Originally published in September 2009 - Nothing has changed.
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Keynesians, listen up. Krugman, pay attention. Stimulus without structural reform (public and private sector cuts and restructuring) is doomed to fail. Look no further than Japan where government debt is an astonishing 200% of GDP. The brilliant former Morgan Stanley chief economist, Andy Xie, makes a convincing case that we are headed for the same.
Andy Xie
Anyone who doesn't believe in the harm of a financial bubble but does believe in Keynesian stimulus magic should visit Japan. A likely dip for the Anglo-Saxon economies next year will underscore these truths. The same goes for anyone who thinks China's latest real estate bubble, asset borrowing and shadow banking system are worthwhile substitutes for real economic growth.
We can learn much from Japan's experience. The global economy -- mainly the Anglo-Saxon economy -- is facing the consequences of a massive credit bubble. The remedies most governments have embraced are to keep interest rates low and fiscal deficits high. These are the same policies Japan pursued after its bubble burst nearly two decades ago. How today's bubble economies are treating bankruptcies and bad debt is shockingly similar to what was seen in Japan. The United States and others have suspended mark-to-market accounting rules to let banks stay afloat despite large amounts of toxic assets. It's the same "let them earn their way back" strategy that Japan pursued. The strategy fails to work because it keeps an economy weak, limiting the earning power of financial institutions.
As the global economy is again showing signs of growth in the third quarter, most governments are celebrating the effectiveness of their policies. Yet Japan's experience forces us to pause: Its economy experienced many such growth bounces over the past two decades, but was unable to sustain any of them. The problem was Japan only used stimulus, not restructuring, to cope with the bursting of its bubble. After the demise of any big bubble, serious structural problems that hamper economic growth remain. Stimulus can only provide short-term support that makes structural reform possible. When policymakers celebrate the short-term impact of stimulus and forget structural reforms, economies slump again. I think the Anglo-Saxon economies will dip again next year.
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DB here. The nature of the problem here as well as Japan is political, which makes it all the more frustrating considering the sheer insanity of politics and partisan bickering.
The solution is simple, except few in the public sector are brave enough (the private sector does not have this problem except for the banking industry, and well, it's not a private industry) to advance the restrucuring and reform that is essential for a positive economic outcome.
Politicians have huge egos, bankrupt souls, and don't care much about anything beyond re-election. They hate recessions ultimately because they fear a voter backlash and the possibility of being sent back home from cozy Washington. So they are generally prepared to do anything to avoid/prevent/mitigate the process. Such is why they will vote to spend money whether they have it or not. Throw trillions in cash at the problem, shy away from fixing the structural issues, and maybe it can be held together long enough to be re-elected for another term.
Too bad the trillions are coming from you and your kids (and grandkids) and they never asked for your permission.
