Richard Koo tells politicians facing a crisis to throw more money at it.

Richard Koo is a name that seems to be popping up here and there when people discuss what to do about America's current continued economic problems, likewise with Japan. Richard Koo has an excellent resumé, at least it would seem that way. He has worked as an economist for the Federal Reserve Bank of New York and he is now the chief economist of Nomura Research Institute. I don't know how popular he is in Japan, but a quick look at Amazon shows he has some books in Japanese that seem to be selling relatively well. Recently I read an interview with him in Barron's online, and he said some things to me that just don't add up. In fact, they sound like ideas that would do harm to both the American and the Japanese economy if they were followed. In this post, I want to point out what it is that bothers me.

First, from the interview, he gives his standard line, which is this:

The Bank of Japan brought the rates down to zero, did massive quantitative easing, with no result whatsoever. This happens because of a balance-sheet recession. ... This happens because the private-sector companies are no longer maximizing profits; they are minimizing debt.

Now I take it that one is supposed to read this and have a eureka moment. Oh, now I see.

But basically what is being stated here makes no sense. Presumably if we are discussing a free market, then there are competitors. If one company were not to focus on profit, another company would. Eventually sales would shift to that company, and the other company would go under. Moreover, if a company is over its head in debt, then shouldn't it be going bankrupt in the first place?

While I'm not yet willing to accept Mr. Koo's theory, I will say this, to the extent that is *might* be true, it must be true because there has already been tampering with the economy. Namely, the government must be extending aid either directly or indirectly to the relevant company in order to keep it from going under. Naturally, in this case, they are not concerned with profit, but in cleaning up their balance sheets. There's a certain logic here, and I can easily imagine a situation where it makes less sense to worry about profit, and more sense to clean up one's balance sheet. This certainly would make sense to me if I were running a bank in the US right now, and various US governmental institutions were all that were keeping me afloat. The last thing I would want to do would be to take on new risks.

So my main point is that to the extent Mr. Koo might be right, his point needs to be turned on its head, namely the government shouldn't be propping up bad companies, instead it should be letting them fail.

However, here is what Mr. Koo comes around to saying:

In an ordinary, garden-variety recession, as we learned in school, the private sector uses money more efficiently, and a budget deficit is considered bad. But when the private sector is completely absent and paying down debt at zero interest rates, and the government doesn't borrow this money, what happens? Even a child would understand the whole thing could collapse. The only way the government can turn this economy around is to do the opposite of the private sector -- borrow the money the private sector saved and spend it, which means fiscal stimulus. That's what saved Japan from entering a Great Depression.

There's a lot packed into this statement that would nearly take a book to discuss. There have been several contrarian views of the depression, many of them showing that government interference actually probably prolonged the depression. Here are a couple of examples, Murray N. Rothbard's America's Great Depression [pdf] and Robert Murphy's The Politically Incorrect Guide to the Great Depression and the New Deal.

Basically, the government never uses money as productively as the private sector does. It's easy to understand why. First, central planning is no match for the powers of the free market. A central planner simply cannot be made aware of the individual problems affecting each individual, while a market through alterations in price can actually fairly quickly respond to changes. This is why there were constant shortages of products in the old Soviet economy, but rarely at your local super market. Second, the government does not attempt to use money efficiently, because there is no incentive to use money efficiently. In fact, there is more incentive to use money to obtain political ends than there is to use it wisely.

So I find what Mr. Koo is recommending extraordinary. First the government interferes by keeping companies propped up rather than letting them go under. (And here I presume he's talking mostly about banks), then what happens next is that these companies stop focusing on making a profit, and so Mr. Koo suggests that the government should thereby sop up any left over savings and then spend that money. I can barely explain how horrible this all sounds to me.

Of course, in America, this is sort of a bad joke, because most of the savings is from China and Japan these days (at least it is these countries that are buying US bonds). Moreover, when you look at the horrible way the government has used most of its money in Japan, one is further depressed. A lot of this misuse of money is detailed in Dogs and Demons for anyone who wants to understand this.

I can only hope that the right people are not listening to Richard Koo.