By James Saft
Jan 7 Default, capital controls and high
inflation are all such ugly words but they may, for many of the
world's largest economies, prove to be necessary tactics.
Thus far the official response to the crisis has
concentrated on rather less painful measures: a bit of
austerity, a willingness to create conditions which are helpful
to debtors (AKA kicking the can down the road), and the hope of
But the sheer size of the debt burden in large economies,
not to mention the historical record, argue that ultimately we
may need to turn instead to more painful measures, ones which
unfortunately make it much easier to see who is benefiting at
Two new papers by Harvard economists Carmen Reinhart and
Kenneth Rogoff address both the historical experience of growth
and recovery post-crises and the mix of policies used.
One, a study of 100 banking crises over two centuries, found
it took an average of eight years to reach pre-crisis income
levels. That is good news for Germany and the United States,
which have handily beat that benchmark, but not quite so cheery
tidings for the other 12 major economies which, six years or so
in, are still waiting.
One obvious lesson, that it is good to be Germany or the
U.S. with their better credit and superior financial
flexibility, is true but of far less general use.
That may well be because the U.S. and Germany have helped to
dictate tactics which emphasize softer, easier responses like
mild austerity and loan forbearance, while steering the global
debate away from tougher options. That is politically easier -
it is far more opaque to allow growth to winnow away debt than
to tax savings outright, or, heaven forfend, actually allow
insolvent entities to default.
"The claim is that advanced countries do not need to resort
to the standard toolkit of emerging markets, including debt
restructurings and conversions, higher inflation, capital
controls and other forms of financial repression," Reinhart and
Rogoff write in a paper authored for the International Monetary
"As we document, this claim is at odds with the historical
track record of most advanced economies, where debt
restructuring or conversions, financial repression, and a
tolerance for higher inflation, or a combination of these were
an integral part of the resolution of significant past debt
WORSE THAN THE 30S?
To be clear: the authors are suggesting that we may end up
with a crisis worse than the depression of the 1930s because we
are unwilling to turn to the tools which have consistently
proven needed and useful in similar earlier busts.
Those tools, of course, are not pretty.
Unlike "forbearance" in which a debtor is allowed to muddle
along without fully discharging its obligations, a default is a
sharp and painful event. It crystallizes the loss for the
lender, who must then recognize it and adjust capital
accordingly. It is also vastly psychologically more painful for
Financial repression too is less fun than a trip to the
dentist. It involves, in essence, taking people's money away
from them, by forcing their pension funds to invest in ways
which the state wants, or by achieving a tax on savings in other
Perhaps worst of all is high inflation, a genie ever
resistant to being put back in its bottle, and one which is
extremely capricious about whose wishes it grants and whose it
And yet, as Reinhart and Rogoff demonstrate, these are all
tactics which are employed, by great nations and small, time and
again in the aftermath of large busts.
First World War debt owed the U.S. by a host of nations was
written off in 1934, giving France a break on loans equal to
nearly a quarter of its GDP and Italy a break on debts amounting
to 19 percent of output. Don't forget that this happened a year
after the U.S. went off the gold standard, essentially helping
itself to a debt writedown of 16 percent of a much larger GDP.
Now of course, things may be very much different this time.
The debts however are not, at least in scale.
Indeed debt in advanced economies is approaching a
two-century high. When compared to gross domestic product,
government debt is now almost as high as it was during the
1940s, when countries borrowed heavily to fund a world war. And
while total debt, public and private, in advanced economies has
diminished somewhat, it is still more than double where it was
at the beginning of the last decade.
While some of us may outgrow or outrun our problems, it may
be time to grapple with the real possibility that some will not.