Economic Outlook Discussion with Richard Koo

[00:00:00] John Hamry: My name is John Hamry and my role here is entirely ornamental. I'm just going to get us started. I'll turn the program over to Steve Shragi real soon. I wanted to say a word of welcome to all of you and a word of welcome again to Richard Kuh. My personal hobby is whitewater canoeing and I've gone up to Maine a number of times. The last time I was up there, several of my buddies fell away and there were only two of us and I'm not that strong a canoeer. In the past, I'd always had somebody else kind of guide us down the rivers. We're going down the east branch of the Penobscot and I'm looking at the guidebook. We're kind of drifting down and it says, be careful to see the approaching narrowing of the river. You'll see two large boulders. It's completely impassable. Lethal beyond this point. And I look, I'm like, here in the hell are these two boulders and we back paddle like crazy and pull off. It's right over the edge of a thing called the hulling machine. They used to run logs down this and they'd get caught in that and just strip the bark right off them. We would never have made it. Well, I thought of that last night when I was thinking about Richard Kuh. Richard has written some guidebooks for how to survive treacherous waters and we first had a chance to hear him last fall. And Richard, he comes to this with a remarkable personal history. He, of course, is the chief economist for Nomura and in his time in Japan has become one of the lead intellects in Japanese economic and business circles to think through the remarkable problems and challenges that Japan has been experiencing. And when I first met Richard, he said, you all don't know what you're living through right now. You're in the front end of something very different. This is not a typical recession. You know, and this is, as he said, you don't have the flu. You've got, you've got double walk of pneumonia here, you know, and you've got to realize this is a very profoundly different era. So, and Richard has, in his work, pioneered the concept of a balance sheet recession. I have to be careful how I say that. And that it is a, it's a psychology that grips the entire country and everybody at the micro level is doing the right thing. And at the macro level, it's turns out to be astoundingly difficult to manage. So Richard is like the, the, the, the guy who went down that river first. I don't know who, I don't know who wrote to says, pull off now or otherwise you get killed because they obviously didn't go down the river the first time. But, but Richard is, has been down this path. He has experienced very dangerous waters and he has, he's helped many administrations kind of survive to help think it through and he's going to help us today. So, Richard, do you want to say a word, Steve, before you start? Should we turn to, why don't I turn to, to, to, to Steve just for a second and then we'll turn it to you. [00:03:21] Steve Shragi: Just quickly, because I think Dr. Hamry covered it so well, but I think you're going to see from this presentation, [00:03:26] John Hamry: You can hand him a mic, that portable mic, for sure. Great. I'm sure you use that for a second. [00:03:33] Steve Shragi: Perfect. Got it. No, no problem. And I think as John encapsulated so well, Richard just has such a phenomenal background and he's been praised from leading economic thinkers and speakers ranging from Martin Wolf to Larry Summers. I think we're going to see why today. One of the things I was struck by in rereading many of his pieces over the last several days was a real sense of deja vu. Not only in the sense of the economic situation, but also in the sense of the political situation and how we've failed to really confront this and deal with this. Can you hold the light on? Sure. And deal with this head on. Is that better? Right. And, and I was at a lunch actually yesterday with Paul Krugman and, and Professor Krugman said that, you know, after all the criticism that Americans had heaped on the Japanese in the 1990s, we all owed them a sincere apology as we struggled to deal with many of these same issues. So I don't know if I'm in a position to apologize for all Americans, but I can really thank Richard Koo for coming here and sharing his wisdom. And we really look forward to this presentation. Thank you very much. [00:04:45] Richard Koo: Richard Koo: Thank you all for coming. I'm Richard Koo, Chief Economist of Nomura, and I've been stuck in the island for the last 25 years. I'm actually an American citizen. I started my career at the New York Fed. And I was in charge of syndicated loans at the time, almost more than 25 years ago. And when Latin America debt crisis happened, I was in charge of that. And for those of you who are old enough to remember how bad the Latin American debt crisis was. Richard Koo: I can't. I have to use my hands. [00:05:32] John Hamry: Richard Koo: Use your hands. Maybe I can trade with you. [00:05:37] Richard Koo: Richard Koo: This can come down. I was in the middle of this massive banking crisis where it was said that seven out of eight U.S. banks were actually under water. Because if you remember what Latin American debt crisis was like, everybody from Latin America, Mexico, down to the southern tip of Chile, were all under water, all went bankrupt, couldn't pay. And that's how bad the situation was. Then I moved to Japan. And then Japan has a huge banking crisis. And I used a lot of my experience as a New York Fed economist handling Latin America debt to help Japanese go through its banking crisis. Richard Koo: And then I see something similar happening in the United States now. So I'm coming from this crazy background with a Taiwanese name, Japanese background, a U.S. citizen, and then a New York Fed person, a former New York Fed person. And I see there's so much similarities between what's happening around the world today compared to what happened to Japan over the 15-year period. Richard Koo: Now, we know how bad the economy is all around the world. This is the United States. Fast utilization and unemployment down very sharply. This is Europe. It's going down also very, very sharply, even beyond the 9/11, the bursting of the IT bubble, that incident. Richard Koo: And this is China, where the house prices are also falling. This is Shenzhen, the most exposed part of China, as it were. And exports are also falling very sharply as well. And a lot of people call the current situation the return of Great Depression. In some ways, what we are faced with is worse than the Great Depression, because during the Great Depression, there was a very clear-cut epicenter that was the United States. Richard Koo: But this time, the same problems are happening all over the world, all at the same time. All of them have real estate bubbles that are bursting. And it ranges from the United States, China, Spain, Ireland, South Korea, parts of Australia, parts of France, and it's all going at the same time. And so I find this situation very, very disturbing. And as a result, even though Japan has no bubble inside the country, the Japanese economy is collapsing very rapidly as well. And the reason behind that is that if you look at which part of consumption is falling all around the world, it's the durable goods, then the regular goods, and then the services. Richard Koo: There's almost no decline in services, but huge decline in durable goods. Because Japan makes so many good durable goods, people say, well, I can keep this Toyota for another year, two years, no big problem. And as a result, we are suffering very, very badly. Against this problem, central banks all around the world have lowered the interest rates very, very sharply. Richard Koo: The United States, in particular, started from September of 2007, and brought rates down to the fastest rate in Fed's history, down to the same level of Japanese, almost zero. And other central banks also followed suit. But nothing has happened. The economy continued to weaken. Asset prices kept on falling. And this is very different from what we learned in schools. But there is an example of this before. And that is Japan. Fifteen years ago, when Bank of Japan was cutting rates from 8% to zero, nothing happened. The economy continued to weaken. House prices kept on falling. And this kind of recession, I call that balance sheet recession, as Dr. Henry mentioned a little earlier, because I think we are faced with a situation where private sector people are no longer maximizing profits. As we learned in schools, as we learned in schools, they are actually minimizing debt. And they are minimizing debt because asset prices collapsed, liabilities remain, everybody realized that their balance sheets are underwater. Well, some are significantly under the water, but some may not be so under the water, but they are feeling extremely uncomfortable with the state of their balance