Wednesday, August 15, 2012

After a lost half decade, how Japanese are we?

In his Wall Street Journal blog, Matt Phillips looks at the performance of the US economy since the beginning of the financial crisis and compares it to Japan's in the early years after its financial crisis.

He finds that regardless of when central banks adopted zero interest rate policies there is still no economic growth, let alone a recovery.

Regular readers are not surprised by this finding as central bankers using monetary policy do not have the tools  to deal with a bank solvency led financial crisis.

The simple, straight forward and only proven way to deal with a bank solvency led financial crisis is to require banks to recognize all the losses hidden on and off their balance sheets today.  By making banks absorb the losses on the excess debt in the financial system, the banks protect the real economy and society.

In a modern banking system with deposit guarantees and access to central bank funding, banks can operate for years and support the real economy while rebuilding their book capital levels.  During this time, the deposit guarantee effectively makes the taxpayers the banks' silent equity partner.

Your humble blogger refers to this as the Swedish model and it has been successful whenever and where ever it has been implemented.  This includes the US to break the back of the Great Depression, Sweden and Iceland.

By comparison, the US (EU and UK too) and Japan have chosen a model that protects bank book capital levels at all costs.  This puts the burden of servicing the excess debt in the financial system squarely on the real economy and society.  A burden that shifts resources from economic growth and social programs to debt service.

It is no surprise that this model, which I refer to as the Japanese model, doesn't work.  The only beneficiaries from pursuing this model are the bankers.

Having said that, it is still not too late for policy makers to require the banks to absorb the losses on the excesses in the financial system and to bring to an end the downward spiral in the real economy.

Unfortunately, neither the Republicans or the Democrats is talking about having the banks absorb the losses and protect society.  Instead, both are talking about how they would cut the social programs for the benefit of banker bonuses.

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