Foreword xix
About the Author xxv
CHAPTER 1 Balance Sheet Recession Theory Basic Concepts 1
GDP and Inflation Fueled by Growth in Money Supply, Not Monetary Base 5
Japan Fell into Balance Sheet Recession in 1990s 10
Plunging Asset Prices Create Balance Sheet Problems for Businesses 12
Japanese Firms Rushed to Repair Balance Sheets by Paying Down Debt 13
Correct Private Sector Behavior Tipped Japan into Contractionary Equilibrium 14
Collapse of Japan s Bubble Destroyed ¥1,500 Trillion in Wealth 16
Why Japanese GDP Did Not Fall after Bubble Burst 18
Fiscal Stimulus Saved Japan s Economy 21
Good Fiscal Deficits Were Not Perceived as Such 23
Balance Sheet Recessions and the Limitations of Econometric Models 25
Fiscal Stimulus Works in Two Stages 28
FDR Made Same Mistake in 1937 28
Reactive Fiscal Stimulus Is Far Less Efficient 30
Fiscal Deficits Are Easily Financed during Balance Sheet Recessions 31
Self-Corrective Mechanism for Economies in Balance Sheet Recessions 33
Two Types of Fiscal Deficits Require Different Responses 34
Fiscal Deficits Must Be Viewed Relative to Private Savings 36
Consequences of Leaving Things Up to the Market in a Balance Sheet Recession 37
GFC Triggered by Insistence on Market Principles 40
Volcker Understood Systemic Crises 41
Little to Be Gained from Bashing Those Who Have Already Come to Their Senses 42
Recovery from Balance Sheet Recession Takes Time 43
Forward Guidance Important for Fiscal as Well as Monetary Policy 43
Fiscal Consolidation: Better Too Late Than Too Early 45
Three Points to Consider Regarding Costs for Future Generations 47
Japan Had a Shot at Full Recovery in 1996 ... 49
Conflation of Balance Sheet and Structural Problems Extends Recession 50
Distinguishing Balance Sheet Recessions from Structural Problems and Financial Crises 53
Democracies Are Ill-Equipped for Dealing with Balance Sheet Recessions 55
Keynes Also Overlooked Private-Sector Debt Minimization 56
Those Who Prevent Crises Never Become Heroes 58
Democracy Plus Balance Sheet Recession Equals Secular Stagnation 59
Appendix to Chapter 1: Summary of Yin and Yang Phases of Economy 60
CHAPTER 2 Monetary Policy and the Quantitative Easing Trap 63
Monetary Policy Impotent without Demand for Funds 64
Mechanisms for Money Supply Growth 65
Government Borrowing Drove Money Supply Growth in Japan 67
Economics Dogged by Incorrect Analysis of Great Depression 68
Japanese Monetary Policy Has Relied on Fiscal Policy for Past 20 Years 72
Balance Sheet Recessions Triggered by Borrower-Side Problems, Financial Crises Triggered by Lender- Side Problems 74
Bernanke Himself Says QE2 Unlikely to Have Major Macroeconomic Benefits 75
Real Aim of QE2: Portfolio Rebalancing Effect 75
Can Higher Share Prices under QE2 Be Justified on DCF Basis? 77
QE2 a Big Gamble for Bernanke 77
QE Undermined U.S. Leadership in G20 78
QE with No Income Effect Harms Other Countries 79
Dollar-Buying Intervention by U.S. Authorities Would Have Produced Different Outcome 80
Inward Capital Controls Help Keep Bubbles Fueled by Hot Money in Check 80
QE Represents Government Intervention in Asset Markets 81
Operation Twist Lowered Long-Term Rates, but to No Effect 81
Operation Twist Provided Only Limited Economic Boost 83
Bernanke Admits the United States Faces Same Problems as Japan 84
Fed Overestimates Impact of Quantitative Easing 84 Lower Long-Term Rates = Higher GDP Formula Does Not Hold during Balance Sheet Recession 85
Fed Has Also Underestimated Costs of QE 85
Unorthodox Monetary Policy Distorts Signals from Bond Market 86
Needless QE Acts as Drag on Financial Institutions 87
Why Fed Embarked on QE3 Two Months before Presidential Election 88
Post-Bubble Wage Growth Nearly Identical in the United States and Japan 89
