By Jason Clenfield and Norihiko Kosaka
Oct. 23 (Bloomberg) -- U.S. officials contemplating an exit from record fiscal stimulus are in danger of repeating mistakes that plunged Japan into its lost decade of stagnant growth, according to Richard Koo of Nomura Research Institute Ltd.
“This isn’t a cold, its more like pneumonia,” said Koo, author of “Balance Sheet Recession,” a 2003 book about the malaise that hit Japan after its stock and real-estate markets crashed in 1990. “We still need more government spending,” he said, adding it could take “three to five years to get out of this mess, even under the best of circumstances.”
Koo’s comments echo the view of economists including Nobel laureate Paul Krugman, who warn that the U.S.’s likely return to growth in the second half of 2009 doesn’t mean a sustained recovery is assured. The Obama administration aims to rein in a record $1.4 trillion budget deficit as growth returns, seeking to safeguard the value of a declining dollar.
“If you learn your lesson from the Japanese experience, you don’t remove your fiscal stimulus until private sector de- leveraging is over,” Koo, 55, chief economist at the research arm of Japan’s biggest brokerage, said in an interview at his Tokyo office last week. “When we see the private sector coming to borrow again, I’ll be the loudest person on earth arguing for fiscal reform. That’s the exit.”
Wealth Destruction
Koo calculates that the bursting of Japan’s asset bubble in 1990 erased 1,500 trillion yen ($16 trillion) in wealth, equivalent to three times the size of the economy. Companies focused on repaying debt rather than undertaking new projects, causing demand to plummet and triggering a cycle in which cash flows fell, asset prices dropped and balance sheets deteriorated.
This time it’s the U.S. consumer that’s inundated with debt. Household debt soared more than 10 percent each year from 2002 to 2005, when the economy expanded an average of 2.75 percent.
Koo, who previously worked at the Federal Reserve Bank of New York, said the solution for what he calls a balance-sheet recession is sustained government spending to fill the hole left as households and businesses retrench.
The Fed’s efforts, lowering the benchmark interest rate to near zero and pumping more than $1 trillion into the banking system, aren’t sufficient, he said.
“We have zero interest rates and still nothing’s happening,” Koo said. Businesses and households don’t want to borrow money even at zero rates; they’re too busy rebuilding savings and paying off debt, he said.
Preventing Collapse
For Japan, it was only government spending that prevented a collapse potentially worse than the Great Depression, Koo argued in his 2009 book, “The Holy Grail of Macroeconomics: Lessons From Japan’s Great Recession.” A decade of investment in roads and bridges also led to a government debt nearing 200 percent of gross domestic product, the biggest among advanced economies.
Krugman wrote earlier this month in the New York Times that “it’s time, I keep hearing, to shift our focus from economic stimulus to the budget deficit. No, it isn’t.” He added that “the complacency now setting in over the state of the economy is both foolish and dangerous.”
The Commerce Department will probably report next week that the U.S. economy grew in the third quarter for the first time in a year.
President Barack Obama’s administration is spending money to stem job losses while also trying to reassure the U.S.’s creditors it plans to rein in debt once a recovery is secured. The dollar has weakened against 15 of the 16 major currencies this year as the budget shortfall widened.
Stimulus Spending
The government’s $787 billion economic recovery plan swelled the federal budget gap to $1.42 trillion for the year ended Sept. 30, more than triple the $455 billion record set a year earlier, according to Treasury Department figures released last week.
Fed Chairman Ben S. Bernanke said Oct. 19 the government should establish “a sustainable fiscal trajectory, anchored by a clear commitment to substantially reduce federal deficits over time.” Treasury Secretary Timothy Geithner said in an interview with CNBC broadcast Oct. 16 that “when we have an economy that’s growing again and we get unemployment down, we’re going to have to bring those deficits down.”
Japan’s so-called lost decade, a period during which the economy slipped in and out of recession and grew at an average rate of about 1 percent a year, dragged on because the government was in a hurry to pay off debt, according to Koo. A telling example came in 1997 when, after a year of 2.6 percent growth, Prime Minister Ryutaro Hashimoto raised the sales tax, smothering consumer spending and squashing a recovery.
“We had these false starts,” Koo said. “The economy would begin to improve and then we’d say ‘oh my god, the budget deficit is too large.’ Then we’d cut fiscal stimulus and collapse again. We went through this zigzag for 15 years.”
To contact the reporters on this story: Jason Clenfield in Tokyo at jclenfield@bloomberg.net; Norihiko Kosaka in Tokyo at nkosaka1@bloomberg.net
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