.
Jack Riddler Deconstructs Carmen ReinhartA second public meeting was held on May 26 of the
“National Commission on Fiscal Responsibility,” which is referred to above as the "Kill Social Security Commission" because of its high proportion of members who have long sought to turn the supposed "crisis of entitlements" into the nation’s number one source of panic.
The commission is due to present its findings in December 2010, conveniently after the November election and whatever aftermath that brings. Obama seems to have set it up as a means of having an independent-seeming "bipartisan" body of "experts" hand down the inevitable proposals for austerity measures in the guise of a national necessity, so that both parties can go along with the ensuing cuts.
The session started with a genuinely interesting presentation by economist Carmen Reinhart. It was interesting for two reasons. First, because her work with Ken Rogoff attempts a broad, comparative, aggregate analysis of financial crises of different kinds over more than a century’s time. The results are worth a look.
Second, it is interesting because the questions and her responses made clear the limits imposed by ideology and capitalist euphemisms. At times Reinhart appeared not just unwilling but constitutionally unable to state clearly what her own data suggested, insofar as this wasn’t what the panel (or other adherents of mainstream finance beliefs) wanted to hear.
One of the most obvious examples of the euphemistic language is in the contrast between the concept of "financial innovation," which refers to the bankster scams in bubble times that Reinhart and her interlocutors seem freely to accept as the generators of financial crisis; and that of "financial repression," which refers to government policies that roll back "innovation" and regulate what the banksters can do (e.g., limiting how much interest they charge and to what purpose they may lend).
No one present disputed Reinhart’s assertion that financial "innovations" set up crises and generate high private debts, which then largely pass into public debts following the inevitable crash. But this is treated as a given and quickly passed over. The discusion shifts to public debt as the lone, intolerable problem that must be addressed, in part because of its supposedly bad effects on "growth" (another famously ideological term).
The alternatives mentioned as remedies for public debt are similarly narrow. Top of the list is fiscal austerity, which is taken as the most positive and necessary measure although it is also acknowledged that it usually has even worse effects on "growth." Default is mentioned only reluctantly and treated as a disaster, and "financial repression" comes only as an afterthought, a necessary evil that should be taken in small doses.
Completely omitted are ideas such as making the financial “innovators” who caused the problem pay for the damage, i.e., of liquidating or expropriating the banksters rather than bailing them out, of establishing a public-utility banking system, or of taxing the rich to cover the public debt that made them even richer.
While Reinhart makes no suggestions on the specifics of financial austerity measures, it’s a big question whether the Commission’s December plan will address the giant sinkhole of "defense" spending at all.
The most historic thing about the meeting was that I was allowed to attend the proceedings and practice real-time peer review, as the following transcript of the first hour reveals. 
The presentation is available on video at the commission’s site.
http://www.fiscalcommission.gov/meetings/And from C-SPAN (better angles and labeling) through Mike Norman’s interesting blog, which I discovered recently.
http://mikenormaneconomics.blogspot.com ... tlook.htmlThe slides used in her presentation to the panel are available at
http://www.fiscalcommission.gov/meeting ... 6-2010.pdf, although I have also uploaded them here.
Transcript of Commission Meeting, May 26(This is my own transcript from a public meeting of a US government commission, and belongs to the public domain. The transcript has been edited lightly to remove chunks of filler language such as ums and ahs and repeated phrases, as indicated by ellipses.)After opening formalities and friendly banter between Erskine Bowles (D) and former Sen. Alan Simpson (R-WY), who is one of most notorious promoters of the idea that Social Security is a timebomb…
CHAIRMAN ERSKINE BOWLES (D, investment banker, current board member of Morgan Stanley and NC Mutual Life Insurance, former Clinton Chief of Staff, failed NC Senate candidate) : Everybody has left their partisanship at the door and hopefully we can get something done… But first we’re going to have a chance to hear from Prof. Carmen Reinhart from the center of International Economics at Maryland… She has vast experience in public and private sectors of the economy as well as at the academy, including a period as head researcher at the IMF. She just co-authored a book entitled This Time Is Different: Eight Centuries of Financial Folly…
PROF. CARMEN REINHART: It’s a real honor. I’d like to have the interaction as we go along rather than prepare remarks and then questions at the end so please feel free to chime in at any point in time. What I’d like to do is divide my presentation into four parts. The first two very, very short. One is the global setting and say a little about… the stages of crises, how we progress from one problem to another, that’s the negative way to put it. Then talk a little about the antecedents of crises but very little just as to the point where it’s relevant to where we are today. Most of my talk is going to be devoted to the aftermath of crises. I’ll say very little about the aftermaths as regards to the typical post-crisis experiences in housing and employment but the main thrust of my remarks is about debt, government debt. And there’s two themes. One is, when does a severe financial crisis end up being a debt crisis, as it is in Europe as we speak. And the second is what are the implications of high public debts for growth and inflation based on a very broad historic study that I have done with my co-author Ken Rogoff of Harvard University.
JACK RIDDLER (ACORN,* NY) : Now that’s how to frame a problem!
* Anarcho-Communist Order of Raging NihilistsREINHART: So in the handout starting with where we are in a global context if we could just move to the first chart…
REINHART: What is shown in that chart is basically the incidence of crises from 1900 to 2008, everything else that I talk about will be through 2010. But the focus is to highlight that we’ve seen in recent years and what we see now is really pre-[World War II], that post-World War II we haven’t really seen anything quite like this.
