Richard Koo on China's Risk of 'Japanification'

0:00You're being sold an AI future where you're obsolete or irrelevant. That vision is wrong. At Palantir, they're building AI that helps workers and unlocks their full potential. American workers are our nation's greatest strength. AI shouldn't eliminate them. It should elevate them. Palantir is here to tell their stories. From factories to hospitals, AI is freeing people from drudgery, letting them do what humans do best. Create. Solve. Build. Palantir, making Americans irreplaceable.

1:01mobile devices, message and data rates may apply. JPMorgan Chase Bank N.A. Member FDIC. Copyright 2025, JPMorgan Chase and Company.

1:22Hello and welcome to another episode of the All Thoughts podcast. I'm Tracey Alloway. And I'm Joe Weisenthal. Joe, do you remember at the beginning of the year, there was so much excitement about China reopening? Yes, absolutely. You know, it's interesting because I think if you go back to last fall, there was all this talk. It's like, why isn't China giving up on COVID zero? When is China going to give up on COVID zero? And then and they're like, oh, it's not going to happen anytime soon. And then one day it just happened. And everyone's like, OK, here comes China. Here comes all the demand from China.

1:55It's on. That's right. And so a big plank or portion of the bull thesis for 2023 was that because China was reopening its economy after basically being shut for three years, you were going to get all this additional economic activity. And while we have seen markets rally, it is not it is definitely not because of China. In fact, China really seems to be struggling here. So we have, you know, Chinese manufacturing is still at or near contraction. I think exports are flagging. Inflation is basically around zero, which might sound great to a number of other countries right now. But of course, it means that in China, growth is subpar.

2:37Yeah. I mean, I think it also the big story for the world, too, has been oil demand. And there was a lot of expectation that's like, OK, commodity prices are kind of soft, but China is going to reopen. Oil demand is going to surge. And that was expected to contribute to like further inflationary pressures throughout the world, oil, copper, etc. etc. And so, yeah, that's that totally caught that market by surprise and changed a lot of the sort of macro dynamics globally that people were expecting. Yep. So now is the perfect time to dig into what is going on with the Chinese economy. And, you know, to some degree, the weakness this year sort of highlights these longer term concerns around China.

3:21How is it actually transitioning or developing its economy? Is it going to be able to achieve the ultra high levels of growth that we've seen in the past? Or is it going to fall into something like a middle income trap? What's going on with Chinese local government debt? That's been in the headlines quite a bit recently. And all of that put together has given rise to this idea of Japanification risk for China. So the notion that you might have ultra high levels of debt that weigh on future growth because everyone has to spend their money basically paying down their debt. rather than investing in new and exciting things.

3:58Yeah, it's weird because I feel like there's like now there's two conflicting themes that I think about with China. So one is exactly as you said, that there is this sort of sluggish growth, overcapacity, debt indebted cities and so forth, lack of domestic consumption. And then the other one is this sort of awe that the world has at like the booming electric vehicle exports, that they finally got the first flight of their domestic wide body aviation, that first plane, the COMAC that we talked about with Brad Setzer. And of course, all the anxiety about the chip progress that the country has made, which is why the Biden administration has cut off access to various high tech cutting edge semiconductor equipment.

4:42So there's these two things. There's this like sort of like shock and awe at the success they're having in batteries, cars, and so forth. At the same time, the macro numbers do not look good. It's true. China is always like a giant waiting in the wings to take over everyone else's economy and also simultaneously this bundle of vulnerabilities that people are worried is going to tip into a massive financial crisis. That's always the case. But OK, I have to say, we really do have the perfect guest to discuss all of this. We're going to be speaking with Richard Kuh, chief economist at the Nomura Research Institute, which is the research arm of Japan's biggest brokerage, Nomura.

