The theory of 'balance sheet recession' proposed by Gu Chaoming: It is recommended to accelerate the introduction of fiscal stimulus policies before incurring excessive costs.

On September 22nd, Nomura's Chief Economist, Gu Chaoming, expressed his latest viewpoint that everyone is saving instead of borrowing, and if this situation continues, it could lead to a balance sheet recession.

Gu Chaoming made this judgment at the 5th "Bund Financial Summit" jointly hosted by the China Finance 40 Forum (CF40) and the China Center for International Economic Exchanges (CCIEE).

Gu Chaoming is the proponent of the theory of "balance sheet recession." The Institute of Finance of the Chinese Academy of Social Sciences explained in its "2023 Q2 China Leverage Ratio Report" released in July this year that a balance sheet recession refers to the contraction of the balance sheet itself, resulting in insufficient effective demand and subsequently triggering an economic recession. Therefore, the term "recession" here has two meanings: the contraction (negative growth) of assets and liabilities, and the economic recession or slowdown.

Gu Chaoming stated that after the economic bubble burst in Japan, a situation arose where everyone was constantly reducing their debt, which brought about problems with the balance sheet. "During the bubble period, everyone borrowed a lot of money because they could leverage it to earn more. After the bubble burst, asset prices fell, but the debt did not decrease, so the balance sheet was actually on the verge of bankruptcy."

Using Japan in the 1990s as an example, Gu Chaoming stated that in 1990, Japan and many other countries had huge trade surpluses, and everyone wanted to buy Japanese cars and cameras. Cash flow was not a problem, but the balance sheet was negative. At that time, Japan's debt reached 87% of GDP, so in this situation, even though there was still cash flow, they were heavily indebted and everyone had to repay their debts.

What consequences would repaying debts with cash flow bring? Gu Chaoming stated that in a normal economic cycle, it is usually the financial industry that lends money from depositors to companies in need of funds. If there are too many borrowers, interest rates will rise, and if there are fewer borrowers, interest rates will decrease, allowing the cycle to continue. However, if everyone is repaying debts, even if the interest rate is lowered to 0, it will be useless, and deflation will occur.

When asked about the lessons that can be learned from the Japanese experience, Gu Chaoming said, "Textbooks tell us that when private enterprises are willing to borrow, the government should not borrow money. Because when the government is willing to borrow money, it will cause misallocation of resources, raise interest rates, and keep inflation high. Once private enterprises are unwilling to borrow and are committed to repairing their balance sheets, the government should borrow money." "Many scholars worry that doing so will reduce private investment and create a crisis in fiscal policy, but in reality, it is not as feared. When the government finances itself, many people buy government bonds, and the yield curve will decline. This is a very flexible issue."

Subsequently, in an interview with The Paper, Gu Chaoming also added that many economists believe that the situation in China is different from that of Japan. "However, as someone who has personally experienced a balance sheet recession and has seen similar cases, I still recommend speeding up the introduction of fiscal stimulus policies before incurring excessive costs." This article is written by Qi Yeyun and sourced from The Paper. The original title is "Proposer of the 'Balance Sheet Recession' Theory, Gu Chaoming: Before incurring excessive costs, it is recommended to expedite the introduction of fiscal stimulus policies."