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The Escape from Balance Sheet Recession and the QE Trap: A Hazardous Road for the World Economy

Book Description

Compare global experiences during the balance sheet recession and find out what is needed for a full recovery

The Escape from Balance Sheet Recession and the QE Trap details the many hidden dangers remaining as the world slowly recovers from the balance sheet recession of 2008. Author and leading economist Richard Koo explains the unique political and economic pitfalls that stand in the way of recovery from this rare type of recession that was largely overlooked by economists. Koo anticipated the current predicament in the West long before others and issued warnings in his previous books: Balance Sheet Recession and The Holy Grail of Macroeconomics. This new book illustrates how history is repeating itself in Europe while the United States, which learnt from the Japanese experience, is doing better by avoiding the fiscal cliff. However, because of the liberal dosage of quantitative easing already implemented, the United States, the United Kingdom, and Japan may face a treacherous path to normalcy in what Koo calls the QE Trap. He argues that it is necessary to understand balance sheet recession in order to resolve the Eurozone crisis, particularly the competitiveness problems. Koo issues warnings against those who are too ready to argue for structural reforms when the problems are actually with balance sheets. He re-examines Japan's two decades of experiences with this rare recession and offers an insider view on the Abenomics. On China, readers will gain a very different historical perspective as Koo argues that western commentators have forgotten their own history when they talk about the re-balancing of the Chinese economy.

  • Learn from Japan which experienced the same predicament afflicting the West fifteen years earlier

  • Discover how unwinding of quantitative easing will affect the United States, the United Kingdom, Japan, as well as the emerging world

  • Examine solutions to the Eurozone problems caused by two balance sheet recessions eight years apart

  • Gain insight into China's problems from the West's own experiences with urbanisation

  • Koo, who developed the concept of balance sheet recession based on Japan's experience, took the revolution in macroeconomics started by John Maynard Keynes in 1936 to a new height. The Escape from Balance Sheet Recession and the QE Trap offers the world cure for balance sheet recession.