5:22And of course, he is also the man who basically wrote the book on balance sheet recession. So Richard, thank you so much for coming back on All Thoughts. Oh, thank you for having me. Yeah, really appreciate it. Maybe just to begin with, I know you've been talking and writing about this theme of a potential balance sheet recession in China. You also have a book that came out, I think it was just last year, called Pursued Economy, where you talk quite a lot about the trajectory of China's economy. But talk to us about what you're seeing now that suggests there may be signs of a Japan-style balance sheet recession in China.

5:59Well, a lot of Chinese journalists, economists have been contacting me on this issue also, that are we going to be Japan soon? Or are we already on that path? And my answer to that is that, well, a lot of similarities between what happened to Japan 30 years ago, and what's happening to China today, but there are also important differences. And what the Chinese economists are worried about is that China may be falling to what I call balance sheet recession. And balance sheet recession is triggered by this whole notion that people feel uncomfortable with their balance sheets. Suppose their debt is too large relative to their assets, and that typically happens after bursting of a bubble.

6:46If the bubble is financed with debt and asset prices collapse, but the liabilities remain, people realize that their balance sheet is underwater. And if the balance sheet is underwater, you have to fix it. Well, how do you fix it? You pay down debt. Well, that's the right thing to do at the individual level. But when everybody does this all at the same time, we got into a fallacy of composition problems in that in a national economy, if someone is saving money or paying down debt, you need someone else to borrow and spend those money to keep the economy going. And in a usual economy, if there are too few borrowers, you bring interest rates down.

7:21Too many borrowers, you push interest rates higher. And then that's how you keep the economies going. But when the big bubble bursts and asset prices collapse, everyone will be paying down debt. no one will be borrowing money even at zero interest rates. Because if your balance is underwater, you're not going to borrow money even if interest rates come down to zero. And that's the prospect that Chinese are worried about. And China got this huge bubble, especially in the residential real estate. And the amount of price increase that China observed on the residential real estate is almost the same as what happened to Japan 30 years ago in Tokyo and Osaka.

8:07And so when the real estate bubble started collapsing last year, all these Chinese economists began to worry about a Japan-like situation where so many people are paying down debt all at the same time, and the economy could then fall into a deflationary spiral. I think that is actually already happening in China. A lot of people are saying very few people are borrowing. So many people are paying down debt, even with these low interest rates. And that's a very bad sign macroeconomically. Individually, they might be doing the right things, but collectively, they may be killing the economy. But there's also a big difference between the Chinese situation and the Japanese one.

8:52and that is that Chinese are already very much aware of this risk called balance sheet recession. And 30-some years ago, when this thing was happening in Japan, no one in Japan, including myself, had any idea about this balance sheet recession because it was not taught in economic textbooks. I mean, certainly not when I was going through. And so when the economy began to lose forward momentum, Bank of Japan brought rates down to very low levels, nothing happens. Structural reform, nothing happens. Fiscal stimulus. Well, fiscal stimulus always worked, but that was cut short because they thought every time the economy showed even a slighter sign of growth, they said, aha, we don't need fiscal stimulus anymore.

9:42economies are improving. And then the economy tanked again. And it tanked again because people were still repairing balance sheets. And when a large bubble burst and asset prices collapsed

9:58badly, it's going to take five, 10 years easily to repair those balance sheets. And in the Japanese case, the bubble was led by the commercial real estate. The commercial real estate prices fell 87 % nationwide, not just in the little corner of Tokyo, but the entire country. And so the balance sheet challenge that Japanese companies face was absolutely massive. They all start paying down debt all at the same time. And that's how we got into this very slow growth. But the government did not know how to handle this type of recessions because in economics, we were never taught to look at balance sheets.

10:37And so Japanese responses were very inconsistent, I should say. Whereas in the Chinese case, they are fully aware of this recession, cobalancing recession. That's why they have been calling me very frequently these days. I was told, I don't know, I have no way to prove this, but one Chinese professor told me that about half of the PhD dissertations written on economics in China today are based on my work on balance sheet recession. now I don't know whether he was just making that number up but what that suggests to me is that now the Chinese government know that there is this disease called balance sheet recession and they should know how to handle it also because once you know that this is a recession which is produced by lack of borrowers and the borrowers are not coming in to borrow money because they have balance sheet problems So the private sector themselves cannot change their behavior.

