Quelle Surprise! QE Zombifies Economies

Nobody has wanted to heed the lesson of post bubble Japan until way too late.

Early in the crisis, the Japanese took the uncharacteristic step of telling American policy makers loudly that Japan had made a big mistake in how they handled theirs. They stressed that the most important step was cleaning up the banks. Then the IMF had the bad fortune to release a study of 124 banking crises on the heel of the Lehman and AIG meltdowns, which meant its findings were ignored, since the finance officialdom was too busy trying to deal with the wreckage to process new information. But it too came squarely down on the side of making banks take their medicine:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.5 Of course, the caveat to these findings is that a counterfactual to the crisis resolution cannot be observed and therefore it is difficult to speculate how a crisis would unfold in absence of such policies. Better institutions are, however, uniformly positively associated with faster recovery.

This section of the IMF report is particularly germane to austerity-mad Europe:

Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.

Now in Europe, the salvaging of otherwise insolvent French and German banks isn’t being done via anything as straightforward as “blanket guarantees” but the result coming to look a lot like that, despite all the smoke and mirrors involved.

One of the major features of the current programs, which also emulate Japan but was not analyzed in IMF paper, which focused on fiscal operations, has been the use of extraordinary monetary measures, at first to stabilize asset values and then to encourage new borrowing by putting money on sale. That hasn’t worked at all in Japan, where overly cheap loans have not done much to spur new investment but have served to prop up inefficient borrowers who remain on life support. This was a concern early in the crisis: Japan’s super competitive exporters stood in sharp contrast with a very inefficient retail sector, and in some industries, mom and pop suppliers too. Japan prioritizes stability of employment over profit, so initially, this seemed like a sensible move at first.

But the super-cheap funding has become permanent as the economy has never attained liftoff and the cost of incurring a lot of pain is still perceived to be too high. Now John Plender of the Financial Times, citing some new research from JP Morgan, argues that zombification is an inevitable result of distorting the price of capital. Note that we’ve been on the path of distorting capital markets prices for a very long time. The Greenspan, later Bernanke put, has been perceived (correctly so far) of reducing the downside risk of speculation and the degree of support has grown over the last 25 years as the amount of intervention it takes to staunch crises has only kept growing.

From the Financial Times (hat tip Joe Costello):

The deeper problem is that this monetary ease tends to freeze the existing industrial structure. Looked at from the Austrian perspective of Von Mises, Schumpeter or Hayek, the Japanese bubble that burst in 1990 fostered economic distortions they dubbed “malinvestments” – credit-driven investments in real capital that prove loss making when a credit bubble implodes. The results of these misconceived investment decisions take a long time to work their way out of the system, while industries that expanded in response to high demand in the bubble are left with excess capacity. The elimination of this excess and the process of adjustment to a new industrial structure to reflect changed demands, which in Japan’s case means a greater service orientation to address an ageing population, is invariably painful.

In effect, low funding costs in Japan have impeded the process that Joseph Schumpeter dubbed creative destruction because “zombie” companies have been kept afloat at high cost to the competitiveness of others. Worse, the public credit guarantees introduced to help the banking system lend to industry and commerce have had unintended consequences. The Bank of Japan fears the banks’ capacity for credit assessment is being diminished, while the restructuring of non-viable small and medium sized businesses is discouraged.

If you know anything about Japan, the idea that the Japanese banks have managed to get worse at judging credit risk is truly scary. The part of the Japanese financial debacle that isn’t discussed widely enough is that Japan had a highly regulated banking system through the mid 1980s, when the US pressed it hard to liberalize its market. Being a military protectorate of the US, it wasn’t exactly in a position to say no, with a result that it deregulated rapidly.

The result was not, contrary to US fond hopes, that American banks were able to get a strong foothold and make oodles of money. Japanese strongly prefer doing business with established Japanese firms, except for clearly foreign business (and even then, a lot of medium and large corporations would prefer a Japanese firm) and foreign banks also found it hard to attract top Japanese graduates (Western firms didn’t offer lifetime employment, nor were they as prestigious). But what did happen was Japanese banks raced out to do all sorts of things they had been formerly prohibited from doing, and started doing it badly. When I had Sumitomo Bank as a client (and it was seen as one of the best run, most innovative banks in Japan) I was horrified to see how far behind US banks it was on pretty much every front, except being a super low cost operation. A couple of simple indicators: branches (and its New York operation was a branch) had six month revenue targets. No notion of risk weighting or funding costs. So my revenues in no-risk M&A were treated the same as up front fees on $500 million of lending to Campeau (a famous turkey LBO that the bank did indeed lend to, along with a host of other terrible deals).