    Table of Contents

    1. Foreword
      1. Notes on the Data Used in This Book
    2. About the Author
    3. CHAPTER 1 Balance Sheet Recession Theory—Basic Concepts
      1. GDP and Inflation Fueled by Growth in Money Supply, Not Monetary Base
      2. Japan Fell into Balance Sheet Recession in 1990s
      3. Plunging Asset Prices Create Balance Sheet Problems for Businesses
      4. Japanese Firms Rushed to Repair Balance Sheets by Paying Down Debt
      5. “Correct” Private Sector Behavior Tipped Japan into Contractionary Equilibrium
      6. Collapse of Japan's Bubble Destroyed ¥1,500 Trillion in Wealth
      7. Why Japanese GDP Did Not Fall after Bubble Burst
      8. Fiscal Stimulus Saved Japan's Economy
      9. “Good” Fiscal Deficits Were Not Perceived as Such
      10. Balance Sheet Recessions and the Limitations of Econometric Models
      11. Fiscal Stimulus Works in Two Stages
      12. FDR Made Same Mistake in 1937
      13. Reactive Fiscal Stimulus Is Far Less Efficient
      14. Fiscal Deficits Are Easily Financed during Balance Sheet Recessions
      15. Self-Corrective Mechanism for Economies in Balance Sheet Recessions
      16. Two Types of Fiscal Deficits Require Different Responses
      17. Fiscal Deficits Must Be Viewed Relative to Private Savings
      18. Consequences of Leaving Things Up to the Market in a Balance Sheet Recession
      19. GFC Triggered by Insistence on Market Principles
      20. Volcker Understood Systemic Crises
      21. Little to Be Gained from Bashing Those Who Have Already Come to Their Senses
      22. Recovery from Balance Sheet Recession Takes Time
      23. Forward Guidance Important for Fiscal as Well as Monetary Policy
      24. Fiscal Consolidation: Better Too Late Than Too Early
      25. Three Points to Consider Regarding Costs for Future Generations
      26. Japan Had a Shot at Full Recovery in 1996…
      27. Conflation of Balance Sheet and Structural Problems Extends Recession
      28. Distinguishing Balance Sheet Recessions from Structural Problems and Financial Crises
      29. Democracies Are Ill-Equipped for Dealing with Balance Sheet Recessions
      30. Keynes Also Overlooked Private-Sector Debt Minimization
      31. Those Who Prevent Crises Never Become Heroes
      32. Democracy Plus Balance Sheet Recession Equals “Secular Stagnation”
      33. Appendix to Chapter 1: Summary of Yin and Yang Phases of Economy
      34. Notes
    4. CHAPTER 2 Monetary Policy and the Quantitative Easing Trap
      1. Monetary Policy Impotent without Demand for Funds
      2. Mechanisms for Money Supply Growth
      3. Government Borrowing Drove Money Supply Growth in Japan
      4. Economics Dogged by Incorrect Analysis of Great Depression
      5. Japanese Monetary Policy Has Relied on Fiscal Policy for Past 20 Years
      6. Balance Sheet Recessions Triggered by Borrower-Side Problems, Financial Crises Triggered by Lender-Side Problems
      7. Bernanke Himself Says QE2 Unlikely to Have Major Macroeconomic Benefits
      8. Real Aim of QE2: Portfolio Rebalancing Effect
      9. Can Higher Share Prices under QE2 Be Justified on DCF Basis?
      10. QE2 a Big Gamble for Bernanke
      11. QE Undermined U.S. Leadership in G20
      12. QE with No Income Effect Harms Other Countries
      13. Dollar-Buying Intervention by U.S. Authorities Would Have Produced Different Outcome
      14. Inward Capital Controls Help Keep Bubbles Fueled by Hot Money in Check
      15. QE Represents Government Intervention in Asset Markets
      16. Operation Twist Lowered Long-Term Rates, but to No Effect
      17. Operation Twist Provided Only Limited Economic Boost
      18. Bernanke Admits the United States Faces Same Problems as Japan
      19. Fed Overestimates Impact of Quantitative Easing
      20. “Lower Long-Term Rates = Higher GDP” Formula Does Not Hold during Balance Sheet Recession
      21. Fed Has Also Underestimated Costs of QE
      22. Unorthodox Monetary Policy Distorts Signals from Bond Market
      23. Needless QE Acts as Drag on Financial Institutions
      24. Why Fed Embarked on QE3 Two Months before Presidential Election
      25. Post-Bubble Wage Growth Nearly Identical in the United States and Japan
      26. The “Inconvenient Truth” of the Real Cost of Quantitative Easing
      27. BOJ's First Round of QE Was Easy to Wind Down Because It Was Conducted in Money Market
      28. Redemption of Central Bank Bond Holdings Will Not Reduce Commercial Banks' Current Accounts
      29. Government Issue of Refunding Bonds to Private Sector Would Absorb Excess Reserves
      30. Redeeming Fed Bond Holdings Has Same Effect as Issuing Deficit Bonds
      31. Strength of Private Loan Demand Different at Start and End of QE
      32. Paying Interest on Excess Reserves Would Enable Rate Hikes . . .
      33. But Cost Could Be Prohibitive
      34. Cost of Winding Down QE Has Yet to Be Properly Analyzed
      35. Debate over Winding Down QE Sparks “Bad” Rise in Rates
      36. “QE Trap” Appears Increasingly Likely
      37. Continued QE Trap More Likely Than Hyperinflation
      38. BOJ Found Itself in Same Position in 2006
      39. Fed Admits That Supply and Demand Matters, Too
      40. Fed Changes Course Despite a 1.1 Percent Inflation Rate
      41. Traditional Phillips Curve Relationship No Longer Holds
      42. Upcoming Chapters in QE Saga
      43. Capital Injection Could Also Be Threatened If Blame Shifts to Fed
