We are following Japan’s path of decline. The real test comes later this year.

Summary:  a look at the US economy.  Richard Koo’s dark forecasts have proven right so far.  Now we test his last and most important prediction.

Most Americans knew 4 great things at the start of this recession, confidently explained by our experts.  Richard Koo, economist for Nomura, said that time would prove all of these wrong.

1. Our banks were the strongest they had ever been on the eve of a recession.  Unlike Japan’s before their 1989 crash.
2. We were free-market capitalists.  Any banks that proved weak would be closed (as we did during the S&L crisis).  Unlike Japan, that propped up their banks (becoming zombie banks).
3. We were smart.  If the recession was deep, we would stabilize the economy with wise public spending, repairing and building our infrastructure (as FDR did during the depression).  Unlike Japan, who channeled stimulus funds to politically powerful interests, wasting vast fortunes on large train stations in villages and bridges to nowhere.
4. Our economy was resilient and adaptable, so any recession would be brief.  Unlike Japan, where the crash ushered in a 20 year (and counting) period of economic stagnation.  The economy slumped every time the fiscal stimulus was slowed (either through higher taxes or spending cuts).

So far Koo is 3 for 3.

1. Much of our financial system collapsed.  Large banks, investment banks, AIG (a weird hybrid), and the government-sponsored enterprises (Fannie Mae and Freddie Mac), and an ongoing stream of smaller banks. 
2. We boldly closed small  S&L’s during the 1990s.  But when politically powerful banks tottered, our government politely asked how many billions would they like — on the easiest possible terms, at low rates, combined with a wide range of additional subsidies from the Fed.
3. We’ve spent — and continue to spend — tens of billions on fiscal stimulus.  Some provides valuable support for the unemployed.  Some has gone to the States, so that they can continue their feckless spending.  Some has gone into visible infrastructure work (e.g., roads).  Most of the rest has left behind  little but public debt.

Now the fiscal stimulus slows.  In the remainder of 2010 we’ll learn if Koo’s 4th proposition proves correct.  The data already shows some slowing.

• The weekly leading index of Economic Cycle Research Institute  peaked in May and since crashed.  See this graph of its rate of change, and this long-term graph as of last week (both from Bloomberg, posted at Zero Hedge).  The Conference Board’s Leading Economic Index was flattish in April and May; see this report.
• One of the best economic indicators is new claims for unemployment insurance.  It’s accurate weekly data on an important variable; about 80% of workers are eligible.  Claims have been flat for since mid-December with an average of 463 thousand per week.  That’s 12 million people fired during the past 6 months, supposedly the 3rd and 4th quarters of this recovery!  Worse, the unemployment rate is higher among uncovered workers — so the total jobs lost might be more than 15 million.  Most of those people found new jobs, but often at lower wages — and often fewer hours.
• Broadly speaking, the economic indicators paint a mixed picture.  Foggy, as usual at inflection points.

On a larger scale, the world economy is growing.  But there are strong headwinds from China’s attempts to slow crazy-high loan growth and Europe’s embrace of austerity economics.  Nobody knows how this all plays out.

One likely outcome, if history is any guide:  a weak economy implies disaster for the Democratic Party in the November elections. 

For a deeper understanding of these events, I recommend reading Richard Koo’s work

Richard C. Koo is Chief Economist of the Nomura Research Institute, Tokyo.

• “‘Plan B’ for the Global Financial Crisis“, presentation at the Center for Strategic and International Studies, 22 October 2008 — Here is a PDF of his slides.
• Interview of Koo by Kate Welling, Welling @ Weeden, 11 September 2009
• “Financial markets rocked by ‘Obama shock’”, Richard Koo (Chief Economist), Nomura Research Institute, 26 January 2010 (also on Scribd)
• “The Age of Balance Sheet Recessions: What Post-2008 U.S., Europe and China Can Learn from Japan 1990-2005”, April 2010 (on Scribd)
• “Whither the patchy US recovery”, 20 April 2010 (on Scribd)
• The Holy Grail of Macroeconomics, Revised Edition: Lessons from Japans Great Recession (2009)

Some posts about the great recession

1. A certain casualty of the recession: the US Government’s solvency, 25 November 2008
2. Obama makes his first major policy error, 27 February 2009
3. News from the front lines of the economic wars, 13 February 2010
4. About the US economy. Where we are. Where we’re going., 17 February 2010

For all posts about this topic see the FM reference pages Financial crisis – what’s happening? how will this end? and End of the post-WWII geopolitical regime.

 (6)  Afterword and contact info

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