Popular Economics Weekly

A very good Barron’s Magazine article just out by a Japanese economist helps to explain why it is so necessary to keep stimulus spending in place for at least another 3 years. The economist, Richard Yoo of Nomura Research Institute, maintains that we could repeat Japan’s 15-year deflationary spiral, if we cut the budget deficit too soon before the recovery is in place.

Why? Because we are in what he calls a “balance-sheet” recession, where assets have been drastically devalued yet the debt used to purchase said assets hasn’t shrunk. That is what happens during a recession, unless government takes steps to bring down the debt loads, as in reducing the mortgage principal on under-water mortgages. The Treasury is considering implementing such a step in the $75 Billion HARP loan modification program.

Japan tried to reduce their deficit twice in those 15 years, according to Dr. Yoo, but on both occasions the economy collapsed and tax revenues dropped. Why? Borrowers and businesses were saving to pay down their debts rather than spending. So the question is how to stimulate enough demand that producers will continue to produce goods and services and therefore hold onto their workforce. Otherwise, if demand continues to fall, it leads to a vicious cycle—job cuts lead to a downward spiral in incomes as well as prices, leading to more job cuts.

The answer is classic Keynesian economics. Lord Keynes asked the question in the 1930s: why do governments spend money during times of war to stimulate economic growth, but not during peace time? Dr. Yoo said it took Japan 10 years to understand that it was necessary for government to stimulate enough demand to prevent deflation. “The (U.S.) economy would be shrinking quickly if the government didn’t borrow money (that is currently sitting unused in banks) so the GDP (Gross Domestic Product) could be maintained; the private sector would have income until debt minimization is over.”

So the key is how quickly debt minimization is happening. The Japanese were hampered by their Keiretsu relationships, or intermingling of bank + corporate ownerships that caused them to hide their bad assets. In fact, it led to putting good money after bad, in an attempt to prop up failing businesses and so starving healthy ones of needed credit to expand.

The good news is that consumers are paying down their debts in record numbers—mainly revolving debt—as we have discussed in past columns. So much so, that consumer revolving, credit card debt levels have returned to 2006 levels, as they cut up their cards and banks cut back on issuing new credit cards.


Consumer credit decreased at an annual rate of 8-1/2 percent in November, according to the Federal Reserve. Revolving credit decreased at an annual rate of 18-1/2 percent, and nonrevolving credit decreased at an annual rate of 3 percent. This graph shows the year-over-year (YoY) change in consumer credit. Consumer credit is off 3.9% over the last 12 months - and falling fast. The previous record YoY decline was 1.9% in 1991.

Such a balance-sheet recession is little understood by either government or business, according to Dr. Yoo. It requires a high government debt load to cure, which takes nothing away from private sector investment as long as private sector, demand side spending is still shrinking.

This recession has therefore baffled neo-classical, i.e., so-called free market economists, who tend to believe that markets cure themselves. But that makes no common sense—at least when balance sheets are so out of kilter. History has shown that businesses won’t begin to hire workers to produce more, unless they see an increase in demand, which means spending. New investment follows increased spending, in other words.

No one wants to see a repeat of Japan’s experience of the 1990s, when both its real estate and stock market bubbles burst. This is something that Chairman Bernanke and Fed officials are well aware of. In fact, it wasn’t until 2008 that Japan came out of its deflationary spiral.


“Unless the (U.S.) government issues a sufficient amount of debt and boosts fiscal expenditures, the (U.S) economy will fall into a deflationary spiral”, is Dr. Yoo’s warning.

Harlan Green © 2010