Earlier we brought you comments from Nomura’s Richard Koo, who blasted QE2 and Bernanke’s gamble, and warned of severe effects on the recovery if the current bubble in asset prices imploded.More generally, he sees a big parallel potentially emerging between the current state of the economy, Japan, and the US during the first Great Depression. Remember, this is is wheelhouse.
Japanese government in 1997 overlooked economy’s reliance on government spending
The reason why government officials and economists decided that Japan was ready for fiscal consolidation in 1997 was that in 1996, the year before the policy was implemented, Japan posted GDP growth of 4.4%, the highest of any G7 nation.
In reality, however, most of that 4.4% growth was made possible by government support in the form of fiscal stimulus worth 5% of GDP. Once that support was removed in 1997, the Japanese economy fell off a cliff and experienced five consecutive quarters of negative growth.
The US and UK economies and money supplies are currently being supported by fiscal stimulus totaling 9–10% of GDP, far larger than the Japanese stimulus in 1997. The deflationary impact could be severe if these supports were removed.
At the very least, the continued decline in private-sector credit is evidence that the two economies are not being supported by growth in private-sector credit.
Roosevelt made same mistake in 1937
This pattern of expansion in the money supply and the economy despite an absence of private-sector credit growth was also observed in 1933–36 as the US economy emerged from the Great Depression. President Franklin D. Roosevelt was unaware of the importance of this relationship and, believing that the economy was already on a self-sustaining growth path, embarked on a path of fiscal consolidation in 1937.
The US economy consequently fell into a severe recession characterised by sharply lower production and drastically higher unemployment. It took the Japanese attack on Pearl Harbor for the US economy to recover from the resulting damage.
What would that be like?
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