Plender points out that the bad behavior of the bubble years continues in reduced form, and (similar to Michael Pettis) he suggests China is following the same failed playbook:

Also extraordinary is that with declining investment, Japan has achieved the same kind of distortion China has brought about through the excessive investment that followed fiscal pump priming after the Lehman collapse.

Tadashi Nakamae, eponymous president of Nakamae International Economic Research, believes Japan is entering the final stage of a structural adjustment that began in 1990, a Schumpeterian endgame; industries with too many companies need the less efficient to be wiped out so profitability can be restored…

This is also worrying for China as it tries to make the transition from a high to moderate growth economy. Japan’s high growth period ran from the mid-1950s to the early 1970s. Average growth was 9.7 per cent, just short of China’s 10.1 per cent since 1990. When the excess labour in China’s rural areas runs out, the country will have to cope with increased wage pressure and declining labour productivity growth. Meantime, the Chinese working population will start to decrease from 2015. A measure of the challenge is that it took all of 30 years from the point where excess Japanese rural labour ran out for Japan’s working age population to decrease.

This means, sport fans, that a slowdown in Japan and China could produce much worse outcomes than conventional thinking believes is possible. It might be time to prepare for a rough ride.

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  1. R Foreman

    So how does this end again? Let me take a stab.. corporations can’t find any good business investments, so they continue cutting payrolls to make a profit (and suckling up to the gov’t transfer teat).. corps also begin making risky financial bets, and we start to witness a few spectacular blowups (Rochdale?).. real gdp falls dramatically, the government keeps printing and borrowing to keep prices/wages high consistent with QE targets, public sector employees keep pace with inflation while the private sector goes on austerity-starvation (the cops stay fat while the protestors go hungry).. then interest rates creep up, financial asset prices fall, house prices fall, panic ensues, and we get that social upheaval we’ve all been waiting for.

    .. but the cops are so fat, and the protestors are so slender, and the difference in firepower between the two is so large, that the elite are STILL able to maintain control, at the point of a gun, by jack-boot, and billy-club.. then, god only knows, we get a big war or sumpin.

    I wouldn’t want that for a legacy.. I don’t know why Obama wanted the job back. At some point I guess this all becomes about survival of you and your family over your fellow country-schmucks, and that’s where much of this pervasive corruption is coming from.

    1. abprosper

      Close, what will happen is polities will eventually shrink in size and scale. Heck even the US might end up being several nations.

      This will be a big change and I think possibly a good one.

      Also as for jackboots and billy clubs (spring truncheons in Europe) well no. It takes little to fight back in some respects, the less the better. If the social welfare state falls and it might, all best are off.

      The rise of all kinds of groups like the Golden Dawn is the natural outcome.

      In the US? Its willpower not firepower. The US militias probably outnumber all security forces including the military and that does not include any security forces that are cored out with members.

    2. Mark P.

      “…and the difference in firepower between the two is so large, that the elite are STILL able to maintain control.”

      Eh. The whole trend of technology in military affairs since the end of the 19th century to today argues against this in the long term.

      That trend has been increasing destructive power in the hands of smaller groups and even individuals, often at cheaper costs. For example, the machine gun: in the 19th century’s latter half, the Gatling and then the Maxim gun were large, cumbersome machines that industrialized slaughter, at first used primarily on indigenous populations during colonial wars till the European nations turned them on each other in WWI. Thereafter, the machine gun became minaturized and cheaper in the tommy-gun, and was brought home for internecine conflict by the likes of Al Capone in the 1920s and ’30s.

      The same democratizing trend exists today with both drone technology and with the distribution and advance of biotech (e.g. DNA synthesizers available second-hand on places on internet markets). And there are other technologies.

      And so any elite, once it has to resort to overt repression though overwhelming firepower, has arguably already lost control since the means for reprisal by sufficiently disenfranchised individuals exist: in the 21st century, class war waged with bioweapons and drones is technically feasible.