So the chart… takes five types of crises. Severe banking crises. (1) Government internal debt crises. (2) Government external debt crises. (3) Right now Europe is having both because the solvency issue is affecting both internal debts and external debts alike. Inflation crises (4) and currency crises. (5) Currency crises is what we saw for example in the UK pound in 2008 and what we’re seeing in the euro right now. So it takes those five crises and it weighs them according to world GDP. So a US financial crisis carries a lot more weight than an equivalent financial crisis in Costa Rica.
REINHART: The red line takes those five severe crises and adds stock market crashes, defined as severe declines in equity prices of more than 25 percent… The bottom line of my showing this chart at the outset of my remarks is really to highlight that we haven’t seen since World War II something of this order of magnitude. You might note that we have similar readings in the 1950s but that’s the lingering part of World War II. That’s because not forget that Japan, Germany, Italy were in a state of default, some of them since the Great Depression, some of them since World War II, and those defaults were not resolved until 1952. Greece, the subject of so much public interest, was in a state of default until 1964… Greece has been in a state default roughly 50 percent of the time since independence in 1830, so [the current Greek crisis] is unprecedented by recent standards but certainly not by historic standards. The second point that I want to highlight from this chart before moving on is that the post-World War II period, the 50s 60s early 70s up to the oil crisis…
RIDDLER: "Oil crisis" is one way to frame the 70s, avoiding the fall of Bretton Woods after the rise of US trade competitors, and the profit-growth decline following the maturity of Western capitalism. These crises in turn saw big business and the banks start demanding every form of deregulation, so that they could squeeze out the remaining profit potentials in production (stagnate wages, for a start) and engage more freely in financial speculation.
REINHART: …was really quite an unusual period of calm, not just for the States but worldwide, and we’ve taken that for granted.
RIDDLER: It’s properly called “The Golden Age of Capitalism,” 1948-1973. It obtained for twenty-five years. Thirty-seven years have since gone by.
REINHART: If I were to extend this chart back another 100 years it would look a lot more like 1900 to 1945 than like the 50s 60s and early 70s. So that’s the point I wanted to make there. Turning to the next chart…
REINHART: This is just the set-up before I get to the heart of my remarks. The flow chart basically highlights the feast-famine cycle that the United States and most of the major world economies have been through. The feast phase has been you have financial innovation, you have a liberalization in the financial industry, we’re all geniuses. And a boom in asset prices ensues, fueled by a lot of credit, and it’s important to note that leverage begins there. Private sector begins to lever up there and this quite often ends in tears, it ends with a lot of those debts becoming non-performing and you have a banking crisis.
RIDDLER: In keeping with Reinhart’s overall framing, all the "good times" and everything that causes the crisis are compacted into one box out of the seven. Nevertheless it’s revealing that "financial liberalization" leads straight to "beginning of banking crisis," and that no one from the panel cares to challenge her when she says so. It’s tacit, but she seems to be acknowledging that, given the freedom to make their own rules, the big financial actors are guaranteed to exploit it to the point of abuse, since that’s how they make the big money.
REINHART: Banking crises have been usually associated with currency crashes as we saw for example in the UK. We really in the United States were the outlier, in that we saw a flight to the dollar in the fall of 2008. I will talk more about that towards the end of the remarks, because we’re seeing something similar right now in a somewhat different order of magnitude [a renewed "flight to the dollar" as haven]. But I will talk about the good and the bad of that. Because as most things it has the good and the bad.
But the point that I want to highlight today is that often times these banking crises, whether there is fiscal stimulus or not, whether there is a large bailout or not, usualy end up with huge build-up in government debts. And that is also because revenues collapse. So even if you go to the pre-World War II experience where bailouts were very limited if you had any and counter-cyclical stimulus packages were non-existent, you’d still get a real serious deterioration in the fiscal because of prolonged severe slumps in revenues. 
REINHART: Moving to the list into the antecedents, this is Slide 6, all I want to highlight is… I don’t want to dwell on this but the stages of crises, the first stage is a run-up in private debts. As the banking crisis unfolds public debts run up and this is where we are right now… I’d be happy to send you all the material, but if you go back to 1914 we have the highest level of private debt by a significant margin in the United States. This is household, non-financial and financial firms have the highest level of debt to income since the data has been kept from 1914 onwards. And so the indebtedness issue extends beyond the public sector…
RIDDLER: And she’s not going to overemphasize it, but let’s look at the real proportions of debt, public debt in relation to the rest, by recalling this chart from an earlier page.
(To create this chart, someone helpfully plugged in the numbers from the table at Federal Reserve, "Flow of Funds Accounts of the United States," Release Z.1, March 2010: Table D3, "Debt Outstanding by Sector" (1978-2009). The full report is at
http://www.federalreserve.gov/releases/ ... ent/z1.pdf)
REINHART: I highlight this because this is a major problem going on in Europe right now. Spain and Ireland for example did not start out with high public debts but they have been in the process of acquiring a huge stock of private debt. In crisis times private debts often become public debts. So that’s also an issue to consider.
RIDDLER: You would think that would be THE issue to consider: privatization of profits in the good times, socialization of losses in the bad.