sheets. And if your main line of business is already bad, and then you have this problem, then of course, you have no choice. You have to raise your white flag and walk off the stage. But suppose your main line of business is still good. You are generating cash flow, but your balance sheet is underwater. Once you are in that situation, what would you do? Well, you use the cash flow to pay down debt, because that's in the interest of all the stakeholders of the firm, in that if you are shareholders, you don't want to be told that your shares are just worth a piece of paper. If you are a banker, if you are a creditor, you don't want to be told that all your loans to the company is now non-performing loans. If you are a worker, you don't want to be told that you no longer have jobs. And so, for all the stakeholders in the firm, the idea of using the cash flow to pay down debt is the right thing to do. And as long as you have a cash flow, you continue to pay down debt, at some point, your balance sheet will be balanced again. And at that point, you can say to yourself, "Ah, I'm out of this problem. Now I'm going to maximize profits. I'm going to go forward." But during this period, where you are paying down debt, you keep your mouth shut, make sure people from outside don't pay too much attention to your balance sheets. Tell the outside investors whatever they want to hear, and you quietly pay down debt. If I'm running one of those companies, I'm sure I'll be doing that. And if you're running one of those companies yourself, I'm sure you'll be doing that. Because as long as you have cash flow, the time should solve this problem. There's nothing wrong with your technology, nothing wrong with your management. It's just that you have this balance sheet problem. But when everybody does this all at the same time, we fall into a fallacy of composition problems, in that in the national economy, when you have a household-- someone saving money, usually household sector, but not necessarily household sector. If someone's saving money, someone out there on the other side better be borrowing and spending that money, or else the income flow will stop. Suppose I'm a member of the household sector. I get $1,000 of income. I spend $900 myself. $100 we save. In the usual economy, this $100 will go through a financial sector and give it to someone who can borrow and spend this money. And with that, $900 plus $100, $1,000 against the original income of $1,000, the economy moves forward. If there are too many borrowers, you raise interest rates, you feel the potential borrowers drop out. If there are too few borrowers, you bring rates down, and some people will raise hands, take up the money, and the economy will forward. That's the usual economy. But in this recession, what I call balancing recession, even with interest rates down to zero, no one's out there borrowing money. Everybody's paying down debt. Then what happens? The $1,000 of income I receive, $900 I spend, $100 comes into the banking system. It just gets stuck there. No borrowers, even with zero interest rates. So only $900 is spent, and that becomes someone else's income. Those who receive the $900, let's say 10%. So $810 is spent, $90 going into the banking system. That $90 gets stuck. So very quickly, you go from $1,900, $810, $730 in this very rapid collapse of economic activity, even under zero interest rate. And no matter how much central bank trying to inject liquidity into the system, since everybody's trying to repair their balance sheets, it just gets stuck in the banking system also. And in this type of recession, if you do nothing about the situation, the economy will collapse until people are too poor to save any money. Then there won't be no, at that point, there won't be any more leakage. The situation will stabilize. But it could be half of the income you had earlier. Then you have to spend all of it. That's why there won't be any more leakage. The last time this thing actually happened was the Great Depression in the United States from 1929 to 1933, where U.S. lost 46% of its GDP in just four years. And when you go back and look at all the numbers, it fits this pattern exactly, that everybody's paying down debt, no one's borrowing money, and the economy collapsed in very, very sharply. In this type of recession, government can do a lot of things to prop the economy up, but the economy never enters a real self-sustaining growth until private sector balance sheets are actually repaired. And so this is going to be a long process, especially in view of the fact that when everybody tries to repair their balance sheets all at the same time, naturally, the economy weakens. When the economy weakens, asset prices fall even further, and the goal moves away from the private sector trying to reach that goal. And the harder they work, further the goal will be. And that's why this process typically takes a long time. Now, how similar, I mean, how similar is the United States to the Japanese situation? This chart shows the demand for funds as viewed from Federal Reserve Senior Loan Officer's opinion survey. And even though there's so much attention paid to the credit crunch, the fact that American banks are not providing sufficient credit, because when you look at the demand side, you also see a very sharp drop. And we often miss this part because bankers not lending is a front page news. Borrowers not borrowing is never a news. And so this part of the development usually is missed by the press during the Great Depression also. If you go back and check, a lot of people are saying banks are not lending money. But actually, the borrowers were disappearing even faster. And in Japan, too, there was a lot of argument about the credit crunch in Japan. We actually never had credit crunch except for a very short period of time. It was actually the borrowers disappearing faster than the lenders. And that's why the economy couldn't move for such a long time. Comparing the U.S. with Japan, this chart shows what happened to U.S. house prices since 1992, and what happened to Japanese house prices exactly 15 years apart. And you can see that Tokyo, Osaka house prices going up was exactly the same amount as the U.S. house prices, and going down almost exactly the same way. So even though a lot of people say, "Oh, Japanese and Americans are a totally different society, different culture, different this and that." When it comes to greed, they're exactly the same. And we are here at the moment, but there's a house price futures listed in Chicago Board of Trade. And that shows that house prices will continue to fall until November of 2010, which is another 18 months or so. And the fact that it may continue to fall suggests that it's going to be very difficult to achieve a true stability in the American banking system because house prices or the real estate prices will be still falling. Now, how much credence shall we add to this particular point? Well, because futures is what futures market says is not always what happens in the future. For those of you who played in the futures market, you know this very well. Well, if you go back on this one, the futures market is saying that house prices have to fall to the level of 2002 or 2003. Then when you look at this other chart, this is actually a work done by the Federal Reserve, where they looked at the relationship between house prices and rents for this very long period of time. There was a remarkable stability of rents and house prices for many decades all the way to 1997. In 1997, the two began to diverge. That's the beginning of the housing bubble. And if what we are seeing now is house prices going back to where the rents are, kind of a historical discounted cash flow value of the house, you have to fall 21% from where we are now based on this data. This data is different from the one you saw earlier, but it goes back much further. So for this purpose, we have to use this of-year house price index. And on this of-year house price index, house prices will have to fall another 21%. And then you go back to what that would mean. House prices will have to fall to the level of 2003. So what the futures market is telling us is that house prices will have to return to the historical discounted cash flow values. And so there is some credence to what the futures market is saying. But what that means is that we are just at the entry level of the problem. We are far from the exit because prices will continue to fall. And this is just an estimate of how much savings American households will have to recreate because of the loss of savings they thought they had in their houses. And this line is assuming that household savings rate is 4%. 