      44. Sales Should Start with Bonds Maturing Soon
      45. Final Cost of QE Can Be Calculated Only at End of Fourth Chapter
      46. Theoretical Debate on QE Has Focused Entirely on Benefits and Ignored Costs
      47. Central Banks Should Establish a New Reaction Function to Drain Reserves
      48. Emerging Markets Need Inward Capital Controls to Protect against QE
      49. Japan Should Learn from Pioneers in QE Using Long-Term Bonds
      50. Financial and Capital Markets during Balance Sheet Recessions
      51. Balance Sheet Recession Brings Special Kind of Liquidity-Driven Market
      52. Is Inflation of 1–2 Percent Too Low?
      53. Does Inflation Improve People's Standard of Living?
      54. Absence of Inflation Concerns May Have Lifted Utility of Consumption in Japan
      55. QE Should Not Be Pursued Any Further Given Difficulty of Winding It Down
      56. QE a Problematic Byproduct of Balance Sheet Recessions
      57. Notes
    5. CHAPTER 3 The United States in Balance Sheet Recession
      1. Rating Agencies Need to Be More Tightly Regulated
      2. Why Was Lehman Allowed to Fail?
      3. TARP Prevented Bank Failures but Also Created Turmoil
      4. U.S. Authorities Changed Course with “Pretend and Extend”
      5. Fiscal Stimulus Shifts from “Three Ts” to “Three Ss”
      6. Obama Has Yet to Disclose the Name of the Disease
      7. Bernanke's “Fiscal Cliff” Warning Saved the U.S. Economy
      8. Bernanke Declared Monetary Easing Could Not Offset Impact of Fiscal Cliff
      9. Fall from Fiscal Cliff Triggered Japan's Deflation
      10. U.S. Households Still Repairing Balance Sheets
      11. Nonfinancial Corporate Sector Faced Difficult Years in the Wake of GFC
      12. U.S. Companies Hit Far Harder by GFC Than by Collapse of Internet Bubble
      13. Can U.S. Corporate Sector Become Economic Engine?
      14. Long-Term Rate “Conundrum” Kept Housing Bubble Alive
      15. Post-2007 Fed in Similar Position to BOJ in 1990s
      16. Flow-of-Funds Data Suffer from Poor Accuracy
      17. Bad Data Were Good for Policy Debate
      18. Estimated Correctly, Private Sector Financial Surplus Continues to Shrink
      19. Recovery in U.S. Private Sector Demand for Funds May Outpace Japan
      20. Housing Market Strength during the First Half of 2013 May Have Contained Temporary Factors
      21. Fed's Reputation Falls to Earth
      22. Notes
    6. CHAPTER 4 The Great Potential of Abenomics
      1. BOJ Already Had a Massive QE Program in Place
      2. Why Didn't Japan's Institutional Investors Follow Their Overseas Counterparts?
      3. Yen Fell and Stocks Rose Because Japan's Institutional Investors Stayed in Bond Market
      4. Honeymoon Altered Japan's Economic Landscape
      5. Bond Market Reaction Ended Abenomics's Honeymoon
      6. Private Sector Continues to Save after One Year of Abenomics
      7. Japan's Growth over Last Year Attributable to Fiscal Policy
      8. Can the Abe Administration Overcome the Trauma of Balance Sheet Recession?
      9. The Trauma of the Balance Sheet Recession Will Be the Last Effect to Go
      10. Focus of Structural Reforms Must Shift from Lenders to Borrowers
      11. Is Japan's Slump Due to Shrinking Population or Balance Sheet Problems?
      12. Slump in Domestic Demand Was Due to Balance Sheet Recession, Not Decline in Working-Age Population
      13. Personal Financial Assets Have Already Been Invested Somewhere
      14. Corporate Debt Pay-Downs Weighed on Consumption and Investment
      15. Real Bottleneck in Japan's Economy: Lack of Loan Demand at Private Companies
      16. Balance Sheet Recession Has Taught Japanese How to Be Frugal
      17. Is Japan Really Closed to Immigration?
      18. Japanese Economy Would Cease to Function without Foreigners
      19. Agricultural Reforms a Major Step for LDP Government
      20. Structural Reforms Are Microeconomic Policies That Take Years to Work
      21. Scale of Structural Reform Is Also Important
      22. We Should Not Expect More Good Fortune
      23. Kuroda May Be Trying to Close Gap between Expectations and Reality …
      24. BOJ and Government Must Stress That Inflation Overshoot Will Not Be Tolerated
      25. BOJ Had Weapon to Prevent JGB Crash during Balance Sheet Recession
      26. No One Has Criticized Japan for Currency Manipulation
      27. Japan Supported Global Economy for Four Years after Lehman Collapse
      28. Real Effective Exchange Rate Does Not Fully Express Japanese Firms' Pain
      29. Rising Fiscal Deficits Caused by Change in Corporate Behavior
      30. How Should Japan's Tax System Be Reformed?
      31. Fiscal Stimulus Introduced to Offset Consumption Tax
      32. Current Corporate Earnings Based on Massive Fiscal Deficits
      33. Working Down Public Debt Will Require Bold Policies to Lift Japan's Growth Rate
      34. Incentives Needed to Restore Japan's Economic Vitality
      35. More Effective Land Utilization Could Propel Growth
      36. Japan Needs Bold Tax Reforms Modeled on U.S. and Hong Kong Systems
      37. Policies Need to Change Perceptions of Japan at Home and Abroad
      38. Notes
    7. CHAPTER 5 Euro Crisis—Facts and Resolution
      1. Euro's Adoption Lowered Interest Rates Sharply
      2. Maastricht Treaty Acted as Constraint on Credit Risk
      3. Greece Was Spoiled by Euro, and Germany Reacted Violently
      4. Germans Believed Structural Reforms Required a Crisis
