Is the U.S. Now In a Lost Decade?

Is the U.S. now trapped in a zombie decade much like what Japan endured in the ‘90s?

Answer: Yes, and the government will be conducting fiscal stimulus and deficit spending for up to 10 years to revive the economy.

And did you know that seven out of eight U.S. banks were actually bankrupt due to the Latin American banking crisis of the early ‘80s? And that printing money won’t fix the problem?

That’s the word from Richard C. Koo, a renowned chief economist of Nomura Research Institute and former economist at the New York Federal Reserve in the early ‘80s.

Koo noted all this in a speech entitled "Great Recessions: Lessons Learned from Japan” to the Center for Strategic & International Studies late last year. 

“People should know what kind of disease [the U.S. economy] is stuck with,” Koo says, adding the government should be clear about telling the taxpayers and consumers this is a balance sheet recession, and the length of time it will take to fix it.

A Time For Leadership

But you don’t see that straight talk, that leadership. Instead you see moves such as tossing more money at mortgage borrowers living on the edge, borrowers who should be renting instead, bail outs of bad loans that will only create more writedowns for banks down the road.

And you see at least $639 mn in taxpayer money wasted on 93,000 homebuyer tax credits (at $8,000 apiece), given to scamsters, including a four-year old child (lawmakers are moving to pass a new age to qualify, 18, while the legal age to buy alcohol in most all states is 21).

No-Doc Tax Credits Follow No-Doc Loans

Government officials say little documentation is required for these credits, so no-doc credits are given to fix a crisis partly exacerbated by no-doc loans. 

All of a piece with the free-money free for all, paid for by U.S. taxpayers. The US government is now on course to spend each year for the next ten years a deficit expenditure amount that is roughly equal to the annual GDP of Russia, once health care reform is factored in.

This open fire-hydrant of taxpayer money is now splashing full circle, as it's pointed at reckless borrowers who basically just create more bank writedowns.

The threat here is that the TARP bailout program will be permanently cemented in the government's architecture, as TARP has been extended to bail out life insurers and mortgage borrowers, $50 bn being used to modify home loans that taxpayers may never see again, the Congressional Budget Office says.

What Triggered the Crisis in Japan?

You may be surprised to hear what triggered the crisis in Japan, which also is just coming out of a deep balance sheet recession with massive writedowns.

“Commercial real estate prices collapsed and housing prices went down” too, Koo says, adding that prices dropped 87% in Japan, as companies borrowed heavily using land or buildings as collateral.

Although the reverse happened here, what Koo says next is chilling given that US commercial real estate loans are quickly souring. “Just imagine commercial prices down 87%” in the U.S., "that’s what we suffered in Japan,” he says.

Japanese banks lost nearly $1 trillion over the last 15 years, he adds, which U.S. banks are already set to surpass. Commercial real estate Kryptonite is just now beginning to cause regional banks to crater here, with major money center banks like Wells Fargo and Bank of America struggling with bad commercial real estate loans as well.

Can Government Spending Fix this Mess?

Koo warns that fiscal stimulus acted like a sugar high in Japan, where the Liberal Democratic party enacted eight stimulus packages between 1992 and 1999. Each time the packages wore off, though, the Japanese markets reacted violently.

But although Koo says “I am no great fan of fiscal stimulus," he adds that without the spending, Japan would have lost 75% of its GDP. Koo says such spending can work, especially when an economy is dealing with deflation, massive debt, and damaged balance sheets at households and companies.

Devaluing Our Way Out of the Crisis

But deficit spending means the U.S. will devalue and inflate its way out of the crisis, as the word out of Washington officials such as Treasury Secretary Tim Geithner is that a weak dollar will not only help create more exports, but will restructure the economy permanently towards exports and away from consumer spending, now 70% of GDP, as households remain overleveraged and unemployment hits 26-years highs.

But in a weak dollar regime, capital flows surpass trade flows, and jobs will continue to flow offshore, economist David Malpass notes, as a weak dollar has U.S. companies setting up shop overseas and funneling profits back stateside. Profits earned in other currencies look massive when reported in a weak U.S. dollar regime. The US's tightening regulatory regime is also causing businesses to flee offshore.