4% happens to be the savings rate at 1997 when the two began to diverge. So I just used a 4%. If they actually saved 4% throughout this period, this is how much they would have saved. This is how much American households actually saved. So the gap between the two is how much they would have to rebuild their savings. This amount is $1.5 trillion. And it doesn't seem like much. Well, it is a huge sum of money, but compared to the kind of numbers we are hearing these days, it doesn't seem like much. But the problem is that this will have to be added on top of savings rate going back to the normal level. And as you can see, savings rates are increasing very sharply now. And that's what's killing exports of so many countries all around the world. Suddenly people are deciding that they should increase their savings because the savings they thought they had here is disappearing very, very quickly. This is all very, very depressing because this is not just the story in the United States. This is happening all over the world, all at the same time. In Spain, in Ireland, in parts of China, France, South Korea, Australia, all facing the same problem, where people are trying to rebuild their balance sheets as quickly as possible. And financial institutions trying to rebuild their balance sheets has devastating consequences because if financial institutions lack capital due to their losses, there's a leverage factor working in reverse. So if the financial institution loses $1 of capital below the required level, they have to cut their lending by $12.5. And so that then adds even more problems to this whole thing. And that's where we are now. Now, this is all extremely depressing because everybody's in this problem all at the same time. But I think there is one ray of hope. And that ray of hope is that those of us in Japan went through this 15 years earlier, and we managed to find out what kind of problem this actually is and how to deal with it. This is what happened to Japan's bubble in the 1980s. In the Japanese case, it was the commercial real estate that led the bubble. And as you can see, commercial real estate prices went up very sharply. And a lot of people, that made a lot of people feel very rich and they spent a lot of money. Because as you can see, Japanese GDP both in nominal and real terms are moved up very sharply. That part, I'm sure anyone can understand. But what's remarkable is what happened afterwards. The commercial real estate prices collapsed and it fell to the level of loss, see, in 1973. On a nationwide basis, it fell 87% from the peak. Just imagine, Washington DC down 87%. Manhattan down 87%. San Francisco down 87%. What kind of economy do you think we have left in the United States? Probably not much, right? Look what happened to Japan's GDP. It never went below the peak of the bubble. It was always above the peak of the bubble. Even though our growth was very slow and we had some bouts of negative growth. Well, this one is the most recent externally driven factors. But even though we had some negative growth, overall, we managed to keep our GDP from falling. And our unemployment rate never went over 5.5%. And it came down afterwards. Given that we lost wealth as a result of the falling asset prices, equivalent to three years' worth of Japan's GDP. We lost just on land and shares, real estate and shares. We lost wealth equivalent to 1,500 trillion yen. That's three years' worth of Japan's GDP. The largest loss of wealth in human history during peacetime. Because when you go back to the Great Depression and see how much wealth was lost when U.S. share prices went to 1,600 during the Great Depression. Latest estimates suggest that the loss that Americans suffered was equivalent to one year's worth of 1929 GDP. This is well over three years' worth of 1989 GDP, the last year before the bubble. And this is just land and shares. If you add golf club memberships, Porsches, Ferraris, and other paintings that the Japanese bought during the bubble days, it would be well beyond 1,500. And 1,500 trillion in Japan is 45 trillion in the United States. Just imagine the United States losing 45 trillion dollars of wealth. What kind of economy would you have left at the end of the day? And in terms of debt repayment, it's debt repayment that causes the GDP to shrink. During the bubble days, Japanese companies borrowed and spent a huge sum of money. And then once the bubble burst, Japanese corporate fund procurement dropped very sharply. Bank of Japan also brought short-term interest rates from over 8% to almost zero by 1995, but to no effect whatsoever. More than that, even though rates were zero, almost zero from 1995, Japanese companies start paying down debt. You can see that it's going into negative range. It means the whole corporate sector is paying down debt. And on some of the bigger years, this is over 30 trillion yen a year. That's 6% of Japan's GDP going backwards. So the blood is then circulating backwards. Now if you add household savings, let's say it was household savings, 4% of GDP, and 6% of debt repayment coming into the banking system, Japan would have been losing 10% of GDP every year. And that would be exactly the Great Depression situation. And Japan would have lost 46% of its GDP in four years. That could have easily happened. But we managed to stay away from that scenario. How did we do that? Well, we did it because government came in and borrowed that money. If the government came in and borrowed $100 and put that back into the income stream, you have $900 plus $100,000 again. So there's no reason for GDP to fall. And then next year, same thing happens. Household saving money, corporate sector paying down debt. Why same thing happens year after year after year? Well, if asset prices fall 80-some percent from the peak, one or two years of debt repayment is not going to be enough. It might take 10 years, 20 years. Some people shaking hands may take 30 years before corporate balance sheets are clean. But as long as you have cash flow, they'll be paying down debt. So same thing happens year after year after year. And the Japanese government, run by liberal Democrats, in those days they were highly liberal with public spending. They built bridges and roads and basically kept the economy from falling. As you can see, after the bubble burst, government spending was actually increased in Japan, even though tax revenue fell. And the gap between the two is, of course, the budget deficit. And this additional spending during this period from 1990 to 2005, adds up to something like 300 trillion yen. Now, 300 trillion yen is no peanuts, 60% of Japan's GDP. But when you consider how much this 300 trillion supported, how much GDP this 300 trillion supported, you realize that this is probably the most successful fiscal spending in the history of mankind. Because when you look at this chart, if GDP was allowed to fall, if the government did nothing, chances are high that this thing would have come down something like this, to perhaps the level of GDP in 1985. If that happened, we would have lost GDP during this period close to maybe 2,000 trillion yen. So 2,000 trillion yen of GDP was supported by 300 trillion of government spending. The multiplier effect is something like seven. Not one or less than one as many of you might have believed or heard from other sources. And the reason you hear these comments that, "Oh, Japanese spent so much money on roads to nowhere, bridges to nowhere, and they still have very slow growth." All that argument that you have been hearing over the last 18 years is based on one assumption, right? That assumption is that even if you did nothing, even if the government did nothing, Japanese GDP would have been flat. And then Japan did 300 trillion, it was still close to flat. So they must have wasted this money on some of the most useless projects on earth. You know, that's how the argument is put together. And when some of these journalists took up the microscope and looked, and there were some bridges to nowhere, some roads to nowhere, and then that become a big scandal. But my argument here is that this country, Japan, lost 1,500 trillion yen of wealth, three years' worth of Japan's GDP, asset prices down 87. This is nationwide, not just our spot, but the whole country. Commercial real estate prices fell 87% from the peak. So some areas, they fell even further. If nothing was done, our GDP would have collapsed. If you measure the effectiveness of fiscal policy from that point, it looks far better. But unfortunately, econometric models are not designed to capture this kind of problems because econometric models assumes that with no input, economy is in equilibrium. Then you add these changes and see how much it added to it. But what the situation we faced was that without the economic stimulus, we would have had 30 or 40% decline in GDP. And so once you understand what was behind it, I think you would agree that fiscal stimulus was useful. Now, if people in the United States, or in Europe, or in China, or in Australia, realize that there is a way out of this kind of crisis after all, that it is possible to keep the GDP from