REINHART: Let me now turn to the aftermath of crises.
RIDDLER: I’d rather not, but please, Prof. Reinhart, this is your show.
REINHART: So we’re on Slide 8.
There are two comments that I’d like to make on this score. Severe banking crises are protracted affairs. In our work Ken and I have been emphasizing this pretty much since the onset of the crisis. When crises are this severe you do not get your typical recession. You do not get your typical housing market cycle or employment cycle they’re more protracted. Even when GDP recovers for example, much more quickly than the labor market. The equity market, this is not just because equity prices rebounded in 2009. The norm is that equity markets recover well before housing does. If you look at this chart, the left panel shows the magnitude of the housing market decline in the worst of all the post-war financial crises. The right panel shows the duration, the time it takes from peak to the market bottom-out. I’d like to leave you if anything with the theme that it’s a protracted process.
RIDDLER: And of course in the present case still ongoing -- below I’ll be posting Whitney’s latest article making the case that housing prices are about to decline by another 10 percent.
REINHART: It’s six years if you include Japan [1990-present], it’s five years if you exclude Japan. I mean we talk about V-shaped, W’s [i.e., chart lines], but in Japan it’s really been an L… But taking out Japan you’re still looking at about five years peak to trough. Let me highlight that in the United States the peak in housing was in the first quarter of 2006. The actual decline using Case-Schiller [the S&P home price index] which showed another decline in the most recent, it showed a 5 to 10 percent decline in the figures released this week, highlights that the slump in housing isn’t entirely behind us.
REINHART: Employment conditions also [show] a protracted recovery, on average the unemployment rate has increased in the worst of the post-WW2 crises by 7 percent. Let me say that this is not melodrama, it’s not meant to be melodramatic. If I really wanted to be melodramatic I would show the same statistics for the Depression, in which you’re talking about peak-to-trough declines that are much bigger. And the duration being much longer. So these are strictly postwar crises.
REINHART: But now I really want to get in the next slide into the heart of my presentation. And the true legacy of financial crises is more government debt. This is where we are right now. In January of 2009 Ken Rogoff and I presented this analysis at the American Economic Association meetings and it was met with a bit of incredulity. We’re basically saying, what this chart says, is that if you take the crisis year to be equal to 100, real government debt a few years later is on average 186. It means that it nearly doubles. This is not debt as a percent of GDP but real inflation-adjusted government debt [that] nearly doubles in three years following a severe financial crisis on average. And we are on track as I will highlight later to meet that near-doubling of debt, not just in the United States but in the major advanced economies.
REINHART: So in what remains of my remarks I’d like to address two issues. One is… the links between what becomes a surge in government debt to what becomes a debt crisis, a surge in insolvency. And the less dramatic, more benign, more common pattern which even absent a debt crisis, what are the implications for economic growth of high government debt.
RIDDLER: (Digression!) As a Greek, this chart shows me how much it sucks to be a perennial plaything in the Great Game of the imperialist powers. I’ll try to resist too much of a history, but let's note the major stations indicated by the chart. In the course of the independence struggles of 1821-1830, the European powers intervened to set Greece up with a Bavarian monarch who didn’t speak Greek, foreign technocrats to make the policies, and a mountain of debt that left the new nation in default at birth. Greece spent the rest of the 19th century paying off as it grew, economically as well as territorially in a series of wars with the Ottoman Empire. Debt rose again after 1888 due to a Great Power blockade meant to limit national dreams of uniting all Greek territories. Following a war lost to Turkey in 1897, Greece went bankrupt and its budget was put under the control of a six-power consortium (at least Crete was acknowledged as Greek). Debt declined until the gap in numbers collection, apparently during the Balkan wars and World War I. The nation’s biggest disaster followed in the 1922 war with the deportation of 1.5 million Greeks from Asia Minor, but apparently no one was lending at the time, because debt went down. The next spike of debt, also leading to default, followed from the Great Depression. The "hyperinflation" represents the period of occupation by the German Reich. A review of these events highlights the limits of an aggregate approach, in which the lines just appear to move on their own according to some abstract mathematical logic. (That certainly plays a role, thanks to the miracle of compound interest and the self-reflexivity of the market.) REINHART: In Slide 12, after we go from financial crash to debt crisis… highlights since Greece has been so much in the heart of the discussion the remarks that I made earlier. But the surge in Greek debts actually is not as of recent vintage as it is for other European countries. We will see that in the next slide. The surge in Greek debts is more chronic. There is an important issue at hand in that remark, because debt crises often don’t happen overnight. They build up for some time and Greece was one of those cases where it was building over some time. However, in the inset of that slide I’d also like to highlight a theme in Greece that is as common in other parts of the European Union as it is in the United States, which is the surge in household debts at the same time. And this has implications that I will discuss later for growth. Because let me put it very bluntly, very high level of public debts is not new to the United States entirely or to Britain. Right after World War II we had a very high stock of public debts but private debts were nil at that time.
RIDDLER: The Greek household debt surge is more recent than in almost any other OECD country, dating back only to 1995, and in fact mainly follows the final introduction of the euro in 2002, after which new individual credit offerings came from abroad, in combination with a painful price equalization with the rest of Europe (inflation), foreign investment and heady promises of consumer paradise (the Olympics effect).
