The Escape from Balance Sheet Recession and the QE Trap: A Hazardous Road for the World Economy

Table of contents

1. Foreword
   1. Notes on the Data Used in This Book
2. About the Author
3. CHAPTER 1 Balance Sheet Recession Theory—Basic Concepts
   1. GDP and Inflation Fueled by Growth in Money Supply, Not Monetary Base
   2. Japan Fell into Balance Sheet Recession in 1990s
   3. Plunging Asset Prices Create Balance Sheet Problems for Businesses
   4. Japanese Firms Rushed to Repair Balance Sheets by Paying Down Debt
   5. “Correct” Private Sector Behavior Tipped Japan into Contractionary Equilibrium
   6. Collapse of Japan's Bubble Destroyed ¥1,500 Trillion in Wealth
   7. Why Japanese GDP Did Not Fall after Bubble Burst
   8. Fiscal Stimulus Saved Japan's Economy
   9. “Good” Fiscal Deficits Were Not Perceived as Such
   10. Balance Sheet Recessions and the Limitations of Econometric Models
   11. Fiscal Stimulus Works in Two Stages
   12. FDR Made Same Mistake in 1937
   13. Reactive Fiscal Stimulus Is Far Less Efficient
   14. Fiscal Deficits Are Easily Financed during Balance Sheet Recessions
   15. Self-Corrective Mechanism for Economies in Balance Sheet Recessions
   16. Two Types of Fiscal Deficits Require Different Responses
   17. Fiscal Deficits Must Be Viewed Relative to Private Savings
   18. Consequences of Leaving Things Up to the Market in a Balance Sheet Recession
   19. GFC Triggered by Insistence on Market Principles
   20. Volcker Understood Systemic Crises
   21. Little to Be Gained from Bashing Those Who Have Already Come to Their Senses
   22. Recovery from Balance Sheet Recession Takes Time
   23. Forward Guidance Important for Fiscal as Well as Monetary Policy
   24. Fiscal Consolidation: Better Too Late Than Too Early
   25. Three Points to Consider Regarding Costs for Future Generations
   26. Japan Had a Shot at Full Recovery in 1996…
   27. Conflation of Balance Sheet and Structural Problems Extends Recession
   28. Distinguishing Balance Sheet Recessions from Structural Problems and Financial Crises
   29. Democracies Are Ill-Equipped for Dealing with Balance Sheet Recessions
   30. Keynes Also Overlooked Private-Sector Debt Minimization
   31. Those Who Prevent Crises Never Become Heroes
   32. Democracy Plus Balance Sheet Recession Equals “Secular Stagnation”
   33. Appendix to Chapter 1: Summary of Yin and Yang Phases of Economy
   34. Notes
4. CHAPTER 2 Monetary Policy and the Quantitative Easing Trap
   1. Monetary Policy Impotent without Demand for Funds
   2. Mechanisms for Money Supply Growth
   3. Government Borrowing Drove Money Supply Growth in Japan
   4. Economics Dogged by Incorrect Analysis of Great Depression
   5. Japanese Monetary Policy Has Relied on Fiscal Policy for Past 20 Years
   6. Balance Sheet Recessions Triggered by Borrower-Side Problems, Financial Crises Triggered by Lender-Side Problems
   7. Bernanke Himself Says QE2 Unlikely to Have Major Macroeconomic Benefits
   8. Real Aim of QE2: Portfolio Rebalancing Effect
   9. Can Higher Share Prices under QE2 Be Justified on DCF Basis?
   10. QE2 a Big Gamble for Bernanke
   11. QE Undermined U.S. Leadership in G20
   12. QE with No Income Effect Harms Other Countries
   13. Dollar-Buying Intervention by U.S. Authorities Would Have Produced Different Outcome
   14. Inward Capital Controls Help Keep Bubbles Fueled by Hot Money in Check
   15. QE Represents Government Intervention in Asset Markets
   16. Operation Twist Lowered Long-Term Rates, but to No Effect
   17. Operation Twist Provided Only Limited Economic Boost
   18. Bernanke Admits the United States Faces Same Problems as Japan
   19. Fed Overestimates Impact of Quantitative Easing
   20. “Lower Long-Term Rates = Higher GDP” Formula Does Not Hold during Balance Sheet Recession