falling with proper government actions, wouldn't that make people here feel a lot better? Because if the Japanese can do it, why not the Americans? Why not the Brits? Why not the Australians? And if -- I mean, none of the countries have faced anything close to declining asset values 87% from the peak. But even with the 87% decline, it is possible -- the fact that it is possible to keep the GDP from falling with the proper fiscal stimulus, I think will make so many people feel so much better, that there is a way out of this kind of recession, and that is government spending. And I would very much like to see, for example, President Obama come out and say, "This is no ordinary recession. This is a balance sheet recession." And this kind of recession happens once every many decades. Because this kind of recession happens only after a bursting of a nationwide asset price bubble. And usually, you don't get this kind of bubble. Because usually people are more careful with their affairs and don't go crazy. But after very many decades, people do go crazy. And when that happens, you get into this kind of situation. And when it happens, and when people suddenly realize that they made a mistake, they were chasing wrong asset prices, and move away from profit maximization to debt minimization, it's only in those instances that we need a big proactive government. Because the government cannot tell the private sector, "Please don't repair your balance sheets." The private sector has no choice. They have to repair the balance sheets. And so if you just let the private sector repair the balance sheets, and let the economy go down the drain, we'd be all dead. So the government has to do the opposite of the private sector. Borrow and spend the money that private sector sorts of saving or paying down debt, and put that back into the income stream. So only in these instances, what I call balance sheet recession, we need a big government, proactive government. In all other recessions, I am against government spending. As a former central banker myself, I can monitor policy and handle it. But in this type of recession, I'm afraid that's not the case. Because people are no longer maximizing profits, as we all assume in our economics, they are minimizing debt. Now, if there's any mistake that the Japanese made throughout this process, it is that at the beginning, no one had a concept of balance sheet recession. I didn't have it, and no one else did. And it's not part in economics either, in any of the universities. And so we thought, well, it's just that we go downtown. We put in the fiscal stimulus, and then it worked. Once you put in the fiscal stimulus, the economy began to improve. They said, oh, the pump priming worked. And then you look at the budget deficit. It's huge. Oh, let's cut it. We cut the spending. The economy collapsed promptly. And then another fiscal stimulus, the economy improved. And then people say, oh, the budget deficit is too large. We cut it down. That's why we had this huge zigzag throughout this period. And that lengthened the period of recession, in my view, unnecessarily, at least by five years, if not more. If we had known in advance that it's this kind of recession, where it's not just the inventory buildup, that private sector is actually minimizing debt because of their balance sheet problems, and that we are going to be in this for a long term, then we would have come up with a better project to prepare Japan for the 21st century, all of that, because the government would have to be in there for this medium term. And I would very much like to see President Obama come out and tell the American people that it's this type of recession, not the ordinary round-of-the-mill recessions. We're going to be in this for at least a few years. And so let's come up with those good projects that will prepare America for the 21st century or something. You know, it's that kind of argument, that kind of social contract, I think, is desperately needed. And so far, I've failed to see President Obama or Mr. Larry Summers or Tim Geithner coming out and say, "This is a different type of recession, and therefore we have to do these things." They're still saying, "It's a recession. It's a very serious recession." So in a sense, they're within the economic orthodoxy. And that's why they are being hit from both sides, those people who argue that the government is going too large and those people who are arguing that it's too small. But once you turn the table and say, "This is a different type of recession. It's a balanced recession. It's a pneumonia. It's not just a cold." Then once everybody knows it's a pneumonia, then, you know, no one would argue about the treatment that's necessary. But that hasn't been said yet, and I think that's why President Obama is having so much trouble. Once the diagnosis is clearly explained to the people, and we all know that deleveraging is happening. Financial institutions are deleveraging. Households are deleveraging. So we know that they're minimizing debt. But someone has to put this argument together to say, "Okay, when everybody's minimizing debt, these things happen, and therefore we have to take those measures, which is government spending." Now, tax cut, even though fiscal stimulus often have these two choices, government spending or tax cut. Tax cut doesn't work in this kind of environment at all. People are minimizing debt. You take the tax cut and you used to pay down debt or increase their savings. And tax rebate in the summer of last year, now people say only 12% added to their consumption. That's the kind of problem you face in the tax cut. It has to be government spending. Now, there is a $787 billion package out there, and that's no peanuts in my view. But what we have to worry about in the current environment is that, is that fast enough to arrest the deterioration in the economy? Because right now, we are losing more than 500,000 workers every month. And we know that for the fiscal stimulus to kick in, they have to, first of all, select the good projects. Engineers will have to design it, then we have to put in the public bidding process. All of these things designed to protect the taxpayers could take months, maybe more than years. By the time all of these procedures are followed and our fiscal stimulus are in place, how many people would have lost their jobs already? If it takes 10 months, 5 million people would have lost their jobs. The whole package is designed to increase 3.5 million jobs, right? That's what President Obama is saying. So by the time it starts working, we are already behind the curve. So we have to move away from this idea of peacetime. We are in a war zone now. If I get to talk to President Obama, I would suggest to him that, even if you have to dig the ditches and filling them up, just do it now. Keep the wound from deepening and widening. Keep the workers employed. Keep the income flowing. And then while you are winning time with these potentially lousy projects, let other people come up with the good projects. And as soon as these good projects are ready, you switch to the good projects. But don't just wait there and say, oh, $787 billion package has passed. Everything is fine. We just sit still. It's not going to work that way. We are in a wartime situation. This is not a peacetime situation at all. And all these nice measures that are put in place to protect taxpayers will actually backfire. because when the wound gets so bad, unemployment gets so horrible, the taxpayers' money necessary to bring the economy back back to life would be so much bigger than if they just used the money now, digging the ditches and filling them up if necessary. I'm not suggesting that we should dig the ditches and filling them up. But even with less than fully desirable projects, it's far better to have that in place, get the economy moving, than wait and do nothing for this very critical period. Now, many people would argue that, well, Japan could have done this because Japan is a high-savings country. The United States cannot afford it because the savings rate in the United States is so low. I would say that's not a problem. And I think Japan has also shown us the way. Actually, this is Japan's cumulative government deficit. And as you can see, it grew up very, very sharply. During this period, rating agencies, the IMF, the OECD, those people who know nothing about anything, kept on bashing Japan and saying, "Gosh, with this kind of increase in government debt, Japanese interest rate will go sky high, the whole thing will come crashing down." Never happened. This is what happened to Japanese government bond yield. It kept on coming down and stayed low for the last 10 years at the lowest level in human history. Less than 1.5% in many periods. Now, once you understand the exact mechanism of this recession, you can understand why this thing happens. In a balance sheet recession, the