      The far superior alternative is deception, the strongest force on the planet, as somebody here keeps pointing out.

    3. different clue

      Why did Obama want the job back? To collect the multimillion dollar payouts he expects from his owners and handlers for finishing what they want him to finish.

      Like getting the Congress to pass the Grand Theft Bargain so he can sign it.

  2. Richard


    Great post. The Japanese Model of how to deal with a bank solvency led financial crisis only makes the situation worse.

    Fortunately, there is the alternative of adopting the Swedish Model and requiring the banks to recognize upfront all of the losses they are currently hiding on and off their balance sheet.

    Now that President Obama has been re-elected despite Wall Street’s best efforts to support Mitt Romney, President Obama is free to abandon the failed Japanese Model and adopt the Swedish Model.

    1. Andrew Watts

      The Swedes had a healthy global economy to export to ignite their recovery. It wouldn’t work in this environment. That’s why the major exporters are going to be hurting just as much if not more then net import countries the deeper we head into the global economic crisis.

      President Obama isn’t likely to force the banks to realize any losses. Not when every official in his previous term was scared to death of re-igniting the financial crisis.

      Things haven’t changed that much. For the better anyway.

      1. Susan the other

        With productivity eating its young and the planet but growth waning globally, and probably for the next 30 years, what’s a bloated, bailed-out bank gonna invest in? I think this is where Oklahoma learns to love climate change.

        1. different clue

          One hopes all the Inhofe-voters get F6 and F7 tornados, with melon-sized hailstones in them. But just the Inhofe voters (and the Coburn voters too, I suppose).

    2. Carla

      @Richard “Now that President Obama has been re-elected despite Wall Street’s best efforts to support Mitt Romney, President Obama is free to abandon the failed Japanese Model and adopt the Swedish Model.”

      This is a great idea. Unfortunately, those of us who have been paying attention are well aware that President Obama has never shown any interest in the Swedish Model.

      Barack–Please surprise us!

  3. fresno dan

    “The Greenspan, later Bernanke put, has been perceived (correctly so far) of reducing the downside risk of speculation and the degree of support has grown over the last 25 years as the amount of intervention it takes to staunch crises has only kept growing.”

    The maestro got it wrong!?
    What burns me the most is that we now flat out have “capitalism without failure for finance” – we don’t even really pretend that our system “works” without ETERNAL QE. When could it possible stop and not cause a “crisis????” TBTF – obviously, the solution is TOO GINORMOUS TO FAIL. And the most important part of the safety net is for billionaires.
    We now have a belief that the people who got us into the worst financial crisis in 80 years, who didn’t see it coming, are the best people do get us out. Astounding…

  4. RT

    Quote: “zombification is an inevitable result of distorting the price of capital”

    I think it’s not only QE. Our Free Market apostles are distorting everything they can – e.g., the “labor market”, hence the price of labor, is heavily distorted, too, as is the housing market, the bond market, and even the price of the ultra-hard Swiss franc is distorted – just to make believe that their fantasy world can and will move on. QE is just a lubricant to this end. They already lost the future (youth-unemployment tells) so it’s no wonder that they can’t correctly price capital, insurance, pension plans, business risks etc.pp. anymore.

    Now, the future will (hopefully soon) tell how many distortions a system can bear that is and will further be proclaimed as being solely based on Free Market principles when in fact it isn’t (as in nil, nada, niente, tipota). Future will tell for how long there will be enough believers so that The Creators can carry on with their ridiculous Mr Market show (as in The Truman Show). Us “True-men” will eventually sail to what they call “horizon” as humans always did in the past to find out the truth (I think the MMTers, e.g., already set sails on one such boat). It’s more than clear that “you can’t fool all of the people all of the time.” So the zombified world will only drag on until it dies. And it will die, that’s for sure (as did, e.g., the system behind the iron curtain which only pretended to be “socialist” but never was; past WWII, it went to the dustbin after just about four decades of suffering). I estimate the birth of our current system to be 1971 (abandonment of the gold standard) or 1975 (Friedman’s Chile experiment). So, that’s already forty years ago… (however, if the date would be 1990 – Washington Consensus – then it’s perhaps still 20 more years of the same “rough ride” to come).

