His thesis is well documented, to the point where you want to scream, "OK! I GET IT! JUST PLEEEEASSEEE MOVE ON!" It is hard to argue against it, since it does make sense. The problem with it is that Koo--wrongly, in my opinion--assumes that the Government will adequately allocate that capital. According to Koo, the excess savings from the private sector deleveraging, combined with accommodating monetary policy from a central bank, will keep borrowing costs low until the private sector recovers and starts borrowing again, at which time the government should start to scale back stimulus letting the private sector take over. Koo argues that the growth in the debt have little effect because borrowings will be financed at low rates and, as the economy recovers, tax-receipts will organically increase, leading to deleveraging in the public balance sheet as the private one releverages.
While Koo's is an elegant model, I have some bones to pick. First of all, Koo is proposing a solution to a problem--he's giving us insecticides to kill our pests. While I welcome his contribution, it doesn't mean that we shouldn't still focus on reducing or avoiding asset-price bubbles. As Pettis so eloquently wrote:
By net contingent liabilities I mean the excess of debt over the value of the investment it supports. For example, if RMB 100 is borrowed to build a railroad, the debt is sustainable if the railroad creates net economic value to China of RMB 100 or more. If it doesn’t, the difference must be considered net debt that one way or another must be paid for by Chinese households. This will of course reduce their future consumption along with the economic growth associated with satisfying that consumption.Pettis may be talking about China, but the issue of mal-investment still applies. The federal government can borrow as much as it wants to stimulate the economy, guarantee Build America bonds, back-stop bank losses and fight tooth-and-nail to fight deflation, but if the capital is poorly allocated, it may be creating a bigger problem than it started. Fighting asset-price bubbles starts with making sure interest rates are not negative. Greenspan enacted used monetary policy to stimulate the economy after the .com bubble and, as Koo explains Chapter 7, started inflating " the housing market, the most interest-rate-sensitive sector of the economy." Well, look how that turned out.
I am not saying that deflation is a good thing, but I am saying that if the stimulus is applied incorrectly, it could just make problems worse down the road because, while stimulus may make everything rosy in the GDP = C + I + G +NX model, it doesn't take into account value. That is, it uses the GDP as a proxy for value created, which may or may not be right. In the end, all these stimulus funds will do is fund projects that will transfer wealth to the private sector by borrowing from the public's future wealth, keeping momentum going. A problem, however, surfaces when the projects undertaken do not create wealth equal to the present value of the debt. You can keep an economy going by paying people to shovel sand from one pile to another but, if we do that, once the stimulus runs dry all we are left with is a couple of piles of sand. I'm not saying the government wants us to shovel sand--they could be building the next Eisenhower Highway System for all I know--I'm just not comfortable leaving that decision up to the guys that decided to try to reflate the bubble by pulling-forward demand, subsidizing toy arrows and foreign liquor and build useless airports. Just sayin.
As a final clarification, this is not an attack on Koo, not even close. I just think we should question whether we can trust the political class to Do The (Economically) Right Thing for all of us, not just their campaign donors.
Previously, in Angry Rants:
If we ever hope to get back to growth and increasing standards of living we can't all just sit around trading shit back and forth, we need to reduce our speculative activities and get back to funding and working on value creating processes.
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