Richard Koo, who is so close, is still wrong

In an earlier post I highlighted why predicting what will happen in the future is so difficult. Geither, Obama, and Summers have no idea how the monetary system works and therefore are unpredictable in whether they will act to improve the situation or make it worse. Richard Koo, who understands the situation in Japan (which is very very similar) quite well still makes suboptimal recommendations because he too does not understand how the financial system works. Here's him in an article in Barron's:

I'm explaining to the Americans that the disease you've got, is the disease we got 15 years earlier. Most Americans are flabbergasted by the fact that the Federal Reserve has lowered interest rates to zero, flooded the market with liquidity -- and the economy is still going absolutely nowhere. Unemployment is still increasing, people are still retrenching, deleveraging. When the central bank brings rates down to zero, a lot of things are supposed to happen, but there's nothing happening. But that's what we experienced in Japan. The Bank of Japan brought the rates down to zero, did massive quantitative easing, with no result whatsoever. This happens because of a balance-sheet recession.

This is exactly correct. The private sector in the US has taken on more debt than it can/wants to support out of income. Therefore, it is de-leveraging, paying down debt and saving, which is driving aggregate demand lower. Only fiscal action through higher deficits can support aggregate demand while this happens. So, Koo gets that right, but then there is this:

In an ordinary, garden-variety recession, as we learned in school, the private sector uses money more efficiently, and a budget deficit is considered bad. But when the private sector is completely absent and paying down debt at zero interest rates, and the government doesn't borrow this money, what happens? Even a child would understand the whole thing could collapse. The only way the government can turn this economy around is to do the opposite of the private sector -- borrow the money the private sector saved and spend it, which means fiscal stimulus. That's what saved Japan from entering a Great Depression.

He's correct in saying that massive fiscal stimulus saved Japan. They really were on the brink of their Great Depression in the 80s, and have avoided it without going to War. This is good, but none of it was necessary, so really represents a massive failure.

Koo thinks that the Govt is spending the money the private sector has saved. In fact, Govt spending is what is giving the private sector its savings! Government is not borrowing anything. Japan should really just massively slash taxes and fund its private sector. Let the balance sheets heal already!

Koo does not talk about all the terrible malinvestment that the Governments fiscal spending did. The US should simply implement a payroll tax holiday until inflation starts to tick up.

Right now, the US's savings desire is not as high as the Japanese's, but a double dip might get it closer. That just means the US will need even higher deficits. It took Japan 20 years to start getting comfortable with sufficiently large deficits. Now might be a good time to go long the Nikkei, actually.