11:42After all, they are doing the right things, trying to repair their balance sheets. Then the government has to come in and borrow and put that money back into the income stream, which means fiscal stimulus is absolutely essential once you're in balance sheet recession. And so my guess is that Chinese government will put in the fiscal stimulus, which they are actually quite good at. and that will keep the recession from turning into a depression or something. So that's the key difference between the Japanese situation 30 years ago and what the Chinese may be faced with today, that they already know what disease they are dealing with and they are not going to waste any time trying monetary easing or structural reform policies.

12:33my guess is that they'll go straight into the fiscal stimulus to keep the economy from losing its power.

12:56Silicon Valley is selling you a future where you're obsolete, or worse, identical. At Palantir, they're witnessing something different and revolutionary. From re-industrializing the nation's defense base to shipyard workers building faster and frontline workers boosting productivity, AI is transforming work across the nation. AI is not replacing American workers or flattening them into conformity. It's unleashing what makes each one irreplaceable. Their judgment, their craft, their creativity. When American workers become more powerfully themselves, they own the future. Palantir, making Americans irreplaceable.

13:37Support for the show comes from Public.com. You're thoughtful about where your money goes. You've got your core holdings, some recurring crypto buys, maybe even a few strategic option plays on the side. The point is you're engaged with your investments and Public gets that. That's why they built an investing platform for those who take it seriously. On Public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. Plus an industry-leading 3.6 % APY, high-yield cash account. Switch to the platform built for those who take investing seriously.

14:10Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com slash market. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokered services for U.S.-listed registered securities, options, and bonds in a self-directed account are offered by Public Investing, Inc., member FINRA, and SIPC. Crypto trading provided by XeroHash. Complete disclosures available at public.com slash disclosures. So you mentioned that one advantage perhaps that China has is having seen the experience of Japan. Incidentally, the U.S.

14:47also had that advantage when we had the 2008-2009 financial crisis. You wrote a whole book on it, The Holy Grail of Macroeconomics. Of course, U.S. policymakers didn't exactly listen or heed the warnings of that book, and we had this pretty awful decade for growth. I'm curious, though, just in terms of balance sheets diving in, how do you see the distribution of debt in China? So the federal government doesn't have much debt. We know that. How much is it corporates versus real estate developers versus households versus local cities and municipalities? What does the distribution of debt in China look like?

15:28Well, can I first comment on your first comment about the U.S.? Sure. Well, when I was trying to explain to my former colleagues at the Federal Reserve that we were suffering from balance sheet recession in Japan, and therefore we need fiscal stimulus, not structural reform. And as a former recipient of doctoral fellowship from the Board of Governors, I have been going back to the Fed to give seminars on this issue throughout the 90s. And as you mentioned just now, they did not take any of my warnings. I was bashed every step of the way with a Fed economist saying, come on, just Bank of Japan printing the money and everything will be fine.

16:16But I would try to explain that. That doesn't work when there are no borrowers. Well, once 2008 Lehman Crisis happened, someone, I don't know who, brought my book to the attention of Chairman Beninke. And he read it, The Holy Grail Macroeconomics, the book you mentioned. And he told so many other people in the Federal Reserve to read it as well. And if you notice that at the beginning, he was arguing that yes, monetary policy can handle it, as he was a disciple of Milton Friedman, who argued that if the Fed acted more responsibly during the Great Depression, things wouldn't have gone so bad. But after reading my book, he started talking about fiscal cliff, which is the opposite of what Friedman was saying.

