13th
Profit Maximization vs Debt Minimization
Awesome inteview with Nomura’s Richard Koo (full text).
Maybe you didn’t know that:
- the value of land collapsed 83% in Japan since the top of the bubble in 1989
- total amount of wealth destruction since the bubble burst equals 3 years of GDP vs 1 year of GDP in the US during the Great Depression
- nevertheless, nominal and real GDP of Japan never went below its 1989 peak thanks to public borrowing, while US GDP was almost cut in half between 1929 and 1939
The whole interview is really worth reading. Two ideas I found most interesting. First, in a balance sheet recession, companies and individuals need to pay down debts that are worth more than their assets, no matter how low interest rates are. In other words, the strategy shifts from profit maximization to debt minimization.
Second, to keep GDP levels constant, the government simply has to borrow the same amount that is being saved by individuals and companies. In other words, fiscal deficits will be financed by those same savings, with no need of external borrowers. That would explain how long-term interest rates in Japan declined to 1.4% over the past twenty years even with growing public debt borrowing.
My fear is that the public debt buffer only represents a way to postpone the day of reckoning as the obvious political least resistance path. The tipping point could probably be reached as the debt rollover risk becomes sensitive to demographic trends (average population getting older and spending its lifetime savings in retirement, health care expenses or support to unemployed younger family members) or companies switching back to profit maximizing mode or the public sector getting accustomed to higher level of spending, waste and corruption or simply a bout of bond market panic. An interest rate shock at high public debt level would quickly trigger a devastating snowballing effect.