The Inconvenient Truth of the Real Cost of Quantitative Easing 89
BOJ s First Round of QE Was Easy to Wind Down Because It Was Conducted in Money Market 91
Redemption of Central Bank Bond Holdings Will Not Reduce Commercial Banks Current Accounts 92
Government Issue of Refunding Bonds to Private Sector Would Absorb Excess Reserves 92
Redeeming Fed Bond Holdings Has Same Effect as Issuing Deficit Bonds 93
Strength of Private Loan Demand Different at Start and End of QE 94
Paying Interest on Excess Reserves Would Enable Rate Hikes ... 94
But Cost Could Be Prohibitive 95
Cost of Winding Down QE Has Yet to Be Properly Analyzed 97
Debate over Winding Down QE Sparks Bad Rise in Rates 98
QE Trap Appears Increasingly Likely 98
Continued QE Trap More Likely Than Hyperinflation 101
BOJ Found Itself in Same Position in 2006 103
Fed Admits That Supply and Demand Matters, Too 103
Fed Changes Course Despite a 1.1 Percent Inflation Rate 104
Traditional Phillips Curve Relationship No Longer Holds 105
Upcoming Chapters in QE Saga 106
Capital Injection Could Also Be Threatened If Blame Shifts to Fed 106
Sales Should Start with Bonds Maturing Soon 107
Final Cost of QE Can Be Calculated Only at End of Fourth Chapter 108
Theoretical Debate on QE Has Focused Entirely on Benefits and Ignored Costs 108
Central Banks Should Establish a New Reaction Function to Drain Reserves 110
Emerging Markets Need Inward Capital Controls to Protect against QE 111
Japan Should Learn from Pioneers in QE Using Long-Term Bonds 112
Financial and Capital Markets during Balance Sheet Recessions 113
Balance Sheet Recession Brings Special Kind of Liquidity-Driven Market 115
Is Inflation of 1 2 Percent Too Low? 116
Does Inflation Improve People s Standard of Living? 116
Absence of Inflation Concerns May Have Lifted Utility of Consumption in Japan 117
QE Should Not Be Pursued Any Further Given Difficulty of Winding It Down 118
QE a Problematic Byproduct of Balance Sheet Recessions 119
CHAPTER 3 The United States in Balance Sheet Recession 121
Rating Agencies Need to Be More Tightly Regulated 123
Why Was Lehman Allowed to Fail? 124
TARP Prevented Bank Failures but Also Created Turmoil 127
U.S. Authorities Changed Course with Pretend and Extend 129
Fiscal Stimulus Shifts from Three Ts to Three Ss 131
Obama Has Yet to Disclose the Name of the Disease 132
Bernanke s Fiscal Cliff Warning Saved the U.S. Economy 134
Bernanke Declared Monetary Easing Could Not Offset Impact of Fiscal Cliff 136
Fall from Fiscal Cliff Triggered Japan s Deflation 137
U.S. Households Still Repairing Balance Sheets 138
Nonfinancial Corporate Sector Faced Difficult Years in the Wake of GFC 140
U.S. Companies Hit Far Harder by GFC Than by Collapse of Internet Bubble 141
Can U.S. Corporate Sector Become Economic Engine? 141
Long-Term Rate Conundrum Kept Housing Bubble Alive 142
Post-2007 Fed in Similar Position to BOJ in 1990s 143
Flow-of-Funds Data Suffer from Poor Accuracy 143
Bad Data Were Good for Policy Debate 145
Estimated Correctly, Private Sector Financial Surplus Continues to Shrink 146
Recovery in U.S. Private Sector Demand for Funds May Outpace Japan 148
Housing Market Strength during the First Half of 2013 May Have Contained Temporary Factors 149
Fed s Reputation Falls to Earth 150
CHAPTER 4 The Great Potential of Abenomics 153
BOJ Already Had a Massive QE Program in Place 155
Why Didn t Japan s Institutional Investors Follow Their Overseas Counterparts? 157
Yen Fell and Stocks Rose Because Japan s Institutional Investors Stayed in Bond Market 158
Honeymoon Altered Japan s Economic Landscape 159
Bond Market Reaction Ended Abenomics s Honeymoon 160