REINHART: So what is new or newer is the combination of both public and private indebtedness, this is a theme that I’ll return to.
A COMMISSIONER: Prof. Reinhart I have a question. On this chart you showed the household debt in 2008 of 49.7 for Greece. What is the corresponding number for the US now?
REINHART: It’s about double that. It’s about double that… Greece is a newcomer. Greece did not have access to debts, households did not have access [like in the] US ten years ago, twenty years ago. So the US numbers are actually more comparable to other European than Greece per se but the US number is about double that.
…and now for the most interesting chart…
REINHART: The next chart… averages public debt as a percent of GDP. That’s the blue line. And public debt as a percent of GDP for seventy countries that account for about 95 percent of world GDP. And this is not weighted by world income, so here Greek debts receive the same weight as German debts, receive the same weight as Italian debts, it’s not weighted. If we were to weight it by world income we would see that for the advance economies -- because of the surge in private debts and… in public debts have been so severe since the onset of the crisis -- for advanced economies weighted in share of world income we are the highest debt levels since the Depression. Even larger than around the time of World War II. The yellow shading… is where the link between banking crises, public indebtedness and… sovereign debt crises come in. The yellow shading is the share of countries that are in default. The percent of countries that are in default or restructuring. So for instance I’ve noted Greece was in a state of default until 1964. However since 1964 -- well Hungary was in default until 1967 but apart from that -- there have been no high-income countries in default since. So that yellow shading from the mid-1960s onward is zero if we only looked at advanced economies. The surge that you see in the 80s is of course the debt crisis, notably in Latin America but not exclusively. The point being we are seeing an advanced economy debt crisis which you’d have to go back to the 1930s.
REINHART: What are the links between the financial crises and the banking crises? … First of all let me clarify this gross government debt for all the countries. It is only central government. So it does not include things like government guarantees which also surge during crises. So in effect if we were to take a broader view of government debts that includes other levels of government and that includes guarantees, the recent surge… in debts would be that much more dramatic. And this is a global issue, not just a US issue.
RIDDLER: This is a fascinating chart, and rewards repeated observation. We see that debt peaks (blue line) lead to peaks in restructurings and defaults (yellow shading). Inflation numbers probably weren’t kept reliably before the 20th century, but after that hyperinflations are grouped in three periods: World War I and aftermath (during a debt and default upswing), 1970s (again a debt upswing, prior to a bunch of defaults in the 1980s) and in the 1990s, in that case probably more after currency devaluations due to the well-known series of financial meltdowns from that time in Mexico, Asia and Russia. I’ll repeat her observation that all the defaults after World War II and prior to the current crisis were in the third-world and East-bloc economies, under the weight of Western debts, which I submit is how the system was supposed to work.
GUY #1: (inaudible, question about US figure for gross central government debt to GDP)
REINHART: The US is very close to 90 percent gross, gross gross gross.
GUY #2: And that includes intergovernmental debt? Social Security and Medicare…
REINHART: Yes, that’s the gross.
GUY #1: It doesn’t have the guarantees?
REINHART: No, it does not include guarantees, only the federal government, so huge guarantees, Fannie, Freddie are not… and what I also want to highlight is that during the past three years other economies have also extended a huge level of guarantees to the financial industry, primarily but not exclusively.
GUY #2: Have you calculated a percentage with those guarantees for the US?
REINHART: No I have not but I think the IMF publishes some of the…
GUY #3: Do you know what it is?
THE GUY FROM THE IMF: No I don’t have it at the moment here.
RIDDLER: Now that was interesting, and bespeaks the agenda behind the Commission. They don’t want merely to define debt as a sum that must be repaid on past borrowing. They want also to lump in possible future obligations -- the "guarantees." And note that they want to talk about Fannie and Freddie, the Republican Talking Points, not guarantees to the Wall Street banks. And Social Security and Medicare -- the "intergovernmental debt," as the huge surpluses that these programs have built up since the 1980s were put into T-bills and have financed about half of the government discretionary budget deficits ever since then. Social Security and Medicare payments in the future, when these programs may no longer be in surplus, are also commonly seen as "guarantees." Reinhart knows these are not the same as existing debt, but the "Kill Social Security" movement wants to play it that way. So you’ll find that their propaganda often lumps current US government debt in with "expenditures guarantees" through 2040 or later, but still expresses the total as a percentage of current GDP, not taking all income between now and then into account. Reinhart just wants to get back to her presentation, which tends to avoid these issues as complicating. As we shall see, she wants a model that treats debt simply as debt, and wants to deemphasize how debt was accumulated or to whom it is owed, although these are crucial issues.
REINHART: But let me say that the surge in debt, the solvency issues that are in the forefront of Greece are solvency issues that will also have an impact on an area that we haven’t talked about that much, which is Eastern Europe. Right now… the surprise element of having EU members such as Greece, Italy, Ireland, Spain, that has drawn a lot of the discussion, but there is a huge stock of external debts also in Eastern Europe so if I were to expect that yellow shaded percent of countries in default, right now we’re focused on the euro zone countries, the wealthy countries we thought had outgrown this but let us also not forget that… emerging Europe is still an issue as far as debt. Now debt crises come in various shadings, and one thing that I’d like to remind is that barring the most extreme case of a default or a restructuring, there’s still downgrades that have real impacts on risk premium.
