massive labor surplus to depress wages.

Each new job that pays lower than average wage in each respective field/location is step backwards and indicates a society headed towards collapse.

http://www.bls.gov/news.release/realer.h tm

Lastly, one must stop placing blind faith in government manipulated (NEOCON) economic stats. The computer industry as a term for this, Garbage In Garbage Out, (GIGO).

Those who prepared for this mess coming are well prepared for it. Those who got sucked into the illusion will need a whole lot of luck.

http://www.shadowstats.com/alternate_dat a

Both the markets and voters depend on reliable / consistant economic stats, without them one really can’t make rational decisions about investing.

Posted by Tim | Report as abusive

Put an end to the Federal Reserve and central banks and all of this goes away.

Posted by Eric | Report as abusive

Has anyone noticed that we are in the midst of the greatest wealth transfer in the history of the world from the ordinary citizen to the wealthiest? Economics is never a zero sum game. Whenever someone loses, someone else gains that amount. With such monumental losses, don’t we need to ask the question, who are the few that are gaining it all? It is those who are privy to the inside knowledge of the policy maker’s plans. Stock markets that bounce up and down 10% every couuple of days are being played by the big guns trying to extract every last dime out of the suckers. Prudent investors would never fall for it.

We are in an unprecedented era of piracy, with the pirates in charge of the world and nobody willing to face up to what is going on. Curious. So self-delusional. And we have not even hit bottom.

Posted by Jonathan Cole | Report as abusive

Low interest rates and free money are what got us into this mess in the first place. First it was Y2K, and then 2001, and the government kept ‘infusing’ more and more money into the financial system, and it blew up.
So, now the gov is stuffing the financial system with even more un-earned money. It is easy to predict we are destined for the same bout of indigestion in about ten years.

Posted by ForeverSPb | Report as abusive

Some interesting solutions are near by. Did you know our good neighbour Canada is rated #1 on the planet for bank security, even ahead of Switzerland, and there are zero mortgage bankrupts? Maybe its because Canadians have not strangled themselves with credit card debt, and always had to qualify for a mortgage based on documented fact (income, employment, etc.) How to keep the economy solid — well, instead of the government bankrupting itself like the USA with dead-end bailout packages, on January 1, 2009 the Canadian government is offering TAX FREE investment accounts up to $5,000 a year for every Canadian. This re-capitalizes the banks with zero government funding and life is beautiful. How come our USA politicians aren’t this smart???

Posted by turismo | Report as abusive

“Nouriel Roubini, an economist and chairman of RGE Monitor, said he sees the dollar as sharply lower on a trade weighted basis in a year’s time, expecting a fall of at least ten percent, accompanied by a Fed Funds rate of 3 percent, “if not below,” as against 4.5 percent now.” This is a quote from an article by Mr. Saft a year ago. The fact of the matter is that all these gentlemen that are being paid quite a bit of money to provide their insights and forecasts have no better idea of what’s going to happen than any of us. The huge “investment” machine continuously needs feedstock. Whether they get it right or get it wrong is a matter of great indifference to them because they are never held accountable for their words.

Posted by JDC | Report as abusive

Contrary to economic dogma, our interest-bearing, debt-based economies are fundamentally unstable and prone to disequilibrium. Idealised models of economic equilibrium sound nice, and their portrayals of undistorted markets achieving optimal net benefit and harmony attract acceptance and acquiescence. But such models have more in common with the Dark Ages grip on European world-view held by Christian churches, than with an objective rendering of empirical data. Their absence of predictive capability, together with mainstream economic blindness to the long-visible warning signs of the current crisis, are ample demonstrations of this. The Dark Age churches peddled false salvation at the cost of subservience to church authority. The 20th and 21st century economic priesthood peddles false market equilibrium at the cost of subservience to exponential growth.

