Friday, August 5, 2011

Welcome to the New Lost Decade

I see that a stock market crisis is making news today, with some of the worst slides seen since October 2008. Two major causes of the panic and distress selling, it would appear, are recession fears (what else did they think austerity would do?) and the on-going problems in the Eurozone, that neoliberal monetary union that is a contemptible and predictable disaster. Other investors may well be worried about the non-problem that is US debt, US social security, or other sovereign debt in nations with monetary independence.

But there is a much deeper disease rotting modern neoliberal capitalism. Many countries are stricken with debt deflation, caused by excessive private debt and the collapse of asset bubbles in real estate from 2007–2009, which led to severe recessions in many nations (or, in other words, “balance sheet recessions”).

The theory required to explain what is afflicting Western economies is Hyman Minsky’s financial instability hypothesis.

Keynesian stimulus was adopted by many countries from 2008–2010 which prevented depression, along with a poorly-designed and crony capitalist bailout of the financial sector in the UK and the US (which should have been more like a Swedish-style bailout of the early 1990s). Over the past year, there has been a marked turn to austerity and attempts to balance state budgets in many nations.

Two historical examples spring to mind that teach us precisely what happens in these debt deflationary circumstances:
(1) Under Roosevelt, the US had a recovery and falling unemployment in every year of Roosevelt’s administration from 1933 until 1937, but in the latter year Roosevelt listened to the advocates of austerity and tried budget balancing: the effect was to plunge the economy back into recession in 1937.

(2) In the 1990s, Japan experienced its own debt deflationary crisis in the lost decade, which had been caused by a collapsing asset bubble in real estate. In 1996–1997, the Japanese Prime Minister Ryutaro Hashimoto turned to contractionary fiscal policy and austerity, including personal income and national sales tax increases. This plunged Japan back into recession and the lost decade persisted until the early 2000s.
While we have avoided the worst effects of debt deflation so far, we may see disaster in the coming years, as economies plunge back into outright recession.

The Taiwanese heterodox economist Richard C. Koo explains the nature of the crisis below, and how the West is making the same mistakes as Japan. Richard Koo’s notion of the “balance sheet recession,” I might add, owes a great deal to Hyman Minsky, an unsung Keynesian hero, a man whose theories ought to be read by policy-makers everywhere today.


  1. I would just like to add a few more points on the US recession. Personal saving increased from 300 billion $ before the crisis to 500-600 billion $, essentially eating up all of the fiscal stimulus packet.

    Furthermore, corporate profits returned to their pre-crisis levels quite quickly. The reason was that although average hours worked dropped by around 6%, output per hour (productivity) increased by more than 10%(!) while compensation per hour increased only by 2%. So in general the households did not earn the income necessary to deleverage on a sufficient scale while the recovery (which was mostly due to the automatic stabilizers providing additional liquidity to the economy) was mostly jobless.

    Examining the details makes it clear that the stimulus packet was rather small in contrast with the household income needs.

  2. A year ago, I was most definitely a strong deficit hawk, but I have been edging away from it, until I very recently realized how pointless the deficit cutting deal in the US was.

    Why is the US government so eager to stop accepting money from savers who are only too eager to give their money to it? Savers whose only other alternative to put it in investments whose earnings would be taxed to give even lower sums of money?

    The United States government not only has a deficit as a percentage of GDP that is lower than that of fiscal-crisis-stricken governments but also lower than that of fairly stable governments as well.

    Portugal, which is actually facing a fiscal crisis, faces 22% p.a. interest rates, while US has <3% p.a. interest rates that are lower than the rate of inflation. American bondholders were paying the US government to take their money from them.

    And the rise in deficit wasn't even because of rise in government spending - which currently is much lower as a proportion of all economic activity than it was during WW2 and immediate postwar years. It was mainly because of a fall in tax revenues in a recession period, while spending has only increased at a lower rate than it was in prior years.

    THIS is a heavily-debted government?

    Some people don't know the difference between an insolvent government and a wasteful government. Yes, US military spending - for example - is extremely wasteful with huge spending on war machinery with a short lifespan and high replacement requirements. But it is hardly high enough to make a dent in the whole budget.