money that government has to borrow and spend is the money that is saved within the economy, but not borrowed within the private sector. So it's sitting there in the financial system and fund managers and banks and insurance companies are desperate trying to find someone to borrow to place this money. So when the government comes in as the borrower of last resort, all these financial institutions are more than happy to lend to the government, because that's the last borrower out there. Furthermore, in the balance sheet recession with collapsing asset prices, financial institution balance sheets are typically all under water with huge damage to their capital base. And because they don't have enough capital, they really cannot lend to the private sector even if they wanted to lend to the private sector. But when the government comes in to borrow, and if you lend to the government, the burden on your capital is very much less. And so for these two reasons, government end up procuring funds at ridiculously low rates for an extended period of time. And that's what happened in Japan. And I think this is what's going to happen in the United States, UK, and other parts of the world. So once people understand, the savings are actually generated inside the economy, but the savings are not borrowed. If they were borrowed, they won't be in this recession in the first place. So whether you start out as a low-savings rate country or a high-savings country, it doesn't matter. It's the additional savings that causes problems. Now, going forward, we are going to have a problem with rating agencies. I mean, they created enough problems in the subprime. They are going to try to downgrade countries during this process, right? Because they say, well, the budget is increasing, the economy is collapsing, or it's terrible, downgrade. I hope bondholders, bond market participants, and governments remain firm in their belief that that's the right thing to do. We actually wasted some time because rating agencies kept on downgrading Japan. And Japan was rated to the point below Botswana in Africa. Botswana is out there because Japanese government is supporting with all sorts of funds. And Botswana is now rated at one point, rated higher than Japan. And once those downgrades come in, all the policymakers become scared that if they put in any more fiscal stimulus, that rating agencies may downgrade even further. Bond market participants get scared because bonds are being downgraded. Maybe they should buy these bonds. If those things happen and necessary fiscal stimulus will not put in, I'm afraid the situation will just get worse and worse and worse. And when it gets worse, those guys will downgrade anyway. And so I'd very much like to warn you that rating agencies can really throw a monkey wrench into this corrective process. I think this is a corrective process in the sense that market is telling the government that this is the once-in-a-lifetime opportunity to really do something on the fiscal side because there is no crowding out dangers because private sector sources are not borrowing money. And by government taking this action, GDP can be kept. And as long as GDP can be kept, the private sector has the money to pay down debt. And eventually this problem will go away. So the market is trying to tell the government to do borrow and spend. But if rating agencies come in and screw up the whole sentiment, then we all suffer. So please be careful about the rating agencies. Now, this is the Japanese case. This is a debt of the Japanese companies. It increased sharply during the bubble, came down, and stabilized at the level of 1985. Our bubble started around 1986, '87. So all the debris that we accumulated during the bubble, the luggage that we accumulated during the bubble, were finally removed. Debt repayment stopped. And 2005, we actually came out of this mess. The other line shows corporate debt as a percentage of GDP. And during the bubble days, it was as high as 85%. And then it dropped to the level of 52% level lost in 1956. So Japanese corporate balance sheets were fully repaired over this 15-year period. Now, I'd like to skip a few slides to get to the banking issues. As I indicated to you at the very beginning, I have had quite a bit of banking crisis experience under my belt. Not to my liking, but it just so happened that way. And from this experience, I came up with this idea that there's actually four types of banking crisis, not just one. Localized crisis, systemic on the vertical axis, and no more demand for funds or weak or non-existent demand for funds on the horizontal axis. Now, no more demand for funds means private sector sorts of maximizing profits, they're looking forward, their balance sheets are clean. And this one is the balance sheet recession. And if you divide the world in these ways, only in this quadrant, it makes sense to dispose non-performing loans quickly. Because in this case, the problem is localized, a small problem relative to a big banking system. And there is demand for funds. So as soon as the banking system can move forward, the economy will move forward and everybody benefits. And the savings and loan crisis, in my view, was this type of crisis. The savings and loan crisis got a lot of public attention because it was handled so poorly by the FSLIC before it hit the wall. But savings and loans were very small financial institutions. And if you add them all together, it was like only 5% of US assets. And so, and of that, a couple hundred went bad. But it's a case of 5% sick, 95% healthy. If 5% sick and 95% healthy, you can have an operation, take the sick part out, and you can still move forward. But on this case, systemic crisis, where it's 95% sick and 95% healthy, and that's the Latin American debt crisis that I had to handle myself. Where thousands of American banks have their balances on the water. Now, in this case, you cannot really do an operation, a quick operation. Because if you have 95% sick and 5% healthy, how can you cut the 95% off? You know, that option doesn't exist. And Paul Volcker knew this very well. And what we had to do in the Latin American debt crisis, for those of you who are not aware of it. We basically said, keep all the banks, continue lending to Latin America, even though Latin America has completely collapsed. And we kept that situation on for five, six or seven, eight years, calling those bad debt, good debt. But forcing banks to use the profits generated to add to their capital. And at that time, we used this measure called fat spread. Fat spread refers to this concept of keeping the lending rates high, bringing the deposit rates low, so that the banks will gain the difference between the two. And that's what's called fat spread. And we kept this policy in place for very many years to recapitalize the banks. And it was in 1988, I think it was around 1988, '89, that Federal Reserve finally said, okay, these are bad debt. Please write them off. And that's the Brady bond and all of that. The whole process took like 13 years. Cost of the taxpayer, zero. The problem was so big at the beginning. When it happened on that Friday night, 1982, Paul Volcker had to call central banks all around the world and beg all the banks in the countries around the world to continue lending to the American banks, knowing fully well that American banks are all under water. And just to give you an example, Bank of Japan, Paul Volcker naturally called Bank of Japan. But this is August, 1982. August in Tokyo is a miserable place. So the governor, Maekawa, Bank of Japan was already in his country home in Karuizawa, a four hour drive from Tokyo. And this poor soul in the Bank of Japan, who happened to be at the telephone, picked up this phone call from Paul Volcker. And Paul was so desperate to get Maekawa. And so he said, if you cannot get Maekawa on the phone, there might not be any U.S. banks left on Monday. That's how serious August 1982 was. And that person who picked up the phone was the one who actually told me what kind of words Paul Volcker used to get Maekawa on the phone. In that kind of situation, you have to go slowly. There's no two ways about it. I mean, with global banks involved and so many of the U.S. banks on the water, there's no way we can quickly sell the assets because there's no one out there to buy those assets. What's unfortunate about the Latin American debt crisis, however, is that because it was handled so beautifully, that Federal Reserve never had to go to the Congress for money. And during the first seven, eight years or so, everybody had to keep their mouth shut, right? Because they're all technically bankrupt. We all have to keep our mouth shut. And then when American banks were sufficiently strong to start writing them off, no one's interested in the story anymore. So this whole experience of Latin American debt crisis is completely different. It's completely missing from