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For everyone who continues to parrot the phrase "Japan is different" you really need to watch this

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April 19, 2012 – Comments (7)

Many of us have discussed the fact the problems that most developed economies face is that all of their private sectors are in a balance sheet recession. This is something that has been described by Richard Koo, and I have referenced many times. Specifically Koo's work show that the Japanese experience over a decade ago is a prototype for what the developed economies are now facing. Yet the practically knee-jerk reaction to this is: "Japan is different".

For one of the cleanest presentations for why that rebuttal is patently false, watch this really excellent presentation by Koo:

7 Comments – Post Your Own

#1) On April 19, 2012 at 12:58 PM, chk999 (99.98) wrote:

Japan does have one important difference from the US. Their population is falling, our is not. This has some really huge implications over 20 years or so.

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#2) On April 19, 2012 at 1:14 PM, binve (< 20) wrote:

chk999,

Is the Japanese situation an exact one-to-one replacement for the US situation? No. To argue such would be foolish and I do not do so.

Are there *more* similiarites than dissimilarities such that the 'Japan is different' argument is invalid? Yes. The Japanase situation is much more of a prototype than most people admit, as Koo points out very effectively in this video, and in his numerous papers and books. And to dismss that argument does a huge disservice to everybody.

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#3) On April 19, 2012 at 3:12 PM, Frankydontfailme (27.26) wrote:

I haven't had time to watch the video yet, but plan on it.

I will say this, I've come along more to the side that we're all Japan. However, I wonder how much this is a bad thing? Has Japan really been that bad for the last couple decades? Is their life style so miserable with decent wealth and low unemployment? Would it be better to print money and have high inflation or be like Japan?

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#4) On April 19, 2012 at 6:28 PM, binve (< 20) wrote:

Frankydontfailme ,

Is their life style so miserable with decent wealth and low unemployment?

The Japanese private sector has been paying down debt and saving (i.e. getting out of their balance sheet recession) because the Japanese government has done enough deficit spending to prevent aggregate demand from completely collapsing (like the US government did in the Great Depression). This is precisely the dynamic that Koo describe in the video above from 7:30-8:50. This prevented their GDP from falling below the level from where their balance sheet recession started, which means that the Japanese government deficits supported aggregate demand while still providing the funds to the non-government sector to pay down debt and accumulate savings.

But take note of what Koo says from 9:40-10:40. That Japan tried cutting its deficit in 1996-1997 before the balance sheet recession was over and this exacerbated all the problems that already existed. And so your statement about low unemployment is an incomplete one. Because the Japanese unemployment rate which was between 1-3% from 1950-1995 goes from 3-6% after that policy was enacted:

http://www.tradingeconomics.com/japan/unemployment-rate

.

The point I am making is that Japanese employment while comparatively low, doubled as a result of trying to undergo austerity.

That worrying about the size of the deficit while in a blance sheet recession is exactly the *wrong* thing to do, because when the private sector has weak demand because they are paying down debt and the governement sector is propping up economic demand with the deficits, then when those deficits are cut before the blance sheet recession is over ecnomic activity falls which means layoffs and increased unemployment. Read this: http://monetaryrealism.com/businesses-hire-when-they-are-swamped-with-demand/.

Would it be better to print money and have high inflation or be like Japan?

High inflation? We have a major output gap. Where is this high inflation going to come from?

Regarding inflation coming from 'money printing': This is demonstrably false. We have undergone several rounds of QE (just like Japan did as Koo points out in the video above), the monetary base has since exploded and still broad money supply measures show little to no change. There is no transmission mechanism for QE or other Monetarist inspired policies because money supply growth is *not* determined from the supply side, it is determined from the demand side. And what is demand like in the US? We are in a balance sheet recession. Which is why a massive increase in the monetary base and lowering interest rates to 0 has resulted in no inflation.

Now perhaps you are using 'money printing' more generally as in referring to the deficit spending position of the government (I will give you the benefit of the doubt). This *could* result in inflation if the position was large enough. But consider that recent deficits have been 9-10% of GDP and inflation is extremely low (most of which is cost-push inflation from oil). We are absolutely nowhere near a demand-pull inflation environment.