   21. Fed Has Also Underestimated Costs of QE
   22. Unorthodox Monetary Policy Distorts Signals from Bond Market
   23. Needless QE Acts as Drag on Financial Institutions
   24. Why Fed Embarked on QE3 Two Months before Presidential Election
   25. Post-Bubble Wage Growth Nearly Identical in the United States and Japan
   26. The “Inconvenient Truth” of the Real Cost of Quantitative Easing
   27. BOJ's First Round of QE Was Easy to Wind Down Because It Was Conducted in Money Market
   28. Redemption of Central Bank Bond Holdings Will Not Reduce Commercial Banks' Current Accounts
   29. Government Issue of Refunding Bonds to Private Sector Would Absorb Excess Reserves
   30. Redeeming Fed Bond Holdings Has Same Effect as Issuing Deficit Bonds
   31. Strength of Private Loan Demand Different at Start and End of QE
   32. Paying Interest on Excess Reserves Would Enable Rate Hikes . . .
   33. But Cost Could Be Prohibitive
   34. Cost of Winding Down QE Has Yet to Be Properly Analyzed
   35. Debate over Winding Down QE Sparks “Bad” Rise in Rates
   36. “QE Trap” Appears Increasingly Likely
   37. Continued QE Trap More Likely Than Hyperinflation
   38. BOJ Found Itself in Same Position in 2006
   39. Fed Admits That Supply and Demand Matters, Too
   40. Fed Changes Course Despite a 1.1 Percent Inflation Rate
   41. Traditional Phillips Curve Relationship No Longer Holds
   42. Upcoming Chapters in QE Saga
   43. Capital Injection Could Also Be Threatened If Blame Shifts to Fed
   44. Sales Should Start with Bonds Maturing Soon
   45. Final Cost of QE Can Be Calculated Only at End of Fourth Chapter
   46. Theoretical Debate on QE Has Focused Entirely on Benefits and Ignored Costs
   47. Central Banks Should Establish a New Reaction Function to Drain Reserves
   48. Emerging Markets Need Inward Capital Controls to Protect against QE
   49. Japan Should Learn from Pioneers in QE Using Long-Term Bonds
   50. Financial and Capital Markets during Balance Sheet Recessions
   51. Balance Sheet Recession Brings Special Kind of Liquidity-Driven Market
   52. Is Inflation of 1–2 Percent Too Low?
   53. Does Inflation Improve People's Standard of Living?
   54. Absence of Inflation Concerns May Have Lifted Utility of Consumption in Japan
   55. QE Should Not Be Pursued Any Further Given Difficulty of Winding It Down
   56. QE a Problematic Byproduct of Balance Sheet Recessions
   57. Notes
5. CHAPTER 3 The United States in Balance Sheet Recession
   1. Rating Agencies Need to Be More Tightly Regulated
   2. Why Was Lehman Allowed to Fail?
   3. TARP Prevented Bank Failures but Also Created Turmoil
   4. U.S. Authorities Changed Course with “Pretend and Extend”
   5. Fiscal Stimulus Shifts from “Three Ts” to “Three Ss”
   6. Obama Has Yet to Disclose the Name of the Disease
   7. Bernanke's “Fiscal Cliff” Warning Saved the U.S. Economy
   8. Bernanke Declared Monetary Easing Could Not Offset Impact of Fiscal Cliff
   9. Fall from Fiscal Cliff Triggered Japan's Deflation
   10. U.S. Households Still Repairing Balance Sheets
   11. Nonfinancial Corporate Sector Faced Difficult Years in the Wake of GFC
   12. U.S. Companies Hit Far Harder by GFC Than by Collapse of Internet Bubble
   13. Can U.S. Corporate Sector Become Economic Engine?
   14. Long-Term Rate “Conundrum” Kept Housing Bubble Alive
   15. Post-2007 Fed in Similar Position to BOJ in 1990s
   16. Flow-of-Funds Data Suffer from Poor Accuracy
   17. Bad Data Were Good for Policy Debate
   18. Estimated Correctly, Private Sector Financial Surplus Continues to Shrink
   19. Recovery in U.S. Private Sector Demand for Funds May Outpace Japan
   20. Housing Market Strength during the First Half of 2013 May Have Contained Temporary Factors
   21. Fed's Reputation Falls to Earth
   22. Notes
6. CHAPTER 4 The Great Potential of Abenomics
   1. BOJ Already Had a Massive QE Program in Place
   2. Why Didn't Japan's Institutional Investors Follow Their Overseas Counterparts?