American institutional memory, from academia, from elsewhere. People can remember the savings and loan crisis because the government had to go to Congress for money. It cost taxpayers $160 billion. Everybody remembers. Everybody knows all the details. But Latin American debt crisis, very few people were aware because those of us who were involved couldn't say it. And when the problem, we were able to say it, no one was interested in hearing our stories. Paul Volcker actually wrote to the Japanese in 2001 telling them not to listen to American investment bankers and some other crazy journalist who wants Japan to go slowly, for Japan to go quickly on non-performing loan disposal because the size of the problem is so large that if you try to do that, there won't be buyers for those assets. Asset prices will collapse and the situation will just get worse. So he even suggested the Japanese government come up with a speed limit on how fast banks are allowed to write a problem loan. So this, and in the Japanese case also, we never had, so Japanese case is this one. And in Japan, we had to go slowly on non-disposable, NPL disposal because the problem was too large. And we needed the capital injection because in this situation where there's no borrowers, we can't use the fat spread. In order for the fat spread to work, there has to be borrowers out there. And in a balance sheet recession, there's so few borrowers, we can't use the fat spread. And that's why I suggested that we use capital injection. I was the first person in Japan to argue for capital injection, and I saw this concept all the way to the parliament. And I can tell you how much I was bashed, just like the situation here in the United States. People say, "Oh, Japanese bankers are paid so much higher salaries compared to average people. How can you bail out the bankers?" All of that argument that you're hearing here in Washington today was repeated in Japan 10 years ago. And I had to go on national television against the key members of all opposition parties and explain to them that we are fixing the credit crunch first. We are not helping the banks. We are fixing the credit crunch to save the economy. And one thing that you have to remember in this situation is that fixing the banks and ending the credit crunch are two contradictory goals. If you want to fix the banks and you want to make them lean and mean, you have to allow banks to let go of some less than desirable assets as quickly as possible. But when all banks are allowed to do this all at the same time, we fall into a fallacy of composition problems. Asset prices collapse, and then the situation just gets worse and worse and worse. So what we did in Japan is that when we injected capital, we told the banks, "You cannot use this capital injection to write off problem loss. You have to use this capital injection to support the lending." And that's the reason how we managed to come out of this credit crunch that happened in 1997. You know, Tim Geithner and so many people, even people like James Baker are saying, "Japanese economy never recovered, took so long to recover because somehow Japanese never addressed the banking problems." You know, you must have seen this argument many times over. I'm afraid that argument is completely incorrect. We never had a credit crunch except in this very limited period right here, October of 1997 to March of 1999, that 18 months. Before that, as you can see, the bankers' willingness to lend was almost as eager as during the bubble days, when it was said that if you call a banker to bring the money, the banker will bring faster than delivering pizza. That was the period of bubble. And this line is from the Bank of Japan Tankan survey, where 10,000 Japanese companies were asked by the Bank of Japan what the bankers are telling you. And so it's borrowers saying, "Yes, bankers are very willing to lend. Yes, bankers are willing to lend." But were they borrowing? You look at this side. This is the fund that companies actually borrow from the banks. And even though banks' willingness to lend was equal to the level of the bubble, they were not borrowing money at all. So what happened in Japan is that borrowers disappeared faster than lenders. And here too, bankers' willingness to lend was quite high, but people were paying down debt. Here too, bankers' willingness to lend were quite high, but people were paying down debt. So yes, we had a banking problem. And 1997 to 1998, we did have a credit quench. But that's it. That's the only part we had a credit quench. Our economy, the Japanese economy, did not stagnate for so long because of the banking crisis. It stagnated for so long because nobody was borrowing money. Everybody was paying down debt. And I think this is a very critical message that could change the debate here. Because I sense that many American officials who are led to believe that if you don't address the banking problems quickly, the United States will fall into the same lengthly prolonged recession that Japan did. So they're trying to come up with a quick solution as quickly as possible. But for a problem of this magnitude, I'm afraid there is no quick solution. Some people say it takes $4 trillion to pick the U.S. banks. How do you get the $4 trillion? Where do you get the money? Or some say, oh, Chinese and Japanese will buy it. But $4 trillion is almost Japanese GDP. So the arithmetic just doesn't add up. And so I would argue that if the idea that if you don't act quickly, you fall into a Japanese trap is removed because this is wrong analysis. That you can actually do things slowly, the policymakers have a lot more options and they can pick whatever that is of lowest cost to the taxpayers, lowest burden to the economy. Right now, that option is not there. So people have to come up with something very quickly and they cannot come up with anything quickly. And that's why people seem so depressed. And so I think this part of Japanese understanding has to be part of the debate in Washington so that people don't feel so pressed to do something so quickly. And this argument that until banks are completely repaired, they cannot lend is absolute nonsense. Japanese banks were lending and during the period from 1982 to 1992 or so, this aftermath of Latin American debt crisis, US banks were lending also. There is no sign that US banks went on to credit crunch after Mexico went on default. So with the proper care, proper management of banks, it is possible to keep the banks lending money even if their balance sheets may be under water. And Paul Volcker was the master in putting this all together during the Latin American debt crisis. And so it is possible even with banks' balance sheets under water to keep bankers lending, it is possible to do these things slowly if proper pieces are put in place so that some of the moral hazard problems and things that can go out of control are all contained by the bank regulators as we did with the period after Latin American debt crisis. Once these points are made known, that would give so many more options to the American policymakers and as a result people don't have to be so disappointed. Right now, there seems to be this obsession that they have to do everything very quickly and they are not able to do it or the bill seems, the sticker shock is so big and then people are saying, "Oh my gosh, what are we going to do?" And so I hope this message gets out from you people right here in this room to your congressmen and others that, "Hey, we don't have to go so quickly. As long as we do bank supervision correctly, banks can lend and taxpayers won't have to bear such a large burden." American banks are still making lots of profits. The cash flow is not bad at all. And so if they use the cash flow to write up problem loans, after some years this problem will go away. So the real challenge in my view is to put together a framework where banks will use the cash flow to pay down debt, pay down or remove the non-performing loans. But we still need capital injection, of course, to make sure that they can continue to lend. So what I would like to see is a large capital injection to make sure the banks can lend, but allowing banks to use time on their side using the cash flow to clean up their balance sheets. If those things are put in place together with what I said earlier, medium-term government spending based on medium-term fiscal stimulus centered on government spending, if those two packages come in and it's properly explained to the people why they are necessary, this is pneumonia, that's why we need these treatments, then I think people should feel a lot better. And if they feel a lot better, then for this unnecessary fear, those will go out the window and that they can plan ahead. Okay, next five years, government will keep the GDP from falling. We will do this, this, and this. At the end of five years, our balance sheet should be clean. You