Richard Koo’s Great Recession: Confidence Is More Precious Than Gold

Confidence is more precious than gold. Only when everyone believes the future will be better can it truly become better. Richard Koo’s book 大衰退 (Great Recession, descriptive title) analyzes the reasons behind Japan’s decades-long great recession. Start with buying a home and rising or falling house prices. At the height of Japan’s bubble economy, an ordinary worker was preparing to buy a home. Prices were high—what to do? With strong confidence in the future, the worker would not worry. They expected both house prices and their salary to rise, so they would boldly take out a mortgage. Even with substantial debt on the books, they remained confident, continued eating and drinking as usual, and worried about nothing. Where did that positive attitude come from? Quite simply, house prices. Although they owed money, the home kept appreciating. Borrow a million, and perhaps the home’s value would rise by two million a few years later. Seeing assets grow continually, far beyond liabilities, brought security and confidence. They were willing to take risks, invest, innovate, and spend. Then came 1990 and a major event: Japan’s property bubble burst and prices plunged. Suddenly the home was worth much less. Previously, a home worth two million against a one-million bank debt was nothing to worry about. Now the debt was still one million, but the home had fallen from two million to 260,000. That decline is not hypothetical: asset prices in Japan really fell by 87% at the time. Even selling the home would not repay the debt. Liabilities exceeded assets. What could the owner do? Obviously, lavish spending was no longer possible. Every bit of income had to go toward debt repayment. Confidence and hopes for the future vanished. ---- Replace the ordinary household in this story with a company. For a business, liabilities exceeding assets is even more dangerous: bankruptcy and liquidation may be close. The company must use cash flow to repay debt. Survival comes first at a critical moment. That seems reasonable, doesn’t it? But when every business does this, three chain reactions follow. First, all innovation stalls. Businesses no longer want to devote spare cash to R&D, innovation, or new fields. Debt crushes their ambitions. Everyone thinks only about repaying it quickly and keeping the company alive. Nobody is thinking about future development. Investing in innovation is possible only if you had no debt beforehand. Toyota, for example, was among the few Japanese companies still innovating during the great recession. It developed industry-leading hybrid technology. It had the capacity because it never borrowed. After suffering serious financial difficulties early on, Toyota had established an absolute rule: never go into debt. But companies like Toyota were rare. When many companies focused entirely on repayment, a second consequence followed: economic activity stalled. Simply put, the economy functions when some people save and others borrow. During the bubble, Japanese companies’ borrowing amounted to 12% of GDP. After the bubble burst, they abruptly stopped borrowing. If everyone stops borrowing and spending, how can the economy grow? One person saving diligently may be virtuous. Everyone saving and nobody spending is an economic disaster. More troublesome still was the third consequence: all corporate confidence disappeared. How far did it fall? Japanese companies barely borrowed for more than a decade. By 2001, corporate savings actually exceeded those of individuals and households—and Japanese households are famously fond of saving. Once everyone’s goal becomes debt repayment, nobody borrows even if banks cut rates to zero. The Bank of Japan found this puzzling: “Rates are already zero; why won’t you borrow?” Companies thought, “I can barely repay what I owe; how could I borrow more?” Expectations around borrowing and consumption had collapsed, making bank stimulus ineffective. If nobody spends, nobody buys what businesses produce. Eventually the companies fail anyway, triggering unemployment and worsening the problem. What can be done? Someone must take the lead in borrowing and spending. If Japanese companies would not, the government had to. During the great recession, it borrowed heavily from banks and spent the money. This kept Japan’s GDP from falling. With GDP maintained, people still had income and could gradually repay debt, allowing the chain reaction to wind down. The process lasted decades. Koo calls this phenomenon a balance sheet recession: liabilities exceeding assets lead everyone to repay debt rather than borrow, causing economic stagnation. This is his most important economic idea. The frightening part is that, from a microeconomic perspective, everyone involved is making the right decision. A company whose liabilities exceed assets should repay debt quickly, shouldn’t it? Individuals cutting consumption to repay debt are also right, aren’t they? Banks lowering rates to encourage borrowing are right too. Yet these individually sensible actions combine into a great macroeconomic recession. This is what economist Samuelson called the fallacy of composition. Drawing on Japan’s experience, Koo offers two recommendations for balance sheet recessions. First, government should proactively increase its deficit—in plain language, borrow and spend more—to buy companies and individuals time to repair their balance sheets, meaning repay debt. Second, businesses need to regain confidence, borrowing and spending when appropriate. To borrow his words: if a company will not take even a zero-interest loan, it has no capacity to earn profits and no reason to exist. Investors should withdraw their capital and put it into other assets. ---- What matters most when economic pressure intensifies? Confidence. Economists often say confidence is more precious than gold. Only when everyone believes the future will be better can it truly become better. #得到頭條20230713 (Dedao Headlines, July 13, 2023) ---- Robin: “Facing an uncertain future, government can lead investment and expand innovation, giving people—especially the young—confidence in the future. That is how Taiwan can keep moving forward.”