RIDDLER: Another capitalist euphemism. “Risk premium” is the extra points forced on those considered unreliable borrowers. A system that acts as a self-fulfilling prophecy. It can also be sheer windfall, as when the ratings agencies downgrade a country, prompting lenders to force "risk premium" on the inevitable debt roll-overs, whether or not that country borrows more or is truly a higher risk than before.
REINHART: Japan which is a country that lends - lends - to the rest of the world and is now sitting at debt to GDP of close to 200 percent was downgraded several times after its financial crises as public debt soared. And let me reiterate, Japan is a country that has financed its public debts internally, through high level of domestic saving and very little external debt, it was downgraded several times.
RIDDLER: Lucky for them they’ve essentially printed their own deficits internally for 20 years, and maintained a strong export base until now, or they would have been screwed on the “risk premiums.”
REINHART: Slide 15 which now starts moving toward the final issue I wanted to put on the table [asks] what are the links between debt and growth. But before… this chart, which is really dated because it only goes through roughly the end of 2009, those numbers are higher for everyone, the only part that I want to highlight is that 86 percent [average per-case] increase in debt following financial crises after World War II only appears to be a high number, it actually isn’t. We are on track to see and perhaps surpass that.
…but this is Carmen’s money chart…
REINHART: Now the exercise we did… we have put together a very large data set on public debt going back to 1800 in the case of the United States, to 1790 for Britain, about 70 countries of which 44 we have really good data for central government debt, to reiterate. Central or federal, not states or municipalities and so on. So the question that we posed was, if we were to take our historic period and break it down into periods in which government debt was (a) low, zero to 30 percent of GDP, (b) 30 to 60, (c) 60 to 90, and then (d) above 90,
we’re not talking about causal relations or anything esoteric here…
RIDDLER: Certainly not automatically causal! But it won’t be long before the Commissioners and you are treating it that way…
REINHART: …just what was growth, and asked that simple question, what was median, what was average growth during those differen stages of indebtedness? The similar question was asked, what was average inflation performance? And we did this for advanced economies, we did this for emerging markets, we did this for pre-war and postwar, the whole period, and on page 17 I … bolded in red what the main result is. Which is when we look at these four buckets of debt, 0 to 30, 30 to 60, 60 to 90 and then above 90, surprisingly, to us, there is very little difference, it’s not statistically significant, the difference, between debts of 40 percent and debts of 20 percent. Below 90 percent there is very little statistical difference. But… it does kick in at debt levels above 90 percent, namely median growth rates are about 1 percent lower for periods of gross debt above 90 percent, while average growth rates are even lower.
RIDDLER: See? Suddenly the observed average drop in growth is something that "kicks in," as though crossing the threshold of 90 percent debt-to-GDP is the cause, rather than that the threshold is crossed as growth and revenues fall due to financial crisis.
GUY #3: And again, you calculate the 90 percent using both the public debt and the intergovernmental debt. You would say we are at 90 percent today.
RIDDLER: While I think the distinction between US intergovernmental debt (Social Security and Medicare trust funds) and “public debt” (that owed to everyone in the world outside the government, half of which or more is now foreign) is very important, I can’t shake the feeling that it gets so much attention from the politicians because in their hearts, they have already written it off, with the idea that Social Security will be privatized anyway. Remember, the Social Security trust fund -- made up of US Treasury bills -- is what Bush famously called “meaningless IOUs.”
REINHART: That’s right. And … two reasons for that. One is from the vantage point of debt servicing, debt is debt irrespective of who holds it,
RIDDLER: True, but with the intergovernmental these guys may feel they can handle the situation differently on the roll-overs, if for example interest rates rise for the "public" part of the debt roll-overs, they can still be held low on the intergovernmental debt roll-overs.
REINHART: and the second is more attuned to the data that we have, in which the most reliable time set that we have for these countries over these extended periods is gross rather than netting out intergovernment.
RIDDLER: It’s hard to imagine, for example, Greece in 1888 even had the concept in their statistics. The distinction is an "advanced economy" thing.
DAVID M. COTE (CEO of Pentagon contractor Honeywell International, 2009 reported earnings $12.8 million, sits on directors board of JP Morgan Chase, advisor to KKR, and one of the few CEOs invited to Obama’s post-inauguration corporate tete-at-tete) : When you talk about that 90 percent gross debt, if you included Fannie and Freddie, what would it be?
RIDDLER: I think this is the guy who asked that before. Again, "Fannie and Freddie" are guarantees, not (yet) debt, so adding them would make for a surprisingly invalid statistic for a business school graduate to be proposing. Unless you’re assuming that all Fannie and Freddie assets will fail all at once by 100 percent and be compensated by the government for same, a rather unlikely eventuality. But it serves well as a disaster talking point to take the heat off the Wall Street Friends of Mr. Honeywell who actually wrote 90 percent of the failed subprime junk.
REINHART: Well that’s the question of guarantees. All I can say it would be much higher, I’d be happy to look that up and share it with panel members… I don’t have any comparable. Guarantees are not exclusive to the current crisis. When we had the Korean crisis for example in 1997, the first thing the government did was go out and guarantee corporate external debts. So measuring actual guarantees is not, to compare apples and apples historically is not an easy comparison (sic). We just stuck to the things we could compare, which is gross government debt.