      5. German Balance Sheet Recession Eight Years before GFC Started the Crisis
      6. German IT Bubble Brought about Euro Crisis
      7. ECB's Rate Cuts Create Bubbles outside Germany
      8. Misunderstandings Regarding Lack of Competitiveness in Southern Europe
      9. Money Supply Growth Much Lower in Germany
      10. German Reforms Responsible for Only Half of Competitive Gap
      11. Germany Benefited Most from Euro
      12. One More Mutual Dependency between Germany and Eurozone Periphery
      13. Spain's Vicious Balance Sheet Recession
      14. Ireland's Household Sector Forced to Pick Up Pieces after Massive Housing Bubble
      15. Irish Businesses Remain Net Savers
      16. Portugal's Balance Sheet Recession Began Quite Recently
      17. Italy Is in Same Position as Portugal
      18. Why the Polarization of Eurozone Government Bond Yields?
      19. Eurozone Allows Investors to Buy Government Bonds of Member Countries with No Currency Risk
      20. Eurozone-Specific Fund Flows Amplify Economic Swings
      21. Meaning of “Fiscal Space” Differs Inside and Outside Eurozone
      22. Maastricht Treaty Is Defective and Should Be Revised Immediately
      23. In Practice, Fiscal Stimulus Requires EU and ECB Approval
      24. Ban on Buying Other Nations' Debt Ideal Way to Stabilize Eurozone
      25. Efficiency Gains from Single Currency Remain Intact
      26. Different Risk Weights Should Be Applied to Domestic and Foreign Government Debt
      27. Next-Best Alternative to Risk Weights Already in Place?
      28. Separation of Sovereign Risk and Banking Risk a Rejection of Self-Corrective Mechanism
      29. Joint Issue of Eurobonds Would Only Solve Half of Eurozone's Structural Defects
      30. Draghi Unaware That There Are Two Kinds of Recessions and Fiscal Deficits
      31. Outside of Greece, Capital Flight Is the Problem
      32. Explaining Balance Sheet Recessions to the German Public
      33. Even Germans Understand Need for Fiscal Stimulus If Properly Explained
      34. Excessive Focus on Fiscal Deficits While Ignoring Growth in Private Savings
      35. Lack of Private Loan Demand Biggest Problem for Germany
      36. Germany Unlikely to Announce Stimulus Package
      37. Disadvantages of Euro Exit for Greece
      38. Argentina's Experience Also Suggests Euro Exit Would Have Few Merits for Greece
      39. Germany's Competitive Gap with Other Countries Will Also Disappear in a Few Years
      40. Draghi's LTROs Prevented Collapse of Eurozone Financial System
      41. “Grand Bargain” with ECB Is an Empty Promise
      42. Double-Dip Recessions and the Eurozone's Bad Loan Problem
      43. EBA's Lack of Understanding of Systemic Crises Leads to Rash Actions
      44. Cypriot Bank Resolution Could Worsen Financial System Jitters
      45. Vicious Cycle of Creating New Bubbles to Paper over Old Ones
      46. EU Election Results the Result of Economic Policy Errors
      47. European Policymakers Mistake Balance Sheet Problems for Structural Problems
      48. Policymakers Need to Ask Why Euroskeptics Made Such Gains
      49. Disappointment with Established Parties Led to Rise of Nazis and World War II
      50. Continued Disregard for People's Voice Puts Democracy in Jeopardy
      51. U.S. Voters Had Policy Choices, Unlike Their European Counterparts
      52. The Euro Can Be Saved with Two Repairs
      53. Notes
    8. CHAPTER 6 China's Economic Challenges
      1. China's Local Governments Began Borrowing en Masse
      2. Decoupling Would Not Have Been Possible in Ordinary Democracy
      3. China's Remaining Problems Include Overcapacity and Income Inequality
      4. China Understands Political Ramifications of Inflation
      5. China's Shadow Banking Sector: Misunderstandings and Realities
      6. Problem: Sharp Growth in Lending to Local Governments Post-Lehman
      7. Decoupling of China and Developed Economies to Continue
      8. Problems Facing China's Economy
      9. China Has Already Passed the Lewis Turning Point
      10. Rapid Economic Growth Continues until Lewis Turning Point
      11. U.S.-Led Free Trade Regime Enabled the Emergence of Asia
      12. Economy Starts to Mature Only after Passing the Lewis Turning Point
      13. Local and Global Lewis Turning Points and Inequality
      14. China Increasingly Tolerant of RMB Appreciation as Transition to Consumption-Led Economy Proceeds
      15. The West Is Conflating Problems of Trade Imbalance and Financial Crisis
      16. Liberalized Financial Sector and Capital Flows Could Weaken RMB
      17. China Could Fall into the “Middle-Income Trap” If It Neglects to Advance Its Industrial Base
      18. Japan, Korea, and Taiwan Escaped from Middle-Income Trap
      19. Labor Disputes Increase Sharply after the Lewis Turning Point Is Reached
      20. The Dilemma of Patriotism with an External Enemy
      21. Working-Age Population Peaked Just as the Lewis Turning Point Was Reached
      22. Will China Grow Old before It Grows Rich?
      23. The Next 15 to 20 Years Are Critical
      24. Uncertainty Due to Corruption and Lack of Legal Infrastructure Must Be Removed …
      25. Appealing to Patriotism without Creating External Enemies
      26. China Could Become a World-Class Nation for the First Time in Two Centuries
      27. Chinese Ambition and Industry Must Be Steered in Right Direction
      28. Notes
    9. Afterword
    10. Bibliography
    11. Index
    12. End User License Agreement