In a recent story I pointed out that Richard Koo said it was not significant that the USA has been faster to respond to the current balance sheet recession. Now, he was primarily referring to the ineffectiveness of monetary policy during a balance sheet recession and the fact that it doesn’t matter how quickly you cut rates or implement QE during this sort of recession. I largely agree with these comments. But I think it’s important to note that the USA has a slightly different form of balance sheet recession and is responding to it with fiscal stimulus more quickly than the Japanese did. This, in my opinion, is unlikely to result in a balance sheet recession as long as Japan’s.
Just to review – it’s important to note that Japan’s debt crisis existed primarily at the corporate level. In his superb book, The Holy Grail of Macroeconomics, Koo explained the situation:
“Indeed, this leverage issue was another reason Japanese firms moved to pay down debt during the 1990s. Exhibit 2-2 shows leverage ratios at Japanese and US firms. Japanese businesses used to be extremely dependent on debt financing relative to their Western counterparts. In the first half of the 1980s, for example, leverage ratios at Japanese firms were five times those at US corporations. But no one thought twice about this at the time, because the economy was rapidly expanding, and asset prices were surging higher. Few were worried about debt levels under these circumstances. After all, the use of borrowed money to acquire assets raises few eyebrows as long as the economy is expanding and the value of corporate assets is rising. If anything, companies were commended for taking on more debt because greater leverage translated to a higher return on equity.
But this cycle began to reverse when the bubble burst in 1990, and the Japanese economy entered a period of low growth and falling asset prices. Companies carrying heavy debt loads still had to service this debt even as earnings declined, putting their survival in jeopardy. In effect, firms had to pay down debt starting in 1990 not only to put their balance sheets in order, but also to bring leverage down to a level benefitting an era of lower growth. In this sense, too, Japanese firms have made substantial progress in reducing leverage over the past 15 years.”
These are very important points. You could essentially replace “households” with “businesses” in the above paragraph and you’d be describing the situation in America today. And that’s the exact difference....