Revisionism?

George Friedman:

"In making the decision to use a nuclear weapon, the U.S. faced some tough choices. It had to balance its moral responsibility to American troops and those who were still being slaughtered by the Japanese against the lives of those who would be killed in a nuclear attack. But the idea that Japan was ready to surrender is a myth. It was ready to negotiation a peace deal; it wouldn’t accept unconditional surrender. This could have opened the door to another war, allowing the slaughter of Americans who had already fought and survived a long war."

The Dollar

Another great interview on Real Vision with Luke Gromen.  He covered a lot, but I thought his summary below of Bretton Woods and how other countries are turning their backs on it, and the implications, is very useful.  Not for nothing, but part of the reason to prefer a Trump over Clinton was because of the belief that Clinton was prone to follow path one:

“…look, the deal was-- to be flip, the deal was, you take our jobs. You take our factories. You take our dollars. And then you lend us back the dollars, and we'll buy the stuff from you. And in third quarter '14, with the rollover in FX reserves, the world's saying, we're not taking the dollars anymore. And so I think what's ultimately happening is there's two paths for the US to go with that. Path one is, we'll invade your country and make you take the dollars. And path two is, fine. Deal's off. We'll bring the factories back. We'll bring the jobs back. If you don't want the dollars, you don't get to keep the factories. It's your choice.”

More on Koo Recessions

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.

Counter Factuals

I am reading another book right now by economist Richard Koo, innovator of the balance sheet recession concept.  If you remember what his idea entails, it's that when you have a big bust in asset prices when folks are highly levered, causing technical insolvency as values tumble, the introduction of monetary stimulus is of limited usefulness.  Ultimately, you need fiscal policy from the government to help mend the economy.  He notes that the big examples of a balance sheet recession include the Great Depression, Japan's bust in the late 1980's, and most of the large western economies post-2008.  What Koo emphasizes is that fiscal stimulus, in those cases, was the ultimate antidote.  But, look a little deeper, and there is probably cause for concern even beyond the misallocations that are allowed to linger.  In the case of Japan for the past 25 years, and the U.S. since 2008, the fiscal stimulus implemented prevented a Great Depression type event, but still did no better than only tepid growth.  Now, looking at the Great Depression, Koo would argue that there were initially mistakes under Hoover that exacerbated the initial bust, and later under FDR when he tried to cut budget deficits and triggered the double-dip in 1937.  So, what was it, by Koo's account (and others, like Paul Krugman who calls for a space invasion), that did the trick?  Massive, massive stimulus -- and the only thing that ever gets you there is war.

The Holy Grail of Macroeconomics

The subtitle is Lessons from Japan’s Great Recession and the author is Richard Koo (2009).

After seeing the author interviewed on RealVision TV, I decided to pick up his book. He is an economist most well-known for formulating the concept of a balance sheet recession, and then convincingly ascribing it to be the cause of both Japan’s lost decades and America’s Great Depression. What it describes is in the aftermath of a large bubble bursting, balance sheets are damaged – and whereas all classical, mainstream economists assume that economic actors are always profit-maximizing, Koo understands that borrowers prioritize paying down debt in these moments, not further borrowing, and so monetary stimulus holds no weight to turn the economy around until balance sheets are repaired. Therefore, the answer must be fiscal policy to maintain aggregate demand and to avoid a deflationary gap. The government must be the borrower of last resort to keep the economy on a steady plane during these periods.

What are the implications and particular nuances of this theory relative to anything else that gets tossed around?

For starters, it tells us that quantitative easing will not create economic growth, because low interest rates are not an impetus to borrow and invest when the priority is simply to pay down debt. Koo implies that the current global recession is also a balance sheet recession, which might explain why QE has not had the consequences that were hoped for. But I am not sure that his theory offers a complete explanation – specifically, it sure seems like QE has led to another bubble in financial assets, and nowhere do I see an explanation in his theory for why that is happening. Unless we aren’t really dealing with a balance sheet recession.

He distinguishes himself from Keynes in explaining the liquidity trap – which is the effect of zero rates causing bonds and cash to be substitutes for one another. But, Keynes still assumed that economic actors were profit maximizers, and therefore identified the logjam in borrowing to be with the lenders rather than the borrowers. More generally, in contrasting himself to the acolytes of Keynes, Koo understands that the fiscal policy solution is only appropriate for a downturn that qualifies as a balance sheet recession, not just any and all recessions, otherwise government borrowing will crowd out private investors and cause inflation and rates to rise.

With respect to gold, and the idea that the gold standard exacerbated the great depression by preventing the creation of needed reserves, Koo’s theory obviously suggests that where there are no borrowers that the creation of new gold-backed reserves was not the problem – the demand for funds was not there. As a corollary of that point, Koo acknowledges that the Central Bank system requires confidence, and even though the gold standard has been eliminated, it is important that central bankers operate as if such a restraint was still in place.

Overall, another tool and theory to understand the world.

Rational Thinking

When it comes to understanding what's going on in the world -- and, by that, I mean the real facts and actual implications, rather than what the mainstream media normally feeds everyone -- there are a handful of subscription sites that I tune in to.  For geopolitical thinking and insight, I read Stratfor and Geopolitical Futures (which was formed in the past year by the original founder of Stratfor).  For finance, economics and the like, I still tune in to Bill Fleckenstein, but I also really enjoy Real Vision TV.  It is a website that produces long form interviews with some of the smartest, and sometimes obscure, names in that universe.  It provides a forum, versus financial television, where ideas can be fleshed and not everything is driven by catchy soundbites.

With that prelude out of the way, a very recent interview on Real Vision was conducted by Grant Williams (a co-founder of the site) with David Dredge of Fortress Investment Group.  Really interesting stuff, with a few specific points that resonated and brought home the pickle that the world is in.

First off, in the context of the great boogie man, deflation, it was pointed out that over the past 40 years, there have been endless tweaks to the calculation of core inflation.  And the subjects both observed that none of those alterations have ever led to a higher print.  So, if the answer (as preached by central bankers and mainstream economists) to our woes really is inflation, why does it seem that over and over again, the attempt is made to refine its definition so as to bring it down.

Secondly, in a discussion about Japan, but really an insight that applies everywhere, Mr. Dredge noted that there is growing talk of helicopter money as the next step in dealing with the country's financial issues.  And, really, what that evolution speaks to is an admission that monetary policy has done all that it can and it is time to turn to fiscal policy.  And, out of that, the skeptical thinker should have two questions for the Japanese central banker or New York Times "economist" who is a proponent:

(1) Japan has run large fiscal deficits year after year after year since it's economy turned in the late 1980s.  Are we really saying that just a little more of that is really going to make a difference?

(2) Helicopter money implies more debt on the BOJ balance sheet, more government debt, and higher fiscal deficits.  If putting more assets on the BOJ balance sheet and running deficits really was the answer, especially in the case of Japan, shouldn't we have whipped this problem a long time ago?

Anyway, that's the type of stuff that allows you to see the world as it is, and not how others would tell you to see it out of convenience.  Highly recommended.