When the going gets tough, the tough get spending.
This, at any rate, is the view of Richard Koo, senior economist at the Nomura Research Institute, who has developed quite a reputation for arguing governments in the west should be investing rather than saving money to rescue their economies.
Koo has won the respect of several strategists, including Yves Bonzon, chief investment officer of Pictet, for his views. UK shadow Chancellor Ed Balls would appear to be a convert. But Koo is unlikely to be on German Chancellor Angela Merkel’s Christmas card list.
Koo’s stance developed out of watching the Japanese government trying to dig the country out of recession in the 1990s. He thinks governments have no choice but to spend and invest when the private sector refuses do so in the middle of a slump. It can use its status as a low-risk borrower to borrow at low interest rates. If necessary, at risk of cheapening its currency, a government can even print money to buy the debt back later.
Koo argues Japan found itself in this “balance-sheet recession” when companies stretched by its 1980s boom became more desperate to cut their debt than invest in the future, to grow profits. Banks cut back lending in a bid to improve their funding position. As debtors repaid them, the banks squirreled away a large part of the money for a rainy day. Sounds familiar?
In Japan, it never rains when it pours. As companies continued to save and banks kept refusing to lend, the economy was caught in a liquidity trap. When the government printed money to buy back bonds from investors through quantitative easing, even this got caught in the system.
In due course, with a couple of hiccups, the Japanese government became the spender of last resort, wheeling out no less than 15 spending packages. Although Japan stagnated, Koo argues it did a remarkable job avoiding depression. After 15 years, Japanese companies finally stopped paying back debt and banks started to lend again. However, the recovery remains anaemic, not helped by the western credit crisis, falling exports and nuclear fallout.
Koo is worried because companies in the west have become keen to cut debt and save money before recovery has become established. Businesses are finding they need to offer banks more and more security to borrow less and less, as quite a few family businesses have discovered.
The Germans are sanctioning loans to troubled peripheral economies, but urging austerity on borrowers, pushing them towards depression. The UK coalition government is in the middle of a cost cutting programme. A congressional super-committee of Democrats and Republicans has been asked to recommend US cuts later this month. Social unrest is growing.
Having thrown trillions at their banking system in 2008 and 2009, countries have become obsessed with balancing their books. But Koo says they need to stimulate their economies a great deal more, arguing that rating agencies, led by Standard & Poor’s, are playing a dangerous role in scaring politicians into cutting their debt prematurely.
Koo compares the situation to 1937, when the US partially reversed President Franklin Roosevelt's New Deal stimulus of 1933. That time round, it took a war to re-stimulate the US economy, after which Europe was forced to start again from scratch.
Boosting debt to get out of recession looks counter-intuitive to most people and Koo has struggled to get his message across. But Ben Bernanke, chairman of the Federal Reserve, is making noises that the economy is performing worse than expected, potentially requiring unconventional measures to get back on track.
Elsewhere, Barack Obama’s new pitch for job creation is starting to sound a little like Roosevelt’s New Deal campaign. Which is hardly surprising, as the presidential election year approaches.