RIDDLER: Watch the video for Reinhart’s entertaining verbalisms, by the way. Nerds who nervously stammer when addressing a bunch of power-elite suits are cute.
DAVID LEE CAMP (R- MI) : Are there any recommendations for making government reporting of debt more transparent so that the warning signals come more quickly?
REINHART: That is a wonderful question. I didn’t put him up to it [ha ha ha from everybody]. The issue of hidden debts. One of our big themes is the issue of hidden debts… can take many forms, and one of them is guarantees. But there’s more to the hidden debts, if you don’t mind I would like to go back to the issue at the end of my remarks, because there are many manifestations, some of them involving the… reporting of guarantees but also issues of balance sheets, issues of central bank debts and so on that… there’s a broad issue of hidden debts. And hidden debts always sort of like the Loch Ness monster, when you think it’s dead, that’s when they raise their head.
RIDDLER: This is humonguous, but she’ll run out of time without so much as a sketch. The sketchy balance sheets that most readily come to mind are those of the Federal Reserve and the Pentagon. Those would be interesting to see, if they even exist in a proper form for the organization as a whole.
SEN. MIKE CRAPO (R-ID): You indicated the United States gross debt is over 90 percent now, our public debt if I understand if we don’t change things is projected to reach 90 percent in 2019, have you done analysis on what the impact of public debt reaching 90 percent would be?
RIDDLER: Again, he’s distinguishing between “intergovernmental” public debt -- biggest item, Social Security trust fund of currently $2.6 billion in accumulated surpluses since the FICA tax hikes of the 1980s -- and that held by non-government entitities.
REINHART: I have a problem with your views, which are very common, of public debt. I mean public sector. But you’re really talking about held by the public. And all the analysis that I’m presenting here is on gross debt, not held by the public [per se]. Remember, debt service is on both publicly held and non-publicly held, and is just… I’m constrained by the data that I have, and I have not broken that out. And if we broke it out it would be an exercise for the United States and that wouldn’t be enough. Because to be as candid as I can in this, if we were to look only at the US experience, we’ve only had comparable debt levels to this right after World War II which is a very special case.
CRAPO: Because it’s common here on the Hill to distinguish between public debt as opposed to intergovernmental debt, but I’m understanding you to say that the distinction is not one that is valid, in fact it may be invalid… and that as we analyze we should be looking at gross debt rather than…
REINHART: I would agree with that statement. In effect… there is a bias, not just in the United States, towards actually understating debts rather than the other way around.
REP. JEB HENSARLING (R-TX, got his start as staff to none other than Phil Gramm) : I don’t know if I missed it, but did you actually give a number north of 90 percent as far as our gross debt to GDP today or did I just hear you say… did you give a precise number… ?
REINHART: We are very close…
KENT CONRAD (D-ND, head of the Senate Budget Committee) : I just asked staff to do the calculation. As of today… we are at 89 percent, by the end of this fiscal year we’ll be over 90.
HENSARLING: One other quick question looking at your slide over here… you say that at 90 percent, gross debt to GDP the needle is hitting the red zone with respect to economic growth. You’re not necessarily saying in your roughly 200 year data set that we’re looking at negative… but that growth rates would be at least 1 percent less.
RIDDLER: This is not a conclusion supportable by the aggregate data. It could also be that weak growth pushes debt above 90. She already said that.
REINHART: If you look at the next slide, the average growth rate is slightly - slightly - below zero, but the median is still positive. The 1 percent difference in the median, however… remember if population is growing at 1 percent, 1 percent may not sound like a lot, but it’s the difference between rising per capita income and not at all. There’s one remark on the chart on page 18. We were expecting actually that inflation rates would be higher at higher levels of debt, but we actually did not find that… Let me say this, on inflation there is no statistical difference for the advanced economies. We did developing countries separately which I will show you time permitting… The significant differences [are] in growth, not inflation, in the advanced economies.
REINHART: In the next slide [“Emerging Markets”] the difference is both in growth and in inflation… What I’d like to make clear is this is not a causality, you have high debt therefore you have low growth. It works two ways. I think the causality is both ways. You have low growth, revenues suffer, debt builds up, as debt builds up so does risk premium.
And I need to say this right now, because I think ironically the crisis which began with the subprime in the Uhited States has actually extended the life of the dollar as a reserve currency. And I’m concerned frankly that could lead to complacency. Because we studied the transition as a reserve currency from the pound to the US dollar. And it was… the writing was on the wall for many years in which countries started switching from linking to the pound, switch to the dollar, went from issuing debt in pounds (to the dollar). We were seeing that (now) with the euro. The euro was a serious contender as reserve currency to the dollar and that of course is being shattered right now. Which means that where we might have seen earlier signs of strain in debt issuance or financing, we’re getting a lot of leeway from international capital markets not because we’re doing things great but because of lack of alternatives. And I’d really like to put that on the table. I’ve taken enough time here. CONRAD: You’re on Slide 19? And Slide 19 can you help us interpret this chart? Because this shows… Oh, it’s emerging.
REINHART: Because particularly emerging markets have hit a wall in financing that is much harder. Inflation financing becomes a much, we wanted to be clear that we looked at the two things [advanced and emerging economies] separately.
