Richard Koo doesn’t address the problem of bad debts being carried in the banking system by “extend and pretend” or by having been bought by the Fed and subsequently disappearing into that black hole of unreported charge offs. I have taken a fair use chunk of Koo’s article but encourage readers to read the whole thing.
I have this inkling that because all the derivative bets are off the books, the capital class, those holding financial assets, is not really aware of the risks of a general deflation, and can only see the “problem” of fiscal spending supporting “deadbeats” (the 47 percent) who are dependent on the government for basic needs. We shall see.
Explain the disease to help US citizens
By Richard Koo
In 2008, Barack Obama told the US people the nation’s economic crisis would take a long time to overcome. In 2012, many of those voters are losing patience, because they have not been told why this recession has lasted so long or why his policies were the correct response. Here is the missing explanation – based on not only the US experience, but also that of Japan and Europe.
Today, the US private sector is saving a staggering 8 per cent of gross domestic product – at zero interest rates, when households and businesses would ordinarily be borrowing and spending money. But the US is not alone: in Ireland and Japan, the private sector is saving 9 per cent of GDP; in Spain it is saving 7 per cent of GDP; and in the UK, 5 per cent. Interest rates are at record lows in all these countries.
This is the result of the bursting of debt-financed housing bubbles, which left the private sector with huge debt overhangs – notably the underwater mortgages – giving it no choice but to pay down debt or increase savings, even at zero interest rates.
However, if someone is saving money or paying down debt, someone else must be borrowing and spending that money to keep the economy going. In a normal world, it is the role of interest rates to ensure all saved funds are borrowed and spent, with interest rates rising when there are too many borrowers and falling when there are too few.