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News : Global Economy Last Updated: Mar 31, 2011 - 7:56 AM


A Decade of Debt 2008-2017: Implications for growth in the developed world
By Michael Hennigan, Founder and Editor of Finfacts
Mar 30, 2011 - 6:00 AM

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The authors of 'This Time It’s Different: Eight centuries of financial folly; conceit and money,' say the scale of the bank debt buildup in Ireland and Iceland prior to the crisis, is in their view without parallel in the long history of financial crises. 

A Decade of Debt 2008-2017: Public debts in developed world economies have surged in recent years to levels not recorded since the end of World War II, surpassing the heights reached during the First World War and the Great Depression. Inevitably, the overhang of debt will continue to weigh on economic growth prospects.

American economists, Carmen Reinhart and Kenneth Rogoff, authors of the celebrated history of eight centuries of financial crises, This Time is Different, in a paper published this month say that the combination of high and climbing public debts (a rising share of which is held by major central banks) and the protracted process of private deleveraging makes it likely that the ten years from 2008 to 2017 will be aptly described as a decade of debt. As such, the authors say the issues they raise in their paper will weigh heavily on the public policy agenda of numerous advanced economies and global financial markets for some time to come. 

Reinhart and Rogoff say that historically, high leverage episodes have been associated with slower economic growth. This observation applies to the high-debt episodes that follow on the heels of wars as well as to their peacetime counterparts. It also characterizes episodes where high debt levels were not associated with markedly higher interest rates.

Surges in private debt lead to private defaults (which most often become manifest in the form of banking crises). Banking crises are associated with mounting public debt, which ultimately lead to a higher incidence of sovereign default or, more generally, restructuring of public and private debts.

The authors say banking crises and surges in public debt help to “predict” sovereign debt crises. A subtle form of debt restructuring takes the form of - - financial repression (which had its heyday during the tightly regulated post-war Bretton Woods system). Limiting investment choices of the private sector importantly facilitated sharper and more rapid debt reduction from the late 1940s to the 1970s than would have otherwise been the case. They conjecture that the pressing needs of governments to reduce debt rollover risks and curb rising interest expenditures in light of the substantial debt overhang, combined with an aversion to more explicit restructuring, may lead to a revival of financial repression. This includes more directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, and tighter regulation on cross-border capital movements. A less generous depiction of financial repression would include the savaging of pension funds.

For the countries with systemic financial crises and/or sovereign debt problems (Greece, Iceland, Ireland, Portugal, Spain, the United Kingdom, and the United States), average debt levels are up by about 134%, surpassing by a sizable margin the three year 86% benchmark that the authors reported in 2009 in respect of earlier deep post-war financial crises. The larger debt buildups in Iceland and Ireland are importantly associated with not only the sheer magnitude of the recessions/depressions in those countries but also with the scale of the bank debt buildup prior to the crisis - - which is, as far as these authors are aware - - without parallel in the long history of financial crises. Nor is the 2010 (the third year of crisis for Iceland, Ireland, the UK and US and the second year for the others) the last year in which rising debt will be recorded. At present, forecasts for the US show rising debt levels in the foreseeable future; for several others, austerity programs notwithstanding, debts are likely to continue to mount as economic conditions remain subpar and debt servicing costs climb.

The authors say based on newly-compiled data on forty-four countries spanning about two hundred years, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below 90% of GDP. Above the threshold of 90%, median growth rates fall by 1%, and average growth falls considerably more.

Emerging markets face lower thresholds for total external debt (public and private) - - which is usually denominated in a foreign currency. When total external debt reaches 60% of GDP, annual growth declines about two%; for higher levels, growth rates are roughly cut in half.

The economists say seldom do countries grow their way out of debts and they conclude that for many if not most advanced countries, dismissing debt concerns at this time is tantamount to ignoring the proverbial elephant in the room. "So is pretending that no restructuring will be necessary. It may not be called restructuring, so as not to offend the sensitivities of governments that want to pretend to find an advanced economy solution for an emerging market style sovereign debt crisis. As in other debt crises resolution episodes, debt buybacks and debt-equity swaps are a part of the restructuring landscape. Financial repression is not likely to also prove a politically correct term - - so prudential regulation will provably provide the aegis for a return to a system more akin to what the global economy had prior to the 1980s market-based reforms."

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