SEN. JUDD GREGG (R, NH): If your basic premise is, and I agree with it, that you can’t finance debt with debt without slowing growth, and when you finance with debt you create more debt. So you’re basically your premise is we’re in a downward spiral because it feeds off each other. How do you break it? What is a historical precedent for breaking that downward spiral of financing debt with debt, which slows growth, which leads to more debt?
REINHART: None of the replies I’m going to give are cheerful or easy, so let’s be… I’m not noted for being uplifting [ha ha ha’s all around] there have been some cases where fortuitously debt to GDP has gone down due to fast growth but they are a small number, small small. Most of the cases have involved big fiscal adjustment, have involved restructurings, so even in cases where…
OFF: Can you define restructuring?
REINHART: Restructuring is a polite way of saying partial default. Because a restructuring, what it’s intended to do, is lower interest rate costs, lengthen maturities or a combination of the two.
GREGG (with childish wonder!) : Can a world currency default? (crosstalk)REINHART:
Well, look… the United States defaulted in 1933, when it suspended the gold clause… We suspended the gold standard, let me explain why it… is considered a default. A default is anything that changes… the initial contract to terms that are less favorable to the creditor. And we had a clause, the gold clause, that said our bonds are repayable in gold. And we abrogated that clause in 1933. And said OK, this bond is payable in fiat currency. But the fiat currency had lost 33 percent approximately of its gold value. That is an abrogation of the original contract. So… a restructuring, and this is the way Standard & Poors [defines it], this is not something that I have come up with, this is the legalistic definition… A default involves a change in the contract that is less favorable to the creditor than that of the original term.
SEN. DICK DURBIN (D-IL, closest Senate ally to Obama, on the Keynesian counterattack): I hope I’m following your premise here, that a banking crisis that leads to an economic crisis involving a decline in housing and real estate values, has led in… maybe all of your examples to more government debt, and as the debt grows to GDP, the likelihood of economic growth is diminished.
REINHART: Yes.
DURBIN: If that government debt is premised not on political weakness but on a design plan that said we have to step in as a government, as the economy declines, with safety net and stimulus and guarantees, otherwise, the decline will go even deeper and further, and the debt will last longer. As you look at various countries that have approached this, have you seen, maybe this just basic Keynesian approach, have you seen that intervention by the government and incurring of debt at an early stage of the crisis has been more beneficial than the governments who did nothing?
REINHART: Let me give a very honest to that, which is there are not many examples of that.
Because many of the countries that had -- forget the emerging markets… [where] even if countries wanted to act counter-cyclically, they could not because they had lost access. They couldn’t borrow. --
RIDDLER: Something judged inconceivable for the US. Let’s see later this year when the euro crisis has subsided one way or another, and the US seeks to finance another 1.5 trillion or so deficit, plus roll over at least a trillion in debt. Will the lenders be there? Will there be a massive Federal Reserve print to cover it all, and if so, how will the bond markets and the nefarious ratings agencies react?
REINHART: Those that were not emerging markets, like the famous Nordic crises of the early 1990s, they were constrained on how much fiscal stimulus they could also do, because they were also part of the European exchange rate arrangements. The examples of more aggressive counter-cyclical policy are to be found in this [current] crisis, and in Japan [1990s to today, really]. Those are the only examples.
WOMAN #1: But isn’t there an example in the 1930s in the Depression where there was a cutback in stimulus and actually we ended up in a double-dip?
REINHART: That’s absolutely right. In the 1930s -- I actually have a Brookings paper on this issue -- there was a bouncy, real increase in spending and then a withdrawal and you had a double-dip. But in the 30s the big, huge difference was we waited a long time to leave the gold standard and we had very tight monetary policy up until 1933. Here we had a massive monetary stimulus, so that is why I avoided [that example because] the monetary side in the 1930s was completely different. What you said is absolutely right.
CAMP (apparently throwing a fit at the very idea of stimulus spending) : I just wanted to say that in the 1930s, stimulus was not the only factor. We had tarriffs, to say that government spending was the issue, frankly it was World War II that got us out of the Depression in the 1930s, and that was big, but not, I think this point needs a little more elaboration…
RIDDLER: Now that wins the Bizarro Comment Prize for the whole hearing. World War II "got us out of the Depression," but this wasn’t due to the spending? What was it then? The magical meaning-giving power of war? He just argued for the opposite of his own premise, but never mind…
REINHART: To put it concretely, we had a very aggressive fiscal stimulus in the 1930s, more aggressive than the UK which actually did better, but we were very inconsistent. Namely, every time that there was the perking up of activity, we’d withdraw. So it’s a very bouncy fiscal stimulus… that’s how we describe it and quantify it in our recent work.
RIDDLER: All of which suggests that austerity is not the way to go!
DURBIN: Can I follow up on that because I thought the answer to my question was that stimulus doesn’t really work, but now it seems that inconsistent stimulus doesn’t work. Which is it?
REINHART: For me it’s inconsistent stimulus that didn’t work in the 1930s.
DURBIN: I know it’s a different world today, but looking at the situation today, we have tried to stimulate the economy, we’ve seen some recovery…
REINHART: What I can honestly say is we do not observe the counterfactual. We do not know what we would have looked like had it not been for the interventions that we did, we just don’t know that. I don’t have the long list of comparitors that say, okay, this country did stimulus, this one did not. I can only take my data so far.