    So, we’re living in an ongoing field experiment for contemporary historians: What is, in the post-Enlightenment information age, the maximum life expectancy of a socio-economic system that is based on big lies and mostly ruled and rigged by big liars?

  5. diptherio

    It seems to me that the problem is not QE per se, but rather QE in the particular form of cheap money for banks. Direct insertion into the consumer base of the economy of QE funds would stimulate demand from below, which is what is needed for a recovery in the productive economy. This could happen either through a Job Guarantee program, or through direct transfers to citizens. Of course, current law doesn’t allow the Fed to pursue this course, and Bernanke isn’t asking Congress for the power, so it’s a pipe-dream, but still…

    Treasury could affect the same thing through the $3 trillion coin, or some such maneuver, but again, Geithner hardly seems like the type. So we will probably keep borrowing to pay for whatever programs we don’t cut (which cutting will further worsen the recession) and the Fed will continue to buy the vast majority of new Treasury issues, thus engaging in stealth monetization of the debt, enriching the bond-traders in the process and immiserating the rest of us.

  6. spooz

    As long as Wall Street’s “assets” keep their value, we can call QE a success. Pay no attention to what is happening in the real economy. Wealth must be maintained.

  7. kevinearick

    Implicit Multiplexing, Free Will, & Strange Kindness

    Bernanke can control the relative perception of the majority, which has accepted conventional false assumptions of its own free will, in return for job credit, but he cannot control reality…

    So, you have event horizon circuits, with gates, and you are watching those gates line up, to run the ladder and make the circuit. The empire cannot see the skill set you collected for the occasion because it can only see itself, but labor can and does see, that which is not of the empire.

    Believing in Jesus is one thing; believing Jesus is another. Talk is cheap; the empire gives it away for “free,” watching to see how little you will accept, in exchange for your free will.

    The pyramid is built on dead soldiers, who run in circles, until they can’t. The empire seeks to define labor by circumscribing it, swapping fun for self-destruction in the peer pressure groups. Collect the pieces of your key accordingly.

    Don’t mistake the non-vote for apathy. How did the market vote?

    If you run independent parallel cars on the parallel roller coasters, you always have work to be done ahead of you, and you can employ the empire’s own delay tactics to adjust your twirls. It’s reductive, and you are distributive. Timing, timing, timing. Matthew 6.

    1. Cynthia

      Bernanke is indefensible, but the reality is that the intellectual pygmies in Congress are the ones that need to chart a better course for America other than the one that is full of pork barreling, insatiable wars, and legislation either aiding or abetting Wall Street scum, etc., etc.

      It is beyond my understanding how good governance can be substituted by a central bank manipulating interest rates and printing money. It’s like playing with the thermostat and believing you can change the seasons.

      1. DSP

        “It’s like playing with the thermostat and believing you can change the seasons.”
        Too true.Well said.

  8. Cynthia

    One of the main reasons for QE3 was to support bond dealers in Europe with liquidity. A good portion of QE3 funny-money will find its way to Europe through the back door. Benny knows that he cannot let Europe fail, and now has gone close to all-out to keep it afloat. Things over there are much worse than we are led to believe. Ditto; China, and soon America. And Japan? The poster-child for basket cases is continuing to sink after 20+ years of Benny-like pumpology.

  9. steve from virginia

    It’s hard to say what would have happened if Japan had chopped its banks off at the knees starting in the early 1990s. There was no control group … Japan could have collapsed which is what would have happened if TBTFs had been chopped off in 2008. As it was, Lehman Brothers’ dive was almost fatal. Shadow banking and the repo-commercial paper markets were shattered.

    There are reasons why the banks are propped.

    One is the banks create the funds by lending them into existence. A systemic bank flop causes a money-supply problem. If the old banks die, there is nothing to convince the public that any replacements banks are of a distinctly superior quality.

    If the perception of the ‘Niewe’ banks is that they are identical to the ones they replace … you effectively have no banks (which is to some degree taking place in Japan right now).

    Ditto with central banks: if commercial banks are insolvent because they have made leveraged loans, central banks are effectively insolvent if they either make similar leveraged loans or take on the commercial banks’ leverage as collateral. If the central banks are insolvent there is no lender of last result (and there are bank runs … as have been underway in the eurozone).

