China's 'Balance Sheet Recession' Is Like, Unlike Japan’s, Economist Who Coined Term Says
Sun Xuedong | Yin Fan | Shen Ying | Cao Yuhao | Zhang Yangyang
DATE:  May 08 2024
/ SOURCE:  Yicai

(Yicai) May 8 -- China's real estate bubble burst was similar as Japan's 34 years ago, but it has a huge advantage as many people know about the balance sheet recession, Richard Koo, chief economist of Nomura Research Institute, told Yicai.

The balance sheet recession concept Koo coined, which is considered the best explanation for Japan's "lost three decades" of economic stagnation, has been very popular in China in recent years.

Koo starts his new book 'Pursued Economy: Understanding and Overcoming the Challenging New Realities for Advanced Economies' with the balance sheet recession and global competition for capital. He explains why the Great Recession lasted so long and why policies that worked so well in the past are no longer suitable.

The fundamental disconnect between free trade and free capital movements must be addressed to maximize the gains from globalization while minimizing costs, according to Koo.

Below are excerpts from the interview:

Yicai: You coined the phrase 'balance sheet recession.' How do you see the similarities and differences between China today and Japan from the past?

Richard Koo: People are seeing the similarities because the real estate bubble burst. Once the real estate bubble burst and people realized that they were chasing what I call wrong asset prices, unsustainable asset prices, which was similar in Japan 34 years ago, if people no longer think the price will continue to go up but might actually go down, then you don't want to borrow too much money because your liabilities are high, the asset prices will be going down.

But when that happens on a very large scale, even though individually, people are making the correct decisions, but collectively, the economy could get killed. But once a big nationwide asset price bubble bursts, so many people will be repairing balance sheets by paying down debt, even at zero interest rates, and very few people would be borrowing money.

So then you have a situation where even at zero interest rates, so many people are saving money, so few people are borrowing money. And once you enter that world, the economy could start weakening very, very rapidly.

Japan took 20 years to really come out of this mess, and that's exactly what happened to the United States after the Great Depression when the New York stock market collapsed in October 1929. Everybody started repairing balances at the same time. No one was borrowing money, and the US lost 46 percent of its GDP in just four years.

In that situation, you cannot tell the private sector, 'Please borrow money,' because they're all doing the right things, paying down debt. So, if you cannot tell the private sector to change its behavior, the government has to come in and borrow and spend.

Yicai: So what's the difference between China now and Japan at that time?

Koo: Everyone in China knows about the balance sheet recession. That's a huge advantage China has over Japan 34 years ago, so if the government acts on it, this is a balance sheet recession, the government should be the borrower of last resort, borrow and spend of last resort, to keep the economy going. Then, average people may never feel a balance sheet recession because the economy will be maintained. That was not the case in Japan 34 years ago.

Yicai: Is China now in a kind of balance sheet recession?

Koo: I do hear that people are not borrowing money anymore, some people are beginning to pay down debt. That's probably a smaller portion of the population than what happened in Japan 34 years ago.

One part that is not in China's favor relative to Japan 34 years ago is that the Japanese bubble was really just a bubble. But in the Chinese case, the construction industry had a huge boom over the years, and it's now 26 percent of China's GDP.

Now construction is down very sharply, which means that industry is shrinking very rapidly. But that would hit the GDP directly. So compared to Japan, which was just a balance sheet problem, China has a balance sheet problem, probably smaller than Japan's, but you have a big construction problem, and the two together could be quite challenging for China.

Yicai: You said that the balance sheet recession typically happens after the bursting of a bubble. Do you think China's purposefully pricking the property bubble is the right move?

Koo: The right thing to do, now we know after the fact, was never to let the bubble happen because the Japanese bubble was also pricked by the government. But once the bubble burst, we never thought repairing balance sheets could take 20 years.

And if they had known that in advance, I'm sure the Japanese government may have taken very many different policies in addition to pricking the bubble. I would like to think that China realizing that there is a disease called balance sheet recession, will pick public works projects very carefully because this is not a one or two-year issue, it could be a five or seven-year issue.

So if it's that long, you better pick a good project so that five or seven years later, you have a public works project that is really helpful for the Chinese economy.

Yicai: Your prescription for addressing the balance sheet recession is for the government to step in to borrow. Do you think what the Chinese government does is enough?

Koo: That all depends on how the private sector is reacting. If the private sector is really saving 10 percent of GDP and companies are not borrowing that much, then the government has to borrow the remaining part to keep the economy going. The fact that the Chinese government bond yield is down to 2.4 percent suggests that there are too many savings relative to borrowings.

And if that's the case, we should listen to the bond market. And if the bond market tells you that everybody's buying government bonds because the private sector is not borrowing money, then that means the government has to borrow money. The sooner, the better.

Yicai: What is the right way to cure Chinese economic woes?

Koo: When going through schools, we were taught how effective monetary policy is. When I moved to Japan and saw what happened after 1990, what we were taught in schools, how effective monetary policy could be, was incomplete at best because the professors never told us that for monetary policy to work, there have to be plenty of borrowers out there. If there are no borrowers, the monetary policy is completely irrelevant.

We found that in Japan first, and we also found that after 2008 in Europe and the US, borrowers all disappeared because they were all repairing balance sheets after the housing bubble collapsed.

Fiscal policy is the key. I will recommend using more fiscal power to revive the economy very strongly. If the government comes in and says, 'We're going to do this fiscal policy, and we're going to keep this fiscal policy until the private sector balance sheets are repaired,' then the private sector will feel very safe. Then, many people might actually spend more or even invest more or borrow more.

Editor: Martin Kadiev

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Keywords:   Japan,real estate,balance sheet recession,fiscal policy