Private Sector Continues to Save after One Year of Abenomics 161
Japan s Growth over Last Year Attributable to Fiscal Policy 162
Can the Abe Administration Overcome the Trauma of Balance Sheet Recession? 164
The Trauma of the Balance Sheet Recession Will Be the Last Effect to Go 166
Focus of Structural Reforms Must Shift from Lenders to Borrowers 167
Is Japan s Slump Due to Shrinking Population or Balance Sheet Problems? 169
Slump in Domestic Demand Was Due to Balance Sheet Recession, Not Decline in Working-Age Population 170
Personal Financial Assets Have Already Been Invested Somewhere 171
Corporate Debt Pay-Downs Weighed on Consumption and Investment 171
Real Bottleneck in Japan s Economy: Lack of Loan Demand at Private Companies 172
Balance Sheet Recession Has Taught Japanese How to Be Frugal 173
Is Japan Really Closed to Immigration? 174
Japanese Economy Would Cease to Function without Foreigners 175
Agricultural Reforms a Major Step for LDP Government 176
Structural Reforms Are Microeconomic Policies That Take Years to Work 177
Scale of Structural Reform Is Also Important 177
We Should Not Expect More Good Fortune 178
Kuroda May Be Trying to Close Gap between Expectations and Reality 180
BOJ and Government Must Stress That Inflation Overshoot Will Not Be Tolerated 182
BOJ Had Weapon to Prevent JGB Crash during Balance Sheet Recession 183
No One Has Criticized Japan for Currency Manipulation 184
Japan Supported Global Economy for Four Years after Lehman Collapse 185
Real Effective Exchange Rate Does Not Fully Express Japanese Firms Pain 187
Rising Fiscal Deficits Caused by Change in Corporate Behavior 188
How Should Japan s Tax System Be Reformed? 190
Fiscal Stimulus Introduced to Offset Consumption Tax 191
Current Corporate Earnings Based on Massive Fiscal Deficits 192
Working Down Public Debt Will Require Bold Policies to Lift Japan s Growth Rate 192
Incentives Needed to Restore Japan s Economic Vitality 194
More Effective Land Utilization Could Propel Growth 194
Japan Needs Bold Tax Reforms Modeled on U.S. and Hong Kong Systems 195 Policies Need to Change Perceptions of Japan at Home and Abroad 196
CHAPTER 5 Euro Crisis Facts and Resolution 199
Euro s Adoption Lowered Interest Rates Sharply 200
Maastricht Treaty Acted as Constraint on Credit Risk 201
Greece Was Spoiled by Euro, and Germany Reacted Violently 203
Germans Believed Structural Reforms Required a Crisis 204
German Balance Sheet Recession Eight Years before GFC Started the Crisis 205
German IT Bubble Brought about Euro Crisis 209
ECB s Rate Cuts Create Bubbles outside Germany 210
Misunderstandings Regarding Lack of Competitiveness in Southern Europe 213
Money Supply Growth Much Lower in Germany 214
German Reforms Responsible for Only Half of Competitive Gap 214
Germany Benefited Most from Euro 216
One More Mutual Dependency between Germany and Eurozone Periphery 217
Spain s Vicious Balance Sheet Recession 219
Ireland s Household Sector Forced to Pick Up Pieces after Massive Housing Bubble 220
Irish Businesses Remain Net Savers 222
Portugal s Balance Sheet Recession Began Quite Recently 224
Italy Is in Same Position as Portugal 225
Why the Polarization of Eurozone Government Bond Yields? 227
Eurozone Allows Investors to Buy Government Bonds of Member Countries with No Currency Risk 229
Eurozone-Specific Fund Flows Amplify Economic Swings 230
Meaning of Fiscal Space Differs Inside and Outside Eurozone 231
Maastricht Treaty Is Defective and Should Be Revised Immediately 232
In Practice, Fiscal Stimulus Requires EU and ECB Approval 233
Ban on Buying Other Nations Debt Ideal Way to Stabilize Eurozone 234
Efficiency Gains from Single Currency Remain Intact 235
Different Risk Weights Should Be Applied to Domestic and Foreign Government Debt 237