Also, emerging markets such as Brazil, Russia, India and China combined represent just a third of the GDP of the U.S. and Europe, plus consumers in these countries combined annually spend one-fourteenth of what consumers in America and Europe spend. It's more than a faith-based initiative to think US exports to these countries will revive the country's economy.

And if a weak currency were the way, as John Tamny of RealClearMarkets notes, Argentina would be an economic powerhouse. And to which I would add Zimbabwe would be a superpower.

The U.S. Has Been Here Before

Koo also said the U.S. has been in a severe banking crisis before, and he's not talking the Great Depression. He said that U.S. banks have gone bankrupt throughout the nation’s history —although the general population isn't told at the time.

Specifically, Koo said that the New York Fed concluded that the Latin American crisis of 1982 was the worst bank crisis in modern US history.

“Our conclusion was that seven out of eight US money center banks were actually underwater," because they were overexposed to Latin American banks, Koo says, adding “everyone from Mexico to the southern point of Chile went bankrupt.”

Then Federal Reserve Chairman Paul Volcker importuned foreign banks, including Japanese banks, to keep their credit facilities wide open to U.S. banks in order to avoid a wholesale collapse in the banking system, “knowing full well these American banks were bankrupt," Koo says.

But “we could not tell the outside world how bad the situation” was, Koo adds.

And Volcker ordered U.S. banks in 1982 to keep lending to “Mexico’s dictators” and banks, so its banks didn’t completely fall into the drink, dragging U.S. banks with them, as they were already “underwater” and near “collapse,” Koo says.

Koo says that the Fed knew at the time that US banks were "bankrupt," but could not publicly discuss how bad the situation was, because “the next day they would be bankrupt” due to a run on the banks.

Koo says that instead Fed officials concocted a party line that the banks were dealing with “good debt on their books."

[Recall what then Treasury secretary Henry Paulson advised in not telling the market in the fall of 2008 about the government’s lack of resolution authority to save Lehman Bros. from collapse, “you don’t want to say the emperor has no clothes.”]

Koo says it actually took the Federal Reserve 13 years to fix the US banking system’s dangerous exposure to the Latin American debt crisis, adding that Volcker created a steep yield curve, just as the central bank is doing now, letting US banks keep loan rates high, while short-term rates were kept low.

That cash flow from this “fat” spread helped banks cure their sickly balance sheets. Doing so also prevented costly taxpayer bailouts — to the point where very few people were aware of the severity and serious dangers of the Latin American banking crisis, and the bankruptcy of U.S. banks at the time, Koo says.

“Americans only remember the S&L crisis,” when the Latin American debt crisis was “ten times larger than the S&L crisis,” Koo says.  

"Print the Money!"

Koo also says that economists Paul Krugman, Milton Friedman, Ben Bernanke, "all travelled to Japan and bashed Japan left and right,” adding they exhorted Japan “to just print money and everything will be fine” to get out of its crisis.

Even former Fed chairman Alan Greenspan was saying that Japan should "just print the money’” in Congressional testimony, Koo says. “Japan can print all the money it wants,” these officials chided Japan.

“But when you think about it, monetary policy is useless when no one is borrowing money, even at 0% interest rates,” Koo says, despite economists who fervently believe monetary moves can solve all problems.

Koo says he even debated Krugman on this point for two hours for a Japanese magazine.

“He kept on pounding this point: ‘Just print money, just print money, just print money,’” Koo says, “and I said 'No, it won’t circulate because no one is borrowing money'” at a time when they are trying to repair damaged balance sheets, so “such monetary policy is ineffective.”

True, too, as U.S. banks now refuse to lend this money, and are instead hoarding it to fill balance sheet potholes blown open by bad assets — and where banks such as Goldman Sachs and JPMorgan Chase are using it to fuel their bond trading desks, which are now minting money hand over fist due to the Treasury’s massive debt financing, $3.5 tn to date.

“Don’t’ put your hope on Mr. Bernanke,” Koo says.