RIDDLER: An admirable attitude in a scientist. Except again that World War II for the US was exactly the high, sustained stimulus that got the economy going.
INAUDIBLE: Inaudible.
REINHART: No, I did not say that. I began with fiscal austerity. I have used this example because I think it’s pertinent to us: Canada in the mid-1990s faced very unpleasant debt dynamics. And… we sort of knew that it was there, and they did not come to a fiscal austerity package voluntarily, actually of all things [it came about because of] the Mexican crisis. You may wonder what the Mexican crisis had to do with Canadian austerity, but in the mid-1990s, Canadian spreads began to move in tandem with emerging markets, and that actually was a wake up call.
RIDDLER: Do these lines just move? Wasn’t this related to the creation of a unified market under NAFTA?
JAN SCHAKOWSKI (D-IL, known to our readers only because of Sibel Edmonds’s claims, you damn voyeurs) : I’m just wondering if you did any analysis of debt as it relates to unemployment, or you mentioned per capita income…
REINHART: Per capita income on average in the postwar crises, it takes four years for per capita income to go back to pre-crisis level. This is postwar. Prewar it took much longer in the United States, it took ten years…
SCHAKOWSKI: Did you break it down by short-term surges in debt versus longer term or more historical surges?
REINHART: No because… our dividing principle was any year in which debt was 60 to 90 percent or above 90… so there is no discrimination of how you got to the debt, which is what I think what you are asking. Did we get to the high level of debt because of a financial crisis or…
RIDDLER: Uh oh. Pauses and filler ensue. Let’s reach for the woo.
REINHART: but it is a very robust result precisely because our sample of observations is big.
RIDDLER: Biiiiiig!
REINHART:You see, if I actually showed you the numbers for the United States, they would actually look worse than what I’ve reported here. And it was debt that we got to mostly through war. This was right after World War II
RIDDLER: May I note on the side that the current debt may also be related to wars?!
REINHART: If we start cutting it because of high debt levels because of financial crises and high debt levels because of wars, then we’d start winnowing our sample, and how much can you extract from a handful of observations. It’s drawing big lessons from six observations for the United States or five observations for Japan is not something… uh, one last thing I’d like to highlight on the issue of hidden debts. In studying all these financial crises, actual debts are on the whole bigger than anything any of the official statistics that we measure here [say], just as I suspect that if we were right now to calculate potential domestic arrears in Greece, debts would actually be bigger than what the official statistics are. There are a lot of ways of hiding debts, this is true of the private sector as well as the public sector. So I think exercises toward greater disclosure would be [good].
DAVE COTE: An observation and a question. The observation and this is as a non-politician here
RIDDLER: Oh shut the fuck up. That old dodge! You’re the one who tossed in Fannie and Freddie. Mr. I Can Afford To Pose As A Non-Politician. Oi.
COTE: …it seemed like we were having an American world economic discussion that started to turn into a political discussion. I hope that, I may be totally incorrect and I’m not trying to be offensive in any of this but I hope we get back to where we first started the conversation.
RIDDLER: You mean back at the slide where "financial innovation" by the likes of your company JPM Chase led directly to a financial meltdown?
COTE: The second one is, getting back to Sen. Durbin’s question, I thought your point at the beginning was not just the debt that the US had, but that it was in combination with all the private debt that exists that eventually turns into public debt because the economy can’t sustain it when we’ve got debt at about 100 percent of income, if I’ve understood. Is that correct?
RIDDLER: All that private debt turns into public "because the economy can't sustain it." A natural law that need not be defined: privatize the profit, socialize the loss.
REINHART: The hard numbers that I have are for gross central government debt. And the issue of private debt, which is a very important one… it is an additional consideration that weighs growth down, and I think, not I know. What I’m saying is right after World War II we had comparable levels of public debts but both the US and the UK had very low levels of private debt. Europe had no private debt. The point… is our study is only… about public debt. We have not done a comparable analysis of private debt. [It’s] different from the postwar experience when we had a lot of public debt. In the US, in the UK, in the Commonwealth, the issue of private indebtedness, which at any point in time can increase public indebtedness, is an additional issue to consider. I hope I’m making the distinction between the results that we do have and the issue of private debt which we haven’t looked at on a parallel basis to the public debt.
RIDDLER: Geez, you’d think the only way to do it was a broad write-down in all categories of debt. D'oh!
ERSKINE (me get last question!) : We’re sitting here today with a significant amount of private debt and public debt. We’ve tried to stimulate a very fragile economy and are at the very best at the beginning of a fragile recovery… Given where we are today, what would you recommend to this Commission?
REINHART: I have no positive news to give. Fiscal austerity is something nobody wants but it is the fact that it is the alternative.
RIDDLER: Only one thinkable to you and this commission, anyway.
REINHART: I am concerned about complacency. I am concerned that because the dollar has renewed its role as a reserve currency we may wait too long. Waiting too long doesn’t necessarily have to run out and act right now in terms of actual tightening but [to establish] a path that is sustainable. Let me also say that one of the things that happened in the 50s and 60s that cannot be denied is we had financial repression.
RIDDLER: AAAAAAH! NOT FINANCIAL
REPRESSION!!!REINHART: