– 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.
NEITHER A PRIVATE BORROWER OR A LENDER WILL
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 –
Once houses in the US reach the level of afforability, which I calculate to averge $250k across the country, the economy will stabalize. in the mean time I suggest that the government provide stimulas in the form credit allocations (or credit cards) to taxpaying consumers.
The consumers only choice with a government paid credit card will be to use up the credit.
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The author is correct in his reasoning when he says that changes in Monetary Policy, especially by lowering the Federal Funds Rate, will do very little to help our economy get out of this recession. A lower interest rate will be ineffective and if anything, will cause businesses that are already over-leveraged to borrow money that they can not afford. As a staunch supporter of the Austrian School of Economic Thought, I believe that the economy will recover the fastest if the government takes a “hands off” policy and allows the markets to clear naturally. The Government “Bail Out” does nothing more than prop up firms that are inefficient and do not satisfy their customers. And who does this benefit you may ask? The bankers, insuarance companies and politicians that receive political funding from the investment banks (or nowadays “bank holding companies”). A perfect example of ineffiencies of government aide is the U.S Auto industry. For years they continued to build low-quality products that they American public didn’t want. GM, Chrysler, and Ford managed to do this for many years dispite their inefficiencies but look at the U.S. Automakers now. The government support may have helped them in the short term but in the long run they are much worse off now because of the continual “propping-up” that they received from both the federal and state governments. If we continue to “bail-out” the Banks, Insurance companies, etc. we will be left with a much more severe financial crisis down the road.
I agree Andrea. This economic house is not worth saving. We have 20th century infrastructure and should be building with a 22nd century mindset. Let it burn to the ground and we can all build anew. May be then we can find the level playing field.
[...] Population Density and International Trade: One Tiny Example http://blogs.reuters.com/great-debate/20 08/11/14/a-long-shaky-bridge-to-recovery /#comment-978 [...]
The private balance sheet is the top priority for US Gov.t. If the private can’t afford to pay back all his debt he will never be able to consume and spend money to stimulate the economy. Prices should colapse and he needs money to start again. Its like after a war where all is destructed. Only time and money are necessary to build and start economy again.
Well stated, Pete Murphy, but what do we do? If we put in transmission lines to carry power from rich wind and solar areas to consumption areas, and smarten the grid to ease microgeneration and demand response, and if we commercialize cellulosic ethanol, and/or commercialize plug-in vehicles, we end energy imports (except maybe Canada hydro), so that sure doesn’t hurt, and we eliminate most greenhouse gas emissions. (See Al Gore’s http://www.repoweramerica.org.) Bad idea? Does anyone know? Is there a less bad one? Fundamentals must be accepted, and I agree there’s more to come and we’re all going to be eating lower on the hog, but if we do spiral beyond the fundamentals maybe all it takes is an emergency brake.
The Japanese may like to believe that they fixed their economic problem with massive government spending, but the truth is that they exported their way out of the problem. No wonder their citizens were able to repair their balance sheets when $100 billion per year poured in from the U.S., along with 1.5 million jobs.
Saft proposes a multi-year government spending spree and make-work projects to make Americans whole again. Then what? What happens when that program ends? We’ll be right back in the same boat again with falling incomes, a decimated manufacturing sector, a dearth of jobs and a reliance on a sell-off of American assets (if any are left by then) to finance the trade deficit.
If it was so hard for Japan to pull out of their recession with an enormous trade surplus, how much harder will it be for us with an even larger trade deficit? C’mon, Saft. Wake up and smell the coffee. There’s another balance sheet you completely missed - our trade balance.
James, you’ve been my number 1 pundit ever since they pulled the cork on the bathtub, and I’m no poorer for it. I liked your color photo better, though. What a smile!
Please don’t let know to Rome-princes in Italy
that “It was the fiscal stimulus that actually
helped end the Great Depression ..”. We’ll be
flooeded by Government media/TV system for months.
There are nations (still deeply in the Middle Age)
that don’t even know the term fiscal policy, they
just take on people what they possibly can.
—————-
But many feel the new debt is just the
coffin any country is puttin in.
Besiedes currencies, I see we need to
track debts in new monetary courses.
See the title ‘In God We Trust’: just one
trust against too many faiths. This is the
heaven to any speculator!
In advance, States should make clear to anybody
what I’m paying for.
I buy a coffee or a piece of oil with the
same exchange. Instead, a fusion-free-energy
program backing a dime would value 100times
a standard oil-backed paper.
Should one State make paper upon real debts,
things would make a shift.
——-
what can a boy do buy caffeine for study,
if he hasn’t a future?