17:11And I thought that was a very important change in the U.S. policy when Chairman Bernanke at various events kept on saying, we cannot afford to fall off the fiscal cliff. The government has to continue borrowing and spending money, meaning that fiscal policy is absolutely essential. And I think that is the key difference between the United States and Europe because Europe really did not heed any of my advice, especially at the top level. And so they fell into a really serious balance sheet recession, and that recession lasted for almost 10 years. Whereas in the United States, which is the epicenter of this global financial crisis, because of the efforts made by Chairman Menemke at the Fed and Larry Summers also, who actually endorsed my book, The Holy Grail of Macroeconomics, He talked about the importance of fiscal stimulus.

18:07It has to be speedy, substantial, and sustained. So Obama administration was trying to put in fiscal stimulus. They made a lot of resistance from the Republicans. But at least the U.S. was trying to do all the right things. And I think that's why U.S. came out of balance sheet recession much faster than the Europeans. So I would say that my book actually did have an impact on the U.S. policy. If it had an impact earlier, it would have probably helped the U.S. economy even sooner. So that's one comment I want to make, and that is that U.S. policymakers realize that they are facing balance sheet recession by year or two into the recession and made all the appropriate changes to fight it.

18:57Now, going back to the Chinese issue of where the debt might be, a lot of people like to talk about the size of the debt. But what is really important is the difference between the size of the debt and the size of the savings. And the fact that the Chinese interest rates, for example, 10-year Chinese government bonds today is offering, what, 2.6%, suggests that savings are far bigger than the debt. Because if the debt or the borrowing is far bigger than the savings, interest rates should be higher, not lower. And the fact that 10-year government bonds is down to 2.6 % suggests to me that overall, China's biggest problem is that there's too much savings relative to borrowings.

19:46So having said that, who has the capacity to borrow and spend this money? Well, as you correctly mentioned, the federal government or the central government probably has plenty of rooms left to borrow and spend. But regional governments, I understand, are in very sad shape because they can't sell the land as easily or as expensively as before. And they have used up quite a bit of their resources in the previous years trying to support the economy and also during the COVID-19. And so the feeling I get is that regional governments are really overburdened already. and probably they will require quite a bit of help from the central government going forward if they are going to be the one who will be actually implementing fiscal stimulus, which is needed during the balance sheet recession.

20:47So just on the idea of fiscal stimulus, historically, it does feel like a lot of China's stimulus has come in the shape of support measures to companies or these huge construction projects, big infrastructure and development projects of one sort or another, what would be the ideal form of stimulus this time around? Because, of course, China is trying to balance various needs and goals here. It's talked a lot about retooling its economy away from manufacturing and real estate and more towards consumption. And yet, historically, we haven't seen a lot of fiscal support for households and individuals?

21:30It just hasn't been a very big thing in China. In terms of, I mean, fiscal stimulus can come in various forms, right? You can have tax cuts as a form of fiscal policy or government actually borrowing and spending money and the spending can go to in very many different places. First of all, tax cuts during balance sheet recession is not going to be very effective. And the reason is quite simple. Those people who get the tax cut will use the money to pay down debt. And that's good at the individual level, perhaps. But collectively, that won't help the GDP from collapsing. And so during balance sheet recession, tax cuts should not be the main force of supporting the economy.

22:14So the government has to borrow and spend money. So within that, what will be most effective? And I would argue that all those residential housing projects that were started but are now put on hold because the construction companies either have gone bankrupt or having so much financial problems they cannot move forward. I would recommend Chinese government to go in there and help those construction companies so that all the promised construction will be actually completed. I think that would be the most effective way to spend fiscal stimulus, fiscal money. Because that way, those people who were feeling very insecure, I mean, they paid for the apartment house already or put the down payment.

23:08Now they're wondering whether they will get anything from all the investments they made. They will at least get the apartments built and they can look forward to perhaps some larger apartments as a result. And the same part would be helping the construction industries. And one key difference between the Japanese and the Chinese situation is that construction is such a large part of Chinese GDP. Construction accounts for something like 26 % of Chinese GDP, whereas during the bubble days in Japan, it was only around 20%. And it wasn't a big part of the picture. Whereas in the Chinese bubble, it came with a huge construction boom.

