January 2015
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The Balance Sheet Recession

In this interview Richard Koo set out his thoughts on the current GFC in a very succinct manner. I agree with him 100% up until the point he starts arguing for government stimulus to tackle the deleveraging.

My opinion is that he is exactly right that this event is a large scale ‘balance sheet recession’, which is just another term for a debt deflation really, there is no need to give something old a new name.

However, I differ when he argues that continued and sustained government stimulus is the answer.

Fighting a debt problem with more debt is not the answer.

For an economy with immaculate credit credentials and little current debt then I’ll say well maybe you can try.

But for an economy with long term credit credentials but a wavering world watching it’s every move and at the same time beginning from a very poor budgetary and debt position (the United States) then the answer is a resounding and an unequivocal nyet.

The primary role of the U.S. government over the next decade should be first and foremost preventing an implosion of the social and economic system.

In my opinion this requires a bottom up rather than a top down approach. Those most at risk should be protected as much as possible in order to ride out the deleveraging that needs to be undertaken.

The deleveraging needs to happen one way or another, what is better a short sharp flu or a long drawn out cold?

Government interference can drag things out for years but is it to the long term benefit?

It should be better for the system to support the parts of the system that are prone to revolt and let the parts of the system that caused the problem die.

If this is done properly you are preventing the worst consequences and at the same time expelling the problem.

This will not happen though.

For one simple reason, the problem has the power.

The problem is much bigger than the solution. In simple terms the deleveraging needed is much larger than anything that government might reasonably accomodate.

In very general terms we need to pay the piper. We made a mistake and now we need to pay the price. There is no shortcut, no magical solution, the answer is a long hard grind of paying off ridiculously high levels of debt that should never have been given or taken in the first place.

The government should not be a ‘borrower of last resort’, it should primarily be concerned with preserving the stability of society. Borrowing more when others have borrowed too much before them is a recipe for disaster not a solution.

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