  3. Leijonhufvud likes to refer to deleveraging and the private debt repayment as "sink holes" for fiscal stimulus - not a bad description.

    It is obvious that the private debt needs to be cleared, by more radical measures.

  4. What's so bad about current Japan economy? No growth? And who cares? I've allways seen all these 'Japanese problems' as exaggeration. They have no unemployment and a high advance productive economy.

    The problem about Japan it's that's sustained by exports, and this obviously can't be applied globally. But the first world have to get used to non-growth environments and the sooner the better, the system needs an institutional and monetary frame that can survive in such environment or we are screwed and it will be problematic politically and socially in the long run.

  5. the first world have to get used to non-growth environments

    Anonymous, congratulations, you have achieved the highest level of development for any socialist/keynesian "thinker", Marks would be proud of you.

  6. Prateek, good question, why should USA stop accepting money from Chinese government trying to keep yuan low by buying US government bonds to subsidize chinese exports (ie richest chinese owners of factors of production), payed by poor Chinese with higher prices? It's just another reason why government should never be allowed to borrow money even when it is profitable. Some poor people are always hurt in any government parasitic consumption (uncanny how Austrian theoretical fundamentals invariably prove true in practice), even if they are abroad and under totalitarian governments, and you as leftists should be somewhat more sensitive to their plight (in theory at least).

  7. Kostas, you may also check whose savings have increased so much thanks to the keynesian stimulus package. Of the poorest? Guess again. Whose salaries did not keep track with productivity? Of the poorest? Guess again. Yes, financial elites will wholeheartedly support your call to increase government stimulus, the poorest will uknowingly pay for that via inflation tax as usual no problem.

  8. "Yes, financial elites will wholeheartedly support your call to increase government stimulus,"

    The financial elites are mostly demanding auterity and budget balancing.
    Get your facts straight.

    "the poorest will uknowingly pay for that via inflation tax as usual no problem.

    You mean inflation that is the secondary effect of the stimulus that causes employment or poor people and increases their income?
    Tell us another fable.

  9. Interesting, afaik, all of the bailout money went to wallstreet, not mainstreet.

    Which employment of poor people? The one that never materialized?

  10. "Which employment of poor people? The one that never materialized?."

    The employment that has occured in vast numbers of countries that used Keynesian stimulus: China, Germany, France, Norway, Sweden, Canada, Australia, New Zealand, South Korea etc etc.

    As for the US, the stimulus has prevented much higher unemployment. If the US had gone bigger on stimulus, as a good many other countries did, they would have seen much better employment growth, as in other countries

  11. Herpderp, "financial elites" are demanding whatever is the opposite of what I want.

    Come on, this sort of shallow internet rhetoric I don't understand - there is always some supposed fictional plutocracy that is opposing your particular agenda. Never mind that billionaires and well-funded interest groups can have dozens of entirely different agendas that can go against one another. What exactly is common between plutocrats Grover Norquist, Warren Buffett, and George Soros? Little.

    LK, Joanna, I imagine that financial institutions have been supporting austerity in the Eurozone given the high bond rates for PIIGs, but in the US, they have been willing to buy American bonds at high prices for a long time. Different behaviours in different markets at different times. No clear agenda.

    As it is, we can't sustain any position based on whether or not billionaire elites disagree with it, unless we have to disagree with the idea that the sky is blue, just because a billionaire said so.

  12. Prateek, I'm just saying keynesian stimulus always benefits the richest, financial elites in particular. Sure the elites would also like to see great fundamentals, just like everyone else, so they often advise government austerity in terms of government spending, but they still love keynesian stimuluses in terms of new money pumping even more. Which then ruins fundamentals. Oh well... the whole cake having and eating business.

  13. LK, normally unemployment would indeed temporarily go up, malinvestments liqudated, just like in the short post WWII slump, before you can have a healthy boom. But sure every government can print any amount of their own currency as they wish, so you can keep keynesian stimuluses running and infinitely oscillate around recession (arguing that it is not really a recession etc), like Japan over last two decades.