23:51And so when asset prices collapse, but construction boom also goes bust, then you are hit from both the real side as well as from the balance sheet side. And balance sheet side, there's not much one can do. But on the construction side, if government comes in and help finish those projects that were started, I think that kind of money will probably go a long way in helping the Chinese economy. Can I ask, what about the role of the foreign sector when we sort of break down the Chinese economy and a sort of sectoral model? So it's like, OK, we know that domestic households have a high level of savings.

24:34We know the federal government has not borrowed a lot. But on the other hand, the trade surpluses are massive. And again, I sort of mentioned in the intro that one of the themes right now is that Chinese these advanced exports, particularly in areas like batteries and EVs and other cutting-edge stuff is kind of booming. If that continues to boom, can that go some ways in sort of mitigating the need for federal government borrowing? Absolutely. I mean, if Chinese companies keep on coming up with new fantastic products, and both Chinese and non-Chinese are willing to borrow money to buy those products, then that will be helping the Chinese economy in massive fashion.

25:20And I realized, as you mentioned already, that there are many Chinese companies that are highly innovative, coming out with a lot of interesting products, and they should find plenty of export markets for those products. So that part is definitely there. My concern, however, is the same concern that Japan had back in those days. At that time, 30 years ago, Japan was running the largest trade surpluses in the world. So many people wanted to buy Japanese cameras, Japanese cars, Japanese appliances. And because it was running such a large trade surplus, it could not push it even more. In that, if Japan wanted to export even more by, for example, for bringing the Japanese yen down a little bit, Americans would be very upset.

26:09The US tiara would be knocking on the Japanese and say, no, you better open your market, not sending these additional products to us. And I was actually involved in the US-Japan trade friction back 30 years ago. At that time, the US ambassador to Japan was Mr. Walter Mondale, the former vice president who passed away recently. he found out that this guy, Richard Koo, who is frequently appearing in Japanese television programs, actually carries an American passport. So he asked me to come over and he basically asked me to represent the United States in all these Japanese TV programs on U.S.-Japan trade friction.

26:52And at that time, U.S.-Japan trade friction was really, really bad. Serious, ugly, you name it, it was really terrible. So I tried to go to the U.S. Embassy to get a full briefing from staffers there and then go to the television studios to try to explain the American position to the Japanese audience, even though I was actually employed by the Japanese Research Institute. And all these other Japanese on the program are waiting with their guns to shoot me down. You know, that was that kind of situation. So I learned a lot about trade friction back in those days. and Japan really could not rely on additional exports because it was already running such a large trade surplus.

27:37So if Japan could have used exports by bringing the Japanese yen down a little bit and export its way out, that would have shortened the balance sheet recession by some considerable years. But that option really was not available to Japan at that time because it was such a large trade surplus country. And I think that applies to China today as well. As you know, China, as you mentioned, China is the largest trade surplus country in the world. And if China tries to bring exchange rates down and try to export its way out, I'm sure a lot of countries will be complaining. so there's something the Chinese can do in that export side especially they're coming up with new products so that other people in United States, Japan or Western Europe have no reason to resist because there's no domestic manufacturers for those new products still overall I don't think it's a good idea for China to rely too much on exports because that could produce backlash called trade friction which is what Japan faced 30 years ago as well.

28:47Just going back to today, we've been talking a lot about both the parallels and the differences between China's current situation and the one that Japan found itself in a few decades ago, but we haven't yet touched on demographics. And of course, population growth or the lack of it is something that is much discussed when it comes to Japan's economy. Is a similar concern going to emerge for China? Well, I know that's the kind of standard Washington consensus, if I may, on Japan. But if you look at the actual statistics, Japan's population peaked 2009. What that means is that the bubble burst 1990.