know, that kind of planning can also be made. So my point is, please study the Japanese example with open mind. I'm afraid many of you are being flooded with wrong analysis and wrong information on what happened to Japan. But if it's properly understood, I think there's a lot that countries today can use from the Japanese example to overcome the crisis we are facing today. Thank you very much. [01:02:48] Speaker 4: I think this distinction that you made is really, you know, critical between normal recessions and the recession we're having today. Most recessions in the U.S. occur when monetary policy tightens because of higher inflation. This is an asset bubble bursting. Now, let me first defend the Obama administration. Larry Summers gave a speech at Brookings only a week or ten days ago when he made precisely this kind of a distinction. This is not the kind of talk you do to the general, I think to the American public, but he did it in his talk to Brookings. Now, I think you make the distinction too sharply because you say that borrowing completely collapses. And that's not the case. We have a credit crunch. There's no question we have a credit crunch. But because you have this notion that nobody wants to borrow, you dismiss and didn't even talk about the various Fed interventions in private credit markets. Okay? The ability to bring down long term rates by buying treasuries with the intent to bring down long term rates. And BOJ never wanted to do that. They didn't want to distort the yield curve in their view. And they didn't make these interventions into private credit markets. So I think that's important. Third, you know, I think it's a question of how fast you go. I think if you go through recapitalization and you let banks recapitalize out of their income, that's an incredibly slow process. But you can speed it up with capital injections. And we don't know if this will be work. But the main element of this program in principle now is to lift toxic assets off bank balance sheets. Recapitalization plus lifting the toxic assets is going to make a world of difference. It may not work. We don't know whether it will work. There's great uncertainty about it. So I'll stop there because I can't run. Okay. [01:04:53] Richard Koo: You mentioned about the BOJ. BOJ knew this very well from the very beginning. Because we didn't have a credit crunch, as you see. And so there's no need for the kind of measures that are taken here because there was no credit crunch. Here there is a credit crunch. And therefore, some of the measures you suggested are, I think, helpful. But as a former central banker myself, that kind of activity should really be done by the Treasury's balance sheet, right? Not the Federal Reserve balance sheet. And I am very concerned about the Federal Reserve balance sheet used for this purpose because so many investors outside the United States, and maybe some here too, are worried about that. Every time I go to brief investors around the world as the chief economist of Nomura, people ask me about this question. What do you think of the Fed's balance sheets? Right. And of course, Fed's balance sheets are guaranteed by Treasury, all of that. Yeah. But we still have to be very careful in that our currencies are not backed by gold or silver. If it's backed by gold or silver, Federal Reserve balance sheet is not particularly relevant. But because it is not backed by gold and silver, it's only the trust people have in the currencies that allow Federal Reserve or the central banks to operate the way they do. And if people start worrying about how the Federal Reserve is actually bankrupt or the balance sheet is worse than that of the Citibank, and if these things began to hit the market, we don't know what's going to happen. And I very much prefer that Mr. Bernanke do this reluctantly because some of his academic writings and the way he bashed Bank of Japan 10 years ago, not knowing what was happening in Japan, made a lot of people worry that he's going to go all out. And at some point, that threshold is reached and people become really scared. And so, yes, Federal Reserve will have to do it because it's very difficult to get Treasury money in the current political climate. Federal Reserve is the only institution in the government with that kind of mobility to act. But I want Mr. Bernanke to impart an image to the outside world that this is done only reluctantly. It should be really the Treasury's balance sheet that should be used for these risky assets. And that when the normal times comes, these assets will be either moved to the Treasury or will be fully guaranteed by the Treasury. [01:07:20] Speaker 4: That kind of guarantees I really -- Okay, one last point before I leave. This is a major issue, certainly, inside and outside the Fed, the intervention of the private credit markets. We should understand, however, that the Fed has taken on, at this point, only high-quality assets onto its balance sheet, number one. Number two, when it took assets that were more questionable, and even in the case where it got AAA, it got first-loss protection from Treasury to secure those loans. And I agree that the rescue operations of the various maiden lane operations that are taking credit risk should be transferred to Treasury. And in the joint statement that Treasury and the Fed announced earlier this week, they said they would be. [01:08:05] Richard Koo: Well, that's good. [01:08:07] Speaker 4: That's good. [01:08:08] Richard Koo: Okay. That's very good. Excellent talk. [01:08:11] Speaker ?: Thank you. [01:08:12] Speaker 5: How about back there? Thank you very much. Can the U.S. pull this off alone? I mean, there's a debate right now, as I read it anyway, between the U.S. and the EU, for example, about the degree to which this kind of deficit spending is needed. And so if the U.S. were to pursue it, but the rest of the world weren't, what happens? [01:08:36] Richard Koo: That's the real danger we face, this accusation of free riding. And I think in that regard, what Tim Geithner said, that everybody put in 2% of GDP, it's a step in the right direction. What I wrote in my book is that everybody should put in enough fiscal stimulus to keep their GDP from falling. And if everybody does that, there's no reason for exports of other countries to fall, because the GDP is kept. And I think that kind of mechanism would be very much essential going forward, because otherwise, you know, the free riding problems, accusation of free riding, and then rise of protectionism, all of that can come together. And that can cause lots of problems going forward. Now, Chinese are very much aware of this risk, and they put in the very large fiscal stimulus before anyone else, still the largest in the world as a percentage of GDP, because they realize that if they are viewed as free riding on a U.S. package, there's no future for them. And they actually studied my work very extensively for a very long time, because they were facing the bubble themselves, and they realized that if they cannot keep the GDP from falling, their regime will go out the window also. What I do worry is Europe, because they have the Maastricht Treaty, which is so binding, and at the same time never considered what I call balance sheet recession. When that treaty was put together, there was no concept of balance sheet recession, and so fiscal stimulus is limited to 3% of GDP, which is nowhere near enough to handle a problem of this sort. And I very much like to see Europeans come together and say, "Yes, there's something wrong with our treaty. Let's make exceptions for this type of recession." And what I like to see in Europe is that if this type of recession happens within the Eurozone, that country, let's say Ireland, will have to do the fiscal stimulus to keep its GDP from falling to make sure that the problem doesn't spread to other parts of the Eurozone. And if all the individual countries all abide by that rule, then there should not be a zone-wide policy of composition, right? I think that kind of treaty, I think, is really necessary, both for the Eurozone and for the world. [01:11:10] Speaker ?: Thank you very much. [01:11:11] Speaker 6: Thank you very much. That was very interesting. I'm Torkel Patterson with Raytheon Company. You mentioned about economic stimulus and that the multiplier effect of that was about eight to nine times. Some studies said that infrastructure has a multiplier effect of eight. Do you feel that where should the economic stimulus money most effectively placed in order to get the best out of the stimulus? You said that it should be somewhere where it can be turned around quickly. What would you see as the best -- in the U.S. economy, where would the best use of that money be spent? [01:11:51] Richard Koo: Well, if you go back in history and see how countries came out of this type of recession -- so dollar of taxpayers' money, the most effective way to come