David R. Kotok
Richard Koo and the Andes
January 12, 2011
Fishing trips have down time. You go out in the morning. Chase some trout and then hurry in for lunch, a fabulous lunch of grass-fed beef from gaucho country cut as a New York strip, a squash and potato mashed combo with Nano’s selected local seasoning, Ahí chileno, and a fresh salad picked that morning from the Alto Puelo Lodge organic garden and dressed with extra virgin and balsamico. A nice Mendoza cab, and the lunch is complete.
Richard Koo is on my mind.
His newest version haunts me. Readers are advised to order a copy of the revised and updated edition of The Holy Grail of Macroeconomics. Read it and think about it. I did in the Andes.
The notion of a “balance-sheet recession” is powerful. Koo lays it out in exquisite detail and supports it with facts. It is refreshing to read well-analyzed data instead of unsupported opinion and innuendo and surmise and assertion.
This is data-driven economics using the world´s – used to be – second largest economy as a reference. Japan is Koo´s case study. Those Americans who avoid this provocative case study do so at their peril.
Koo’s work is an enlightening counter to the scatological contributions we routinely hear from the (far too many) politicians interviewed on Squawk Box. On the Puelo, one need not hit the mute button to rid oneself of Washington, ad nauseum, and the queries of Joe Kernen. Koo is writing about fiscal policy in a very serious way.
I´ll digress. Squawk Box politicians are getting away with murder by talking about destructive fiscal policy. For an example, check the interview of Iowa Senator Chuck Grassley and his unchallenged defense of the ethanol subsidy, in which he invokes the Caribbean Basin Initiative to support the subsidy. Did Kernen ask him about the costs of rehydration and how the subsidy is stacked against competition, reeks of protectionism and is designed to help a few very large Iowa corn farmers, while driving up the price of corn and starving a few hundred million poor people? Sadly, Joe missed it, and Grassley got off the hook.
But this is not about Kernen and Grassley. It is about Koo.
Richard Koo´s book sets out the limits of monetary policy in the present environment. He describes how properly constructed, demand-encouraging fiscal policy is the way to stimulate demand and offset the actions that private firms take to correct balance-sheet imbalances. His point is worthy of consideration.
As a single firm, when your assets go down in market-price terms and you have to mark to the market, you survive by raising your savings, which means debt reduction. When all firms do it together, they engage in what economists call the “fallacy of composition.” Each acts in what it perceives to be its own self-interest. Together they exacerbate a slowdown and create deflationary pressure by contracting demand. Enter the role of government.
Koo argues that the cure for this stage of the cycle lies with constructive fiscal policy, not monetary policy. He demonstrates why this is so, with history on his side. We will leave the rest to serious readers.
Check out chapter 8 and the appendix. We did.
More when we get back. For now, adios from the Alto Puelo Lodge
David R. Kotok, Chairman and Chief Investment Officer