   3. Yen Fell and Stocks Rose Because Japan's Institutional Investors Stayed in Bond Market
   4. Honeymoon Altered Japan's Economic Landscape
   5. Bond Market Reaction Ended Abenomics's Honeymoon
   6. Private Sector Continues to Save after One Year of Abenomics
   7. Japan's Growth over Last Year Attributable to Fiscal Policy
   8. Can the Abe Administration Overcome the Trauma of Balance Sheet Recession?
   9. The Trauma of the Balance Sheet Recession Will Be the Last Effect to Go
   10. Focus of Structural Reforms Must Shift from Lenders to Borrowers
   11. Is Japan's Slump Due to Shrinking Population or Balance Sheet Problems?
   12. Slump in Domestic Demand Was Due to Balance Sheet Recession, Not Decline in Working-Age Population
   13. Personal Financial Assets Have Already Been Invested Somewhere
   14. Corporate Debt Pay-Downs Weighed on Consumption and Investment
   15. Real Bottleneck in Japan's Economy: Lack of Loan Demand at Private Companies
   16. Balance Sheet Recession Has Taught Japanese How to Be Frugal
   17. Is Japan Really Closed to Immigration?
   18. Japanese Economy Would Cease to Function without Foreigners
   19. Agricultural Reforms a Major Step for LDP Government
   20. Structural Reforms Are Microeconomic Policies That Take Years to Work
   21. Scale of Structural Reform Is Also Important
   22. We Should Not Expect More Good Fortune
   23. Kuroda May Be Trying to Close Gap between Expectations and Reality …
   24. BOJ and Government Must Stress That Inflation Overshoot Will Not Be Tolerated
   25. BOJ Had Weapon to Prevent JGB Crash during Balance Sheet Recession
   26. No One Has Criticized Japan for Currency Manipulation
   27. Japan Supported Global Economy for Four Years after Lehman Collapse
   28. Real Effective Exchange Rate Does Not Fully Express Japanese Firms' Pain
   29. Rising Fiscal Deficits Caused by Change in Corporate Behavior
   30. How Should Japan's Tax System Be Reformed?
   31. Fiscal Stimulus Introduced to Offset Consumption Tax
   32. Current Corporate Earnings Based on Massive Fiscal Deficits
   33. Working Down Public Debt Will Require Bold Policies to Lift Japan's Growth Rate
   34. Incentives Needed to Restore Japan's Economic Vitality
   35. More Effective Land Utilization Could Propel Growth
   36. Japan Needs Bold Tax Reforms Modeled on U.S. and Hong Kong Systems
   37. Policies Need to Change Perceptions of Japan at Home and Abroad
   38. Notes
7. CHAPTER 5 Euro Crisis—Facts and Resolution
   1. Euro's Adoption Lowered Interest Rates Sharply
   2. Maastricht Treaty Acted as Constraint on Credit Risk
   3. Greece Was Spoiled by Euro, and Germany Reacted Violently
   4. Germans Believed Structural Reforms Required a Crisis
   5. German Balance Sheet Recession Eight Years before GFC Started the Crisis
   6. German IT Bubble Brought about Euro Crisis
   7. ECB's Rate Cuts Create Bubbles outside Germany
   8. Misunderstandings Regarding Lack of Competitiveness in Southern Europe
   9. Money Supply Growth Much Lower in Germany
   10. German Reforms Responsible for Only Half of Competitive Gap
   11. Germany Benefited Most from Euro
   12. One More Mutual Dependency between Germany and Eurozone Periphery
   13. Spain's Vicious Balance Sheet Recession
   14. Ireland's Household Sector Forced to Pick Up Pieces after Massive Housing Bubble
   15. Irish Businesses Remain Net Savers
   16. Portugal's Balance Sheet Recession Began Quite Recently
   17. Italy Is in Same Position as Portugal
   18. Why the Polarization of Eurozone Government Bond Yields?
   19. Eurozone Allows Investors to Buy Government Bonds of Member Countries with No Currency Risk
   20. Eurozone-Specific Fund Flows Amplify Economic Swings
   21. Meaning of “Fiscal Space” Differs Inside and Outside Eurozone
   22. Maastricht Treaty Is Defective and Should Be Revised Immediately
   23. In Practice, Fiscal Stimulus Requires EU and ECB Approval
   24. Ban on Buying Other Nations' Debt Ideal Way to Stabilize Eurozone
   25. Efficiency Gains from Single Currency Remain Intact
   26. Different Risk Weights Should Be Applied to Domestic and Foreign Government Debt
   27. Next-Best Alternative to Risk Weights Already in Place?
   28. Separation of Sovereign Risk and Banking Risk a Rejection of Self-Corrective Mechanism
   29. Joint Issue of Eurobonds Would Only Solve Half of Eurozone's Structural Defects
   30. Draghi Unaware That There Are Two Kinds of Recessions and Fiscal Deficits
   31. Outside of Greece, Capital Flight Is the Problem
   32. Explaining Balance Sheet Recessions to the German Public
   33. Even Germans Understand Need for Fiscal Stimulus If Properly Explained
   34. Excessive Focus on Fiscal Deficits While Ignoring Growth in Private Savings
   35. Lack of Private Loan Demand Biggest Problem for Germany
   36. Germany Unlikely to Announce Stimulus Package
   37. Disadvantages of Euro Exit for Greece
   38. Argentina's Experience Also Suggests Euro Exit Would Have Few Merits for Greece
   39. Germany's Competitive Gap with Other Countries Will Also Disappear in a Few Years
   40. Draghi's LTROs Prevented Collapse of Eurozone Financial System
   41. “Grand Bargain” with ECB Is an Empty Promise
   42. Double-Dip Recessions and the Eurozone's Bad Loan Problem
   43. EBA's Lack of Understanding of Systemic Crises Leads to Rash Actions
   44. Cypriot Bank Resolution Could Worsen Financial System Jitters
   45. Vicious Cycle of Creating New Bubbles to Paper over Old Ones
   46. EU Election Results the Result of Economic Policy Errors
   47. European Policymakers Mistake Balance Sheet Problems for Structural Problems
   48. Policymakers Need to Ask Why Euroskeptics Made Such Gains
   49. Disappointment with Established Parties Led to Rise of Nazis and World War II
   50. Continued Disregard for People's Voice Puts Democracy in Jeopardy
   51. U.S. Voters Had Policy Choices, Unlike Their European Counterparts
   52. The Euro Can Be Saved with Two Repairs
   53. Notes
8. CHAPTER 6 China's Economic Challenges
   1. China's Local Governments Began Borrowing en Masse
   2. Decoupling Would Not Have Been Possible in Ordinary Democracy
   3. China's Remaining Problems Include Overcapacity and Income Inequality
   4. China Understands Political Ramifications of Inflation
   5. China's Shadow Banking Sector: Misunderstandings and Realities
   6. Problem: Sharp Growth in Lending to Local Governments Post-Lehman
   7. Decoupling of China and Developed Economies to Continue
   8. Problems Facing China's Economy
   9. China Has Already Passed the Lewis Turning Point
   10. Rapid Economic Growth Continues until Lewis Turning Point
   11. U.S.-Led Free Trade Regime Enabled the Emergence of Asia
   12. Economy Starts to Mature Only after Passing the Lewis Turning Point
   13. Local and Global Lewis Turning Points and Inequality
   14. China Increasingly Tolerant of RMB Appreciation as Transition to Consumption-Led Economy Proceeds
   15. The West Is Conflating Problems of Trade Imbalance and Financial Crisis
   16. Liberalized Financial Sector and Capital Flows Could Weaken RMB
   17. China Could Fall into the “Middle-Income Trap” If It Neglects to Advance Its Industrial Base
   18. Japan, Korea, and Taiwan Escaped from Middle-Income Trap
   19. Labor Disputes Increase Sharply after the Lewis Turning Point Is Reached
   20. The Dilemma of Patriotism with an External Enemy
   21. Working-Age Population Peaked Just as the Lewis Turning Point Was Reached
   22. Will China Grow Old before It Grows Rich?
   23. The Next 15 to 20 Years Are Critical
   24. Uncertainty Due to Corruption and Lack of Legal Infrastructure Must Be Removed …
   25. Appealing to Patriotism without Creating External Enemies
   26. China Could Become a World-Class Nation for the First Time in Two Centuries
   27. Chinese Ambition and Industry Must Be Steered in Right Direction
   28. Notes
9. Afterword
10. Bibliography
11. Index
12. End User License Agreement