Hi james, i entirely agree on the points that you had mention in this articule. But there are a few things to take note of.
1) No matter how much stimulus the government is willing to inject will still cause the downturn of the economy as the damage had already been done and not all are known yet.
2) No matter how independent USA is, she is still connected to the rest of the world.
3)The more governments allow herself to be link to the rain and storm in the world of economy, the more vulnerable she will become before the storm is over. And that may cause a even major mayhem.
4)Government intervention will only prolong the recession. and it is simply refusal to acknowledge that the whole world had made a major banking system mistake.
5) No one knows how deep in the mud are we now and we are trapped in too many corners that could be mention.
Some humble suggestions that might be of use;
1) Let the economy fall first, that way we will know which company in particular have been using the wrong strategy or are connected all along. After we identify which company, allow them to fail as humans are a resilient bunch of mammals. they will think of something to resolve it. In that way the govenment can save enough to ‘jump start’ the economy back to recovery when it is all over. (Keep the good throw the bad, i have not heard of an apple that had gone bad will become edible).
2) All the meetings such as G20 are holding are useless as all investors will be looking for goodies that government will be throwing in so someone can suck it in. And bad news waiting to be thrown in. They should come up with a grand 2-5 year plan so as to pick up the pieces where it had went wrong. All the announcement they make can only cause small spikes in the shares market. Humans only remember bad than good things.
3)Lets face it, the economy had been played by some high mighty people all along that had been ‘right’ for the pass few decades. it is going down no matter what. Why allow tax payers money to be suck in when it can be put in better use in the future? Yes jobs may be loss, homes gone. But all the plan that Mr paulson had came up with only save the rich and mighty empire. How about building some homes so that those who lost theirs have a place to live in and pay it back using a small premium in the future. employ jobless personnel to build it. Government intervention as such really save the economy and the poor.
4)Thereafter, economy will go up as the economy had been built by industralisation. Back to basic.
5) All the loss are not worth mentioning as monetary still reside on how we as humans decide to judge it to be.
6) All in all, my belief is that all of us should get back to basics rather than tying ourself with the failure of others.
The primary issue is value. Six months ago gas cost $4.30, and now it is half of that. Copper was $9,000/ton, and now it is $3500/ton. We have witnessed some home prices escalate 1,000% over the last couple of years, but now the values are only falling slightly. Meanwhile, health insurance prices are scheduled to rise 25-50% next year. Meanwhile peoples wages have stayed the same. Everyone is spooked at what the real value of products and services should be. Until things stabilize, people are going to hunker down and do nothing. This behavior will only make things worse.
Furthermore, we have removed virtually all banking regulations, which put us back to the 1800’s. Now our economy is behaving like it did in the 1800’s. We are on this rollercoaster that has enormous highs and lows. Until we restore the proper regulations, and smooth out the economy we are all going to suffer enormously.
Sadly, we took 700 billion dollars from the people who have been punished the most, and given it to the banks who caused the horrible problem. The intent of the funds was a good one. It was designed to ignite borrowing. Instead, the banks used it to buy rivals, and pay bonuses for bad behavior. The only thing the money didn’t do was to ignite borrowing. Very sad fact.
Unfortunately, banks are no longer just confined to national borders. They are now international banks. With banks refusing to lend, this had dragged the entire world down.
Sadly, I seriously doubt that our government can fix this horrible problem they helped create.
John Wibel, I agree with your statement. I do think housing prices need to drop below $250K
Median US income = $48,000. Affordable house price = 3.5 times median income = $168,000.
Current Median single family home price = ~$235,000
Current Median home price (include condos and townhomes) = $215,000
So, we do still have a ways to go.
Jeff
I am from Singapore where land is scarce. I am always very envious of you guys in US owning a piece of land at 3.5 times of the annual income. In Singapore, USD235k would only get us a public housing of 3 bedrooms and size of 90 sq meter. It is really pathetic.
If we are looking at private condo, a 120 sq meter typically costs around USD 700k for those in outskirts areas, and could go as high up as USD 1.5mil for a unit in the CBD, absolutely crazy.
For me, I would like to have a garden of my own, a car porch for two cars, a double storey terrace house with 3-4 bedrooms, and probably a unit of 200 sq meter landed property. But this is going to cost me USD 1-1.2 million over here (for a non-CBD location), which is like 10-12 times my household annual income, and I would have to work very hard for it. I just hope that sanity will bring back realistic property prices around the world.
I agree that housing will bottom in the US when it becomes “affordable”.
The tradition measure of affordability was not spending more than 30% of gross family income on housing (rented or owned) with not more than 80% of that amount going to service debt. And, the buyer must put a cash good faith downpayment of at least 10%.
We are not even close to that result. And, Americans have no savings and therefore no downpayment.
What is worse is that an unemployed person can not pay a mortgage, a creditcard debit, a real estate tax - nothing. That person goes bankrupt.
No rational person will become a debt slave. Once (s)he realizes that (s)he is just on a debt treadmill, with no possibility of getting out of debt or owning a home worth more than the mortgage, that person will just stop jogging, get off the machine, go bankrupt and start over.
Unfortunately, the same applies to the USA. We, as a nation, have breached our capacity to repay debt. Rather than prolong the agony, we should just suspend payment on our Bonds and Bills, reorganize our finances and start over. This may reduce the USA to a cash and carry and barter society.
But, with the world swimming in manufacturing overcapacity, the foreign producers will grant generous terms of forgiveness. They will also remember that we have the mightiest military ever created. Thus, they do not want to provoke an overarmed debt zombie, who just may do something very reckless.
over and out
peter
James,
Love your pieces . . and your take on the economy.
The theme running through yours and every positive critic’s progressive thoughts on what to do in the middle of this mess has to do with certainty.
How to spend the taxpayer dollar and KNOW that it will go to work putting people to work. I believe I have the answer to this question. It’s radical, but it will work. . . and I can more or less prove it.
I’ve always had some pretty contrarian economic thoughts . . . but ideas that I believe can really get this economy going again. Would love to discuss.
In the way of bg I’m an economist who studied at Yale .. . not a Yale economist.
Hey America, keep your eyes off China! Australia needs it to save us from economic armageddon!
I’ve been following your articles for some time, and they seem to be pretty much pre-flect what’s going on, and they appeal to the anarchist in me. The housing con has been going on too long, work for your money - if it sounds too good to be true, it probably is. I haven’t come across an idiom relating to “if it sounds to bad to be true”!
China will see their exports to US drop drastically in the coming years as US consumers slash their demand for all goods. This will reduce the dollar revenues that are going to the pockets of US subsidiaries in China that formerly produced those goods in US. As dollar income falls the Yuan will crash big time as those famous $2T in “reserves” have been bought with printed money. On top of that the Chinese government is going to print 4T Yuan more as this article indicates. It really amuzes me to still read opinions about how the tail (China) will wag the dog (US). Chines GDP is $3.9T, US is $14T.
Once houses in the US reach the level of afforability, which I calculate to averge $250k across the country, the economy will stabalize. in the mean time I suggest that the government provide stimulas in the form credit allocations (or credit cards) to taxpaying consumers.
The consumers only choice with a government paid credit card will be to use up the credit.
I would like to see these Mortgage lenders and banks who rolled those mortgages into credit default swaps get a swift kick in the you know where…and remember those credit default swaps MUST be addressed in all of this.
why not make all Existing U.S. Mortgages 4% Fixed for the next 30 years
anyone who has a mortgage less than 4% is probably doing just fine and doesn’t need the money.
This Way all the excesses of the Mortgage industry will be leveled out and the Homeowners will see a good reduction in their monthly Mortgage statement.Giving them the BUYING power every retailer is looking and hoping for.
Fannie and freddie could administer it a sell them back to the banks if they so choose.
at this point I would rather give my mortgage payment to our gov’t instead of all these Banks that are just lining up to the Taxpayers feeding trough for more $$$
as for a new Public works program… Please , Please , Please make it an Energy self sufficientcy NEW DEAL where America announces Self sufficientcy from all outside energy in 10 years come hell or High Water. Detroit… The hour awaits, you are about to witness an elephant fit through a keyhole. it’s time to jump !!!
There is one country more screwed and more in denial than the US: the UK. Yep: those effete thugs the British are the most indebted people in human history, packed on to an island that is both a social and an economic disaster zone (see the film Children of Men for a quick catch-up).
Their idiot prime minister has yet to fess up his role in making the British so in debt, but reality will do the talking for him. Mass unemployment, social breakdown, poverty, hunger, and a grinding recovery that will take at least a decade. Ta, ta my tea-drinking friends!
Falling housing prices will be great for renters looking to buy and the next generation. It does, however, NOTHING for the thousands of home buyers who got into the system between 2004 and 2007 who bought homes at extraordinarily inflated prices on loans they never should have qualified for. So now nearly all of them are stuck with homes valued less than what they paid, effectively screwing them for years and years.
So your wish of home prices matching current median incomes may come true. And some Americans will benefit. Many though, will go bankrupt, living in inferior homes and stuck with enormous mortgages they’ll never get out from under.