Next-Best Alternative to Risk Weights Already in Place? 238
Separation of Sovereign Risk and Banking Risk a Rejection of self-Corrective Mechanism 238
Joint Issue of Eurobonds Would Only Solve Half of Eurozone s Structural Defects 240
Draghi Unaware That There Are Two Kinds of Recessions and Fiscal Deficits 241
Outside of Greece, Capital Flight Is the Problem 243
Explaining Balance Sheet Recessions to the German Public 244
Even Germans Understand Need for Fiscal Stimulus If Properly Explained 245
Excessive Focus on Fiscal Deficits While Ignoring Growth in Private Savings 246
Lack of Private Loan Demand Biggest Problem for Germany 247
Germany Unlikely to Announce Stimulus Package 247
Disadvantages of Euro Exit for Greece 248
Argentina s Experience Also Suggests Euro Exit Would Have Few Merits for Greece 249
Germany s Competitive Gap with Other Countries Will Also Disappear in a Few Years 251
Draghi s LTROs Prevented Collapse of Eurozone Financial System 252
Grand Bargain with ECB Is an Empty Promise 254
Double-Dip Recessions and the Eurozone s Bad Loan Problem 255
EBA s Lack of Understanding of Systemic Crises Leads to Rash Actions 256
Cypriot Bank Resolution Could Worsen Financial System Jitters 257
Vicious Cycle of Creating New Bubbles to Paper over Old Ones 258
EU Election Results the Result of Economic Policy Errors 259
European Policymakers Mistake Balance Sheet Problems for Structural Problems 260
Policymakers Need to Ask Why Eurosceptics Made Such Gains 262
Disappointment with Established Parties Led to Rise of Nazis and World War II 262
Continued Disregard for People s Voice Puts Democracy in Jeopardy 263
U.S. Voters Had Policy Choices, Unlike Their European Counterparts 263
The Euro Can Be Saved with Two Repairs 264
CHAPTER 6 China s Economic Challenges 267
China s Local Governments Began Borrowing en Masse 268
Decoupling Would Not Have Been Possible in Ordinary Democracy 269
China s Remaining Problems Include Overcapacity and Income Inequality 270
China Understands Political Ramifications of Inflation 270
China s Shadow Banking Sector: Misunderstandings and Realities 272
Problem: Sharp Growth in Lending to Local Governments Post-Lehman 273
Decoupling of China and Developed Economies to Continue 274
Problems Facing China s Economy 274
China Has Already Passed the Lewis Turning Point 276
Rapid Economic Growth Continues until Lewis Turning Point 277
U.S.-Led Free Trade Regime Enabled the Emergence of Asia 278
Economy Starts to Mature Only after Passing the Lewis Turning Point 279
Local and Global Lewis Turning Points and Inequality 280
China Increasingly Tolerant of RMB Appreciation as Transition to Consumption-Led Economy Proceeds 281
The West Is Conflating Problems of Trade Imbalance and Financial Crisis 282
Liberalized Financial Sector and Capital Flows Could Weaken RMB 283
China Could Fall into the Middle-Income Trap If It Neglects to Advance Its Industrial Base 284
Japan, Korea, and Taiwan Escaped from Middle-Income Trap 284
Labor Disputes Increase Sharply after the Lewis Turning Point Is Reached 287
The Dilemma of Patriotism with an External Enemy 289
Working-Age Population Peaked Just as the Lewis
Turning Point Was Reached 290
Will China Grow Old before It Grows Rich? 291
The Next 15 to 20 Years Are Critical 292
Uncertainty Due to Corruption and Lack of Legal Infrastructure Must Be Removed ... 293
Appealing to Patriotism without Creating External Enemies 294
China Could Become a World-Class Nation for the First Time in Two Centuries 295
Chinese Ambition and Industry Must Be Steered in Right Direction 296
Afterword 299
Bibliography 301
Index 305
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