out is military spending. Because military spending creates demand while not creating supply because battleships, fighter planes are absolutely useless. They better remain useless. So you increase demand without increasing supply, and that's why economies do recover very quickly. If you increase supply with the demand, then you're kind of chasing each other. But of course, I'm not here to suggest that we should just increase military spending. That's not what I'm here to say. But if you want the smallest budget deficit and the largest bang for the money, that's the kind of thing you end up spending money. Now, when I moved from the United States to Japan 25 years ago, I criticized Japanese roads, very poor quality, and all of that. 25 years later, my sons were going to college here. So I came back, showed my kids the college that I have to do all the driving. I realized how much work is needed here now. And so I think there's plenty of things this government can do. And on health care, energy areas. But it doesn't have to be roads and bridges. But even roads and bridges, I'm afraid, there's a lot that this country can do. Sure. [01:13:28] Speaker ?: I'm sorry. By the way, Mark Finley from BP. Thank you again. [01:13:31] Speaker 5: So how long does it -- even if the U.S. were to follow this path, how long does it take to work it out? I mean, it seems to me that the bubble wasn't quite as steep as in Japan. So how long on the backside if it was 15 years in Japan? [01:13:57] Richard Koo: Right. I think still it may take three to five years. But I'm just guessing because we haven't seen the bottom of the asset prices yet. Now, Japanese case, there's one area -- there are a number of key areas of difference. One is that Japanese companies and Japanese banks actually had lots of resources when we fell into one of these -- this recession. Japanese banks in particular in those days had a very conservative accounting system. You never mark up. You only mark down. And if you have that kind of accounting system for 30, 40 years, there are a lot of assets that were held at original cost 30, 40 years ago that could be sold and, you know, have this massive capital gains to offset the losses. Japanese banks wrote off a total of one trillion dollars, 100 trillion yen of bad assets over the 10-year period. So that was no peanuts. One trillion dollars, 100 trillion yen. Of that total, about half were realizing the unrealized capital gains they had on their books. And the other half was by current profits. Now, U.S. banks don't have that. They're all spending on bonuses already -- vacation in Bahamas and so forth. So they have to use their current profits to offset all of this. So in that sense, it might take a little longer, especially for the banks. But on the other side -- and on the other point is that Japanese at the time had export markets to rely on. And even though some people made a big thing about this export market, export market for Japan actually did not add or subtract from Japanese growth throughout this period. And if I may ask you to look at this chart, which shows Japan's trade surplus throughout this period, it was remarkably stable for the whole period. So Japanese export did not add or subtract from what happened to Japan. The point being that Japan basically handled its problems within its borders. And what I'd like to see is all countries operate this way. Whatever problem they have, they solve it within their national borders so that it won't spill over to other countries. Then we would be all better off. Now, that means little more than what Japan had to do because Japan never had to worry about falling exports. But I think that's what we are facing at the moment. Yeah? Well, I think some of the key indicators would include demand for funds from the private sector. Like this is a demand for funds from senior loan officer's opinion survey from the Federal Reserve. And we see the demand falling very sharply. Now, if this is beginning to come back up, and people are now forward-looking, they're not so worried about minimizing debt, they're beginning to maximize profits. When those signs come back in, that's the time for the government to cut the budget deficit. Because if the government's still in there borrowing money, and the private sector comes back, tries to borrow money, then we run into discounting our problems. Misallocation of resources, higher interest rates, inflation, all of that. So, when we see this turnaround, and people become a lot more forward-looking, private sector becomes a lot more forward-looking, that's the time you switch. But... So, this would be one of them. Interest rates would be another one. My interest rates can go up for all sorts of silly reasons. Middle East investors might get panicked with what the Federal Reserve is doing with its balance sheet. Pull the money out, and the interest rates could go sky-high. So, you have to look at both what's really happening in the market, and some of these sentiments that might be changing. And corporate numbers... Well, in the Japanese case, it was actually quite simple, because it was the corporate balance sheet that was driving the recession. In the U.S. case, it's the financial sector balance sheets, and the household sector balance sheets. So, you have to look at these two very carefully, to see whether people are willing to borrow money again, or start spending money again. So, I would be looking at balance sheets of these two sectors very carefully. Well, thank you very much. [01:19:01] Speaker ?: If I can ask maybe possibly the last question. [01:19:02] Steve Shragi: One of the things that I thought was very fascinating by your work, you talked about this going on for a long period of time. And one of the differences from the Japanese situation, this is a global situation that we're facing now. And we're already seeing some political and strategic impacts, protests from Latvia to Russia, and China. How do you see this impacting the global, political, and also strategic situation going forward? [01:19:31] Richard Koo: Actually, I think this going forward, we are going to see some democracies fail. We might see some governments fail, because this is such an unusual recession that most economists in those countries are probably unprepared to deal with it. And they might go back and forth between cutting taxes, monetary easing, this and that, and those failing to produce results and people become very upset. Those are the kind of things that we have to really worry going forward. And nothing is worse, in my view, to have dictatorships with wrong agenda having the right economic policy. And democracy is all arguing for a large government, no small government, no large government, no small government, and end up having no government. And these dictatorships doing the right thing. That's basically what happened in the 1930s. Hitler got everything right on handling this type of recession. And that's why German unemployment. This is one of the charts in here, for German unemployment. This is what happened to German unemployment after Hitler. And you can see that it was nearly 30% in 1932-33. And it was brought down to 2% in just this very short year. That's why he became like God. Everybody thought, my gosh, all the other countries are still in a mess. Germany got everything right. And the United States is this one. Our unemployment rate did go almost 25%. And with the New Deal policy, it improved quite dramatically. But in 1997, very fatal year, Roosevelt made the same mistake Prime Minister Hashimoto made in Japan 70 years later. He said, oh, the economy is improving. Everything is fine. We don't need a fiscal stimulus anymore. Budget deficit is too large. He cuts the budget deficit and unemployment skyrockets. And it took so many years for this thing to improve. A lot of people say our new deal policies did not work to pull the U.S. economy out. Well, it was working. But it was interrupted. If Roosevelt did not make this mistake and the economy continued to improve and other countries follow suit, I wonder very much whether Hitler would have a gut to start a war. But at that time, all the other countries were in a mess. Only that dictatorship was doing well. And that gave him an enormous confidence that maybe this time they can get away with it. So there's a huge political implications to this economic crisis. And I'd very much like to see democratic governments come to grip with this problem and put in the right policies before the dictators do. [01:22:40] Steve Shragi: Thank you so much for that really compelling description. And we welcome your insights and really appreciate you taking the time. We hope you'll share it with many other Americans and others around the world in the weeks and months to come. [01:22:54] Richard Koo: And I hope you share this with your friends as well. [01:22:56] Steve Shragi: Thank you very much. Thank you very much.