We have a massive output gap and >8% unemployment. We have the private domestic sector still in a balance sheet recession, which means we will need to run deficits to allow the private sector to continue to save and pay down debt and to keep a floor under aggregate demand. Yet the *opposite* is being discussed. Both Reps and Dems both agree that the 'deficit needs to be cut' which means that the risk going forward is not inflation, it is deflation.

If this occurs before the private domestic sector recovers, then it will be just like Japan in 1996. Deficit reduction will lower economic activity, and the loss of activity will be met with cost-cutting and layoffs, which means unemployment will go up, just like it did in Japan.

But lets say by some miracle the US government gets its head out of its ass and actually increases the deficit instead of embracing some quasi-austerity, should we expect an immediate uptick in inflation? No, in the current environment not a chance. Businesses won't start to increase their prices until they have huge order backlogs that they can't satify by increasing their production (which they will first solve by hiring). Which means that the 'risk' of running larger deficits to increase demand means that unemployment will drop first before we start seeing any meaningful inflation.

In terms of risk, it seems clear to me that when you weigh small deficits going forward vs. larger deficits for the next several years, the economic risks and downsides are far greater by cutting the deficits .

 

 

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#5) On April 19, 2012 at 7:06 PM, Option1307 (29.92) wrote:

Really interesting video, thanks!

+1

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#6) On April 19, 2012 at 7:54 PM, Frankydontfailme (27.26) wrote:

I generally agree with you. A couple points though

"There is no transmission mechanism for QE or other Monetarist inspired policies because money supply growth is *not* determined from the supply side, it is determined from the demand side."

Right, but QE has so far led to increases in asset prices. Banks and speculators take on margin debt to buy securities, increasing their prices. They also speculate in inflation hedges (you would tell them that they are doing so incorrectly, and don't understand QE but as long as they make money they are right). It's all psychological. Ultimately, though, a bubble forms and the margin contracts. In the meantime, we have asset price inflation. When the margin contracts and everyone rushes to sell we'll have deflation...assuming the central planners can't pop out another bubble in the nick of time. End result, massive transfer of wealth from the many to the few (what else is new).

Curious though that you want to fill this output gap by deficit spending (offseting the private sector deleveraging). Wouldn't it be more logical to get at the heart of the matter? Have a jubilee where private sector debt is forgiven... sure TBTF banks will fail, but let them. They were bailed out and so they should be government property... all debt owed to banks that took a bailout is forgiven. Then the government could disband its own banks and allow the functional banks to take over. By deficit spending instead of debt forgiveness (we have a bit of both now), you missallocate capital immensely and instill moral hazard at the core of society.

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#7) On April 19, 2012 at 9:22 PM, binve (< 20) wrote:

Option1307 ,

Thanks!

Frankydontfailme ,

Right, but QE has so far led to increases in asset prices.

NO! Asset prices may have risen coincident with QE, but that is far different than asset prices being 'led' by QE. Correlation does *not* equal causation.

I agree with you that speculators take out margin and that has led to many of the past rallies, as I discussed here: http://caps.fool.com/Blogs/margin-debt-the-stock-market/619644. But that was neither specifically enabled or 'led' by QE. The same margin binge happened in 2000 and 2007. QE did not make it 'easier' for that to happen.

Have a jubilee where private sector debt is forgiven

I am not opposed to that at all, and I think Steve Keen's thoughts on this matter are particularly useful.

sure TBTF banks will fail, but let them

That was precisely the point of this post, particularly Section 5 and 6: http://marketthoughtsandanalysis.blogspot.com/2011/08/why-deficit-spending-and-creative.html#Section5.

By deficit spending instead of debt forgiveness

Like I said in the link that I just listed, there is nothing incompatible with deficit spending and creative destruction. I make the argument for smarter deficit spending and show the smarter courses that can be taken.

We both seem to agree that the status quo is not viable.

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