    Almost anything done with-to a bank has adverse consequences, they are like unexploded bombs. Tick tick tick tick …

  10. Beleck

    sounds like the Soviet Union before its’ economic collapse. feeding the Empire just feeds the downward spiral. sounds more Feudal the more i hear the MIC described and how it works for the Elites.

    connections, money, bribes, the whole nine yards. sounds horrible for those who don’t know the “Right” people/Corporations, and the corruption can’t help but to get worse. but how long before the corruption corrupts the system? the system is so well ordered, so thoroughly self perpetuating once the takeover reached that critical point, whenever that was.

    just now seems so much easier to see the whole corrupt MIC at this point in time. are there any weak points in this corrupt infrastructure. the breakdown or the gradual unraveling seems our only hope. can we do things to sabotage this system. are we able to find key points of weakness for sabotage, or do we just avoid investment within such a system as much as possible. the matrix, lol.

    always think of Solzhenitzen’s description of the Gulag and the Soviet state appartus vs his idea of defeating the system by the withdrawal of any support/connection ot it. Can we Americans do that?, just maintain a distance from and not support it.

    1. R Foreman

      > Can we Americans do that?, just maintain a distance from and not support it.

      You can quietly withdraw and not feed the system, but if you do it overtly, try to make a livelihood while proclaiming your independence (especially if you use a different currency) then you probably will get a visit from Agent Smith or one of his partners.

      They won’t stop you from running a business, but it is all too easy to run afoul of some obscure law regulating commerce. I remember Matt Stoller once saying that our system of so many laws that everyone is guilty of something, but where application of the law or punishment is selective, is a facist system.

      In the end we always get back to that conflict between citizens and government, and the gov’t is being manipulated by money, so without money you can very easily find yourself operating outside the law. Going up against the bureaucracy is not a prospect that appeals to very many people. Most people will try to work within the existing the system, corrupt and unreasonable though it may be.

      1. different clue

        Civil Disobedience will get you marked and targeted. But what about Uncivil Obedience? Grudging Sullen Obedience without Cheerful Compliance? Figuring out how little money you can live a reasonable life on, and then making sure not to make any more money than that? Buying the things which can only be made by expert thingmakers . . . from sole proprietors or smallish bussinesses? Or if you are on a rigidly big box budget, at least from more benign big boxers like CostCo instead of more malign big boxers like WalMart?
        Strangling back your “standard of living” to pay your debts down to zero soonest, and then contracting least possible more debt? Growing your own food, harvesting your own water, making your own dwelling-space-heat with retro-home-insulation and best placement and use of windows etc?

        Passive aggression and passive obstruction. The slow attriting and drying up of upper-class revenue streams by the sullen shuffle of a hundred million dragging feet.

  11. The Dork of Cork.

    I don’t think bank consumer credit does much more then waste a surplus.

    There is a possibility at least that fiscal funds can be put to good use if dirigisme principles are followed.
    This may create a new surplus that can then be subsequently wasted by free banks with the currency of the realm as their unit of account.

    Its a sad state of affairs really.

  12. tiebie66

    Refreshing post! At least it acknowledges that government intervention can cause distortions in the economy with serious unintended consequences. But why should we decry government support to banks yet condone augmentation of flagging aggregate demand that props up inefficient firms? The zombification of firms is no better than that of banks – both lead to much waste.

  13. Schofield

    The Chinese answer to a fall in Chinese labour availability will be to set up factories in low wage countries.

  14. Thorstein

    Yves, I’m shocked.

    I had no idea you opposed QEs.

    I thought you sided with Krugman, Brad DeLong, Mike Konzcal, Chicago FRB president Charles Evans, etc.

    James Grant has leveled your criticism of Greenspan/Bernanke for 25+ years. (But Grant ascribes the origins of Japan’s asset bubble to the ’85 Plaza Accord, when James Baker strong-armed our trading partners, which left the BoJ in the uneviable position of having to placate its export-industries with cheap funds.)

    Should NC readers conclude that you are, like James Grant, also in favor of reinstituting the old “double-liability” rule — the law of the land from 1863 to 1935, when the impairment or bankruptcy of a nationally chartered bank triggered a capital call, not on taxpayers, but on the bank’s stockholders?


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