Prescription For Global Recession

For the global recession, Gu Zhaoming, the chief economist of the famous investment bank, has a theory of "Balance Sheet Recession". In 2009, after publishing the theme of the Great Recession: the Holy Grail of macroeconomics, it became the classic of economics. The theory better explains what happened after the 2001 Internet bubble burst and the 2008 financial crisis. This book has recently been republished, and Mr. Gu Zhaoming used this theory to analyze the macroeconomic situation of the post crisis era (up to 2018) and published the Great Recession era: the other half of macroeconomics and the fate of globalization. Now, the global economy seems to be in the face of the great recession after the impact of the epidemic. These two books may give us some thoughts and inspiration.

Mr Gu's theory is that the burst of asset bubbles as the starting point of the recession cycle of an economy will appear in turn: the government and central banks tighten monetary policy, resulting in a bubble burst. The sharp fall in asset prices leads to corporate liabilities exceeding assets, forcing business operations to transform from profit maximization to debt minimization, leading to the overall economy falling into a balance sheet recession. Because of the debt repayment of enterprises, the private sector has no capital needs, and monetary policy is out of order. The government has to rely on fiscal policy to maintain aggregate demand. The enterprise finishes debt repayment and the balance sheet recession ends. However, the debt resistance of enterprises still exists, and individuals generally continue to be keen on saving, resulting in low interest rates. At the same time, the economy started to pick up because of the transfer of funds originally used for debt repayment. Corporate resistance to lending gradually subsided, and began to more actively financing. The demand for capital in the private sector has been restored and monetary policy has worked again. At the same time, the budget deficit has begun to squeeze private sector investment. Small government has been welcomed, fiscal consolidation has begun to take place, and monetary policy has replaced fiscal policy as the main tool for the government to adjust its economy. The economy is booming, and the private sector is full of vitality and regain confidence. The overconfidence in the private sector triggered the next economic bubble.

Mr. Gu pointed out that such a cycle should last at least two generations or 60 years to complete. A precedent is the great depression: until the year of l959, the us long and short term interest rate rebounded to 4.1% in 1920s, which means that enterprises can resist borrowing for a long time. Of course, when the bubble is relatively small, the time needed to repair the damaged balance sheet will be shorter. At the same time, whether the government can take appropriate measures against the state of its economy is also the key to determining the length of a cycle.

It should be said that this theory is still valid. We can recall the US's response to the bubble burst. If we follow the passive practice, that is, the government does not intervene in economic recovery, it will take quite a long time to complete the recession cycle. In fact, the United States adopted a strategy of positive intervention, that is, through quantitative easing, a large amount of capital was injected into the economic system, which inhibited the motivation of deleveraging of enterprises and families.

However, this is essentially different from the way of intervention proposed by Mr. Gu. Enterprises are eager to repay their debts, and the disappearance of private capital demand leads to the failure of monetary policy. Because the government can not order enterprises to stop repairing their balance sheets, they can only do their best. Therefore, the implementation of fiscal policy is an inevitable choice. As long as the government can continue to implement appropriate fiscal stimulus policies, the overall economy and stock prices will continue to grow even at this stage.

What we actually see is that the United States adopted fiscal stimulus instead of monetary policy. The different prescriptions did save the capital market, but failed to benefit the real economy. Large quantities of money flow into the capital market and continue to push up market prices. On the other hand, some listed companies really lost the enthusiasm of debt deleveraging, continuously borrowed money, and repurchased their own shares with loans, so the US stock market quickly rose again and reached a new high. Of course, Trump's corporate tax cuts also contributed to this. But the balance sheets of American companies are getting worse.

As the saying goes, it always pays to get out. Only after a certain degree of repair can the balance sheet lighten the burden on enterprises and get the impetus to continue to move forward. Once a company completes the balance sheet cleanup, they can use the original debt repayment fund to invest in forward-looking projects, which will effectively drive economic growth. On the contrary, the practice of continuing to increase leverage without cleaning up debts is like giving the body a very weak patient into the "big tonic". The sick body is not compensated, sooner or later, the consequences will be far ahead of the previous crisis.

Most economists' economic policy proposals are different from those of Mr Koo. They are based on the forward-looking operation strategy of enterprises and take profit maximization as the starting point. Therefore, countermeasures and suggestions for economic recession often include increasing monetary policy intensity and reducing government budget deficit to avoid crowding out effects on private investment. At present, there is a high debt problem all over the world. It is necessary to draw on the theory of Dr. Gu Zhaoming and launch a positive fiscal stimulus policy according to local conditions.