China’s “Balance Sheet Recession” Has Already Started | Richard Koo

The speaker warns about a real estate bubble burst in China, likening it to Japan's situation 30 years ago. He believes this is a balance sheet recession and that government intervention is needed. Additionally, the speaker announces this as their final episode of the podcast, passing the mantle to Felix Javen.

Richard Koo, Chief Economist at the Nomura Research Institute, explains the concept of a balance sheet recession, first discovered in Japan during the 1990s. He noticed companies in Japan paying down debt at zero interest rates due to being technically bankrupt, which was unfamiliar from traditional economic education, indicating a need for government fiscal intervention.

Richard Koo describes the phenomenon where, despite zero interest rates, entities such as companies are focused on minimizing debt rather than maximizing profits as they face balance sheet recession. He highlights the economic downturn risk when everyone pays down debt simultaneously.

Koo highlights the critical role of the government borrowing and spending when entities are paying down debt in a balance sheet recession. He credits the U.S. for managing this better post-2008 via bold fiscal measures but criticizes Europe for its austerity measures that prolonged their economic issues.

The discussion suggests that the U.S. managed to emerge from its balance sheet recession post-2008 faster than Europe, due to embracing fiscal expansion despite political pressures for austerity. Speaker uses Spain's severe shift from borrower to saver post-crisis as an example of the recession impact.

China is showing signs of a balance sheet recession akin to Japan's past economic issues. Koo notes low interest rates in China, decreasing bond yields, and repayment instead of borrowing among the private sector, suggesting government fiscal stimulus as the necessary response.

Richard Koo emphasizes that during balance sheet recessions, interest rate reductions alone do not work unless there are borrowers who respond to them. He urges China to acknowledge it's in such a recession and to use fiscal stimuli, criticizing misaligned actions by state-owned banks.

Koo explains China's difficulty of using exports to escape its economic downturn due to being the largest trade surplus holder, which politically limits further surplus expansion. This mirrors Japan's past struggles and he emphasizes China's need to enhance fiscal stimulus rather than depend on exports.

The conversation delves into historical and current dynamics in global trade deficits, particularly how the U.S. handles a continuous trade deficit while benefitting from foreign investment. This longstanding tendency eliminates significant political pressure to balance trade through currency adjustments.

Koo argues that while tariffs are used in trade wars, a fairer approach to U.S.-China trade imbalance is exchange rate adjustments rather than tariffs. He warns against protectionism, suggesting a targeted weaker dollar to avoid potential trade wars, similar to 1985's Plaza Accord strategy.

Koo continues discussing why the U.S. should consider dollar valuation adjustments to improve its trade deficits, referencing historical episodes like the Plaza Accord. He warns that without addressing dollar strength, political dissatisfaction will rise leading to adverse economic policies.

The discussion examines the U.S. fiscal strategy and private sector debt. While bank lending has increased, Koo recommends reducing fiscal deficits if private sector borrowing continues growing. He notes Japan and Europe's slower recovery due to continued private sector conservativism in borrowing.