18 Aug 2011

Balance Sheet Recession: Is this the Japanese lost decade malaise?

So rudderless world stock markets are again sent to the rocks by the merest bit of bad news – today manufacturing confidence in Philadelphia. It turned around 3/4 days of markets going up, and plenty of traders declaring the calm was here until the end of August. Looking at the stock market over the past year, all you see is a money-printing asset price boom lasting 9 months that disappeared when QE stopped. It was a fake recovery. A sugar high.

But now we are in a kind of loop of doom where stock price bungee-jumping is impacting upon business and consumer confidence which could then beget actual economic damage.  And on top of that we have the old questions about what weapons are left to fire.

If the markets are right we are just over half way through a half decade of our own Zero Interest Rate Policy. Banks aren’t lending to SMEs (in net terms, despite the Merlin hyperbole). And in a sovereign crisis, the fiscal weapon is itself the problem.

George Osborne did a remarkable thing last week. He referred to Britain as coming out of a “balance sheet recession”. I missed the speech to the House of Commons, because I was attending to feral markets in New York. I did not really ever expect to hear the Chancellor refer to Britain’s economic inertia in this way. The terminology comes with some baggage. It’s practically a registered trademark of Richard Koo, the chief economist of the Nomura Research Institute in Japan.

It’s a frame of analysis that the likes of Joseph Stiglitz has been pushing. (I include his full interview with me from last week expanding upon  his triple/ quadruple-dip theory and the impact upon social unrest below). That we are in a malaise caused by the bursting of a mortgage and credit bubble, where companies and households have singed balance sheets, and downsized wealth, which means some conventional economic stimulants don’t work. Gordon Brown, I imagine, agrees with this analysis 100%.

As it happens, in his prognosis of what was to come, made to me in late 2009, the author of the Balance Sheet Recession concept has been proven almost entirely correct. Click here to have a look. Ahh yes, and have a look at this graph of comparing stock market relapses after Japan’s bubble with what we’ve has so far in the US.  Ahh yes sovereign bond yields are slumping to record lows in US and UK (allegedly a moment for celebration), just as they did in Japan too.

So why is the Chancellor adopting this vernacular? I’m not expecting any fiscal stimulus. Yet, I can’t help but think that the Government would like to get some growth-enhancing infrastructure projects funded somehow. Could he keep the overall path of deficit reduction in intact and delay or divert some of the spending cuts? Perhaps. Events appear to be changing. He has an alibi. Will the markets really send the UK into a tailspin with a slower reduction in borrowing given that we now enjoy the lowest gilt rates in UK history ?

There are other parallels with Japan. Our babyboomers are beginning their retirement and will act conservatively in their investment decisions, as occurred in Japan. There and here the exit from a giant bubble could interact with ageing population to see a structural flight from risk that will compound our creaking banking system. So where now? I leave you with what Richard Koo told me two years ago about what happened in the second dip of the Japanese malaise.

“A double-dip second time round is usually far worst than the first time around. First time around, when the economy weakens as a result of the bursting of the bubble, most people tend to blame themselves – ‘I should have been more careful’ and so forth. But the second leg, when they realise that monetary policy – zero interest rates, quantitative easing – failed, fiscal policy seems to have failed, then they become excessively pessimistic.

“In Japan that happened between 1997 to 2004. People were so pessimistic, you wouldn’t believe,” Koo told me two years ago.

Is that where we are now?