That 97% of the world’s money supply is generated as interest-bearing debt constitutes a classic positive feedback loop, fundamentally unstable (in the nature of positive feedback systems), and requiring exponential growth in both debt and credit (money) to meet compounding interest on money supply. While ever we rely for our money supply upon interest-bearing debt, we can resign ourselves to continuing boom/bust/bubble cycles.

That such a systemic, positive feedback system, with its inherent, fundamental disequilibrium, has been packaged and presented to collective humanity as a structural necessity, is a testament to the dogma and ideology of a powerful and often self interested finance sector.

Money is a human construct, designed by people, for the benefit of people, to enable the exchange of goods and services within and between the most productive economies in world history. To address an insufficient supply of money, we need to apply some critical thought to the effectiveness and wisdom of our basic money supply mechanism. We are too easily persuaded that this is neither possible nor negotiable.

Posted by Vol | Report as abusive

Put aside interest rates, think about what can you do for your country, society and yourselves. Think about those things that can give you maximum value addition. One and most useful thing is farming. Yes, farming is a way to self-reliance economy. One can start it with your home, village or any free unused land. One can earn Carbon Credit also through reducing its energy usage. We hope, Mr. Obama can be prepared to reform the policy for the self reliability in energy resources and its efficient usages.

Posted by Ashish Vora | Report as abusive

How about revisiting the consumption portion of economic growth and reassess the balance of money spent versus money saved for each household, a ratio that has been hitting record lows for consecutive years?
Is this the kind of economic recovery that we want? It might be slower but this will bring stability back in the economy when we start reinforcing the foundations and not renovating the penthouse.
Deferring consumption does not mean necessarily reducing growth but more like taking insurance on future and sustained growth.
Like Jim says it is time for every household to take a good look at the balance sheets and the cash flows.
All of us if we were to be given a broker guidance we would be an ‘underperform’

Posted by Yiannis | Report as abusive

Being Canadian, I am surprised that my commitment to the free market system seems much stronger than Americans – at least from what I can gather in these articles. (I am not talking about James Saft’s articles.) Bailouts reduce the reward for the risk of innovation. If you indeed want to drive away people with good ideas, take his market away by supporting companies with bad ideas.

If all of the big three car manufacturers go bankrupt, don’t you all think that somebody will come by to fill the void? Don’t seedlings have a better chance of taking root when the rotting trees in the same area are removed? Nature thinks so. Dead trees go up in flames and the nutrients are returned to the soil to feed the next generation. Free market capitalism is a totally green concept. It is the only approach that comes close to being sustainable.

From the standpoint of being a taxpayer, why in the world do I want to subsidize a company? I support companies by buying their products. We are not talking about a “government bailout” but a “taxpayer bailout” of companies. I would let the communists in the American manufacturing industry think a bit before they do yet another dumb thing.

Posted by Don | Report as abusive

To turismo: Maybe the grass is greener seen from the other side. I am Canadian and things are pretty bad here too, but many are still in denial. In regards to the fact that Canada has a banking system that ranks #1 in the world, well, it’s really not that hard to be #1 when everybody else around you is in deep mess. As for the heavily advertised tax-free savings accounts – I’m afraid it’s a gift that is presented in a shiny, sparkly wrap but lacks substance. If you do a couple of simulations online, you quickly realise that the actual gain derived from these fiscal improvisations is practically insignificant.

Posted by Angelica Treap | Report as abusive

Well I’ll jump in here . The way out as I see it is for America to start playing hardball. Pull your money out of the banks with the exception of a monthly minimum, and smaller savings .Pay cash as best you can . Base housing costs on minimum wage , since now those are the strongest area of job growth , and have been for 8 years . We got screwed we know it and were still getting screwed, the educated and the uneducated alike . The Financial sector feels that it is their job to keep screwing us , along with the banks , and the insurance companies and the automakers . No one wants to see it, but do these things and within months hell weeks the ad campaigns will be open a checking account get a free house.

Posted by Jacob | Report as abusive