Balance Sheet Recession
So I was listening to NPR this morning and a Japanese economist was talking about their “lost decade” and chalked it up to what he termed “balance sheet recession.” Basically, too many people had too much debt, and when all these bad assets appeared, everyone scrambled to get their balance sheets in order rather than spending and borrowing. The Japanese tried everything, including 0% interest rates, and in the end none of it worked. Private capital was not flowing. The only thing that did finally work was the temporary introduction of public capital into the system – government spending, essentially, to ride out the recession while all those private balance sheets were righted.
After commercial property value fell 87% in the nineties, Japan entered into a period of slow growth, but not quite recession.
Like Japan in the 1990s, the U.S. is suffering what Koo calls a “balance sheet recession.” When asset prices collapse, the people who bought those assets with borrowed money are left with balance sheets underwater, and all they want to do is pay down debt.
“People are no longer maximizing profits the way it’s assumed in economics. They’re minimizing debt. The invisible hand of [economist and philosopher] Adam Smith works in the opposite direction,” he says.
With private borrowing and spending frozen, the Japanese government stepped in, spending on highways, bridges and other infrastructure, and running up big deficits. Where the Japanese government erred, Koo says, was in worrying about those deficits. It cut back prematurely on the stimulus. The economy faltered, and the government had to resume spending.
Still, by 2005, companies had repaired their balance sheets and the Japanese economy was marching forward — until the latest crisis.
This does seem very similar to today’s recession, though we are obviously in the midst of a more globally widespread problem. I’m curious as to what others think on this matter. Can liquidity be restored through government spending? Is it important to keep that spending restricted to short term projects? Long term? Is there a good middle-ground? (What does short term or long term really mean, in any case? Who determines the terms?)
I’ve always been in favor of broad infrastructure projects. I like the idea of high speed rail and other big, long-term spending projects that create jobs that will last. I also like the idea of projects with public/private partnership potential. A high speed rail may indeed be financed by the government, but there’s no reason that in the future private contractors couldn’t take over some of the operations. Then again, perhaps stimulus projects and long-term spending projects should be two different initiatives. If it’s true that private balance sheets need to be restored before private capital can start to flow again, then we need to evaluate how long that will take and plan appropriately. I imagine a lot of the problem with this is simply determining how bad the balance sheets of some of these institutions are – and they seem to grow worse by the hour.
This leads back to the “bad bank” concept, which would basically speed this process. You take all these bad assets and lump them together in a bad bank, quarantine them from the larger system, and then the stimulus can move forward with less uncertainty. I think the key in all of this is, wherever the government does intervene, they make it clear that their involvement is temporary (except perhaps in certain areas where public spending is an ongoing necessity, like education). When private capital is available again, it should not be prevented from once again flowing into the system, and replacing government spending wherever possible. The trick here is to not force private capital to move too soon or too quickly, essentially pushing healthy private institutions into high risk situations in an already high risk economy, through incentives that simply don’t make sense in the current realities of the market.
In any case, I think the questions from the Right need to be the sort that determine how and where to spend our stimulus dollars (and of course how much), not simply whether or not we should spend at all. Denying that government should play any role at all in this downturn is ludicrous. Conservatives need to be a part of the stimulus effort, both in order to reign in some of the more outrageous spending initiatives being proposed by the Left, as well as to simply have a say in the ongoing process. If conservatives box themselves out of the game from the very beginning, it’s going to be very difficult to nudge their way back in, or to manage the stimulus effectively should they once again take back the Congress or the White House.
The recalcitrant politics of the GOP seem to be less about governance and more about fair-weather ideology. I don’t mean to say that pragmatics are the only metric by which we should operate, only that in order to govern over a civil society, compromises do need to be made. The GOP enlarged government and the power of the Executive enormously for the past eight years, and it’s time they not only owned up to that, but realized that the only way to reverse the damage they themselves did is to partner in this stimulus effort, to insert their own ideological framework into the recovery plan, and to let go of obstructionism in favor of diplomacy.
Conservatives have a lot of good things to say about unnecessary regulations, but they obviously need to then come up with some smart alternatives. Perhaps we need to rethink how our banks are leveraged. Perhaps we need to rethink how our Fed prints money as though it were play money. A clear, cohesive set of basic, easy to understand principles need to be set forth as long-term goals for the Right. These cannot be merely anti-government policies. They need to speak to governance, efficiency, and smart regulation. They cannot be focused solely on tax cuts, because at a certain point that starts to fall on deaf ears.
As Will Wilkinson notes in his piece on “limited” vs “small” government:
The “size” of government is not a good proxy for either economic or non-economic liberty or for economic performance. Advocates of “small government” need to worry more than they do about the moral and economic dimensions of the composition of spending, and they need to realize that they care more than they think they do about questions of “distributive justice,” which is pretty obviously manifest in enthusiasm for reforms, like the “flat” and “fair” tax. I think our real concern ought to be limited government. But whether you think an ideally limited government is also small will depends on lots of things including your account of rights, your beliefs about the relative efficiency and reliability of state vs. market provision of various goods, your beliefs about the necessity of public spending to facilitate growth, and more.
Which is to say, lawmakers need to focus on practical issues, such as the “composition of spending” rather than merely obstruct spending altogether. Wilkinson’s concept of a limited government, as opposed to merely a small government, allows for discussion of where the limits ought to be, rather than merely discussion about cutting back everywhere. I think this is an important point, if only to provide a stronger jumping off point for the conversation. Honest discussion of government spending should never be boiled down to “yes or no.” The time frame, the direction of spending, the transition to private control – all of these are essential. Ignoring this will get us nowhere.
UPDATE: Whatever foibles David Frum may have made in the past – and, trust me, they have been manifold (think “Axis of Evil”) – he is more and more the consistent voice of accountability on the Right. Over at the New Majority, he writes:
A federal bank takeover is a bad thing obviously. I wonder though if we conservatives understand clearly enough why it is a bad thing. It’s not because we are living through an enactment of the early chapters of Atlas Shrugged. It’s because the banks are collapsing. Obama, Pelosi, et al are big-spending, high-taxing liberals. They are not socialists. They are no more eager to own these banks than the first President Bush was to own the savings and loan industry – in both cases, federal ownership was a final recourse after a terrible failure. And it was on our watch, not Obama’s, that this failure began. Our refusal to take notice of this obvious fact may excite the Republican faithful. But it is doing tremendous damage to our ability to respond effectively to the crisis.
Exactly right, and more conservatives need to be saying this if they want to be taken seriously.