As referenced the other day, I read another book by Richard Koo entitled The Escape From Balance Sheet Recession and the QE Trap (2015). As with his earlier work, much time is spent looking at the idea of the balance sheet recession and how it is applicable to, and offers explanatory power for, the current economic malaise in the U.S., Japan and Europe. So, in a sense, it is a bit repetitive with the other book, but with an opportunity for the author to assess his views based on the passage of time – and, to the extent that he said that monetary policy would not be potent after a significant asset bubble burst, he seems to be right.
One idea that Mr. Koo spends more time examining is the “QE Trap”, which he thinks was exemplified by the U.S. experience in 2013. At that time, the Fed started to talk about dialing back its bond purchases, leading to a significant rise in interest rates – a rise that Mr. Koo does not believe was warranted given the state of the economy. In other words, anticipating the change in policy, investors were trying to front-run the Fed, causing rates to rise and weakening all interest rate sensitive sectors as a result. Thus, whatever wealth effect had been created by lower rates stood to be wiped out and any nascent recovery would take a hit. I just don’t see that phenomena ever not being a problem. The Fed balance sheet is going to remain bloated for a long time.
Another topic that he tackles is the idea that the rise in asset values following QE, such as with stocks and real estate, is the result of a liquidity-driven market. But, whereas the Fed machinations would have led to an increase in the money supply with a vanilla recession, in a balance sheet recession, it is liquidity driven merely in the sense that investors and speculators are expecting the money supply to expand once the balance sheet recession has passed. I don’t place much value on that distinction, as it still leads to valuations that are not supported by DCF analysis – i.e., a bubble. And it is also still triggered by reckless monetary policy that leaves rates too low for too long.
As compared to other public economists, I think the author is more honest about the distortions that develop over time with market interventions by governments and central bankers. But, he still speaks to an idea that, in the case of extreme recessions, so as to avoid suffering for the masses, it is important to take steps that very much contravene market principles. That may sound reasonable on its face to save the world and minimize human suffering, but I think it sets up an endless cycle where these busts and crises happen more and more often. At some point, to end that cycle, there has to be some pain.
