Rogoff criticizes debt strategies

By Steven Lamb | May 19, 2010 | Last updated on May 19, 2010
3 min read

Despite the headwinds of poor jobs growth and a troubled housing market, the U.S. will avoid a double dip recession, according to Kenneth Rogoff, the Thomas D. Cabot Professor of Public Policy, Harvard University.

Speaking at the CFA Institute’s 63rd annual conference in Boston, Rogoff assured the audience that his observations of past financial crises over the past eight centuries suggest that this recession will play out the same as past recessions.

In fact, investors should expect the stock markets to bounce back “crisply” and regain their pre-recession highs within two years of reaching the bottom of the trough.

That’s not to say that his outlook is entirely rosy.

Recently, there was some excitement when U.S. consumers began spending again. The reaction stunned Rogoff. Recoveries are built on export growth, usually driven by rising inflation, he pointed out, “but the U.S. thinks it can import itself out of recession!”

So far, the American approach to its total debt problem appears very similar to the Japanese approach in the 1990s, he says. But debt cannot be defeated by taking on more debt, and the U.S. will have to deleverage itself somehow.

He said it was unfortunate that the U.S. didn’t deal with the moral hazard issue and he would have liked to have “seen some haircuts” in the bond markets. Still, he admits that he would not want to roll back the clock at this point in favour of his own prescription.

Whatever problems the U.S. faces, Europe’s are worse. Sure, he says, the IMF and the EU have announced massive support for Greece but he points out that one in three IMF interventions have historically failed to stave off sovereign defaults. And these often come about a year after the aid.

“I’m going to go out on a limb and say that Greece will not fulfill its debt promises,” he said. In response, the EU will have little choice but to bail out the Hellenic Republic once more.

The EU has referred to its €750 billion backstop program as “pointing a bazooka” at the debt crisis, but Rogoff has words of friendly advice: “If you’re going to point a bazooka at someone, make sure its loaded.”

Part of the problem with the package, he points out, is that some of the €750 billion pledged to support Greece was pledged by Greece itself, along with other members of the so-called PIIGS – Portugal, Italy, Ireland and Spain. These countries are ill-equipped to actually pony up their portion of the package price, and will very possibly require their own bailouts in the not-too-distant future.

Despite Germany’s apparent economic strength, it faces its own problems – notably demographics. Like much of Europe, its birthrate is too low and the population is aging. Rogoff says that only Germany has the power to break up the eurozone, and that political considerations make that impossible. But he does not rule out the possibility that some delinquent nations could be “pushed out” of the euro, since it would be unfeasible to bail out every troubled member.

If Greece is unable or unwilling to live up to its commitments, it could find itself suspended from the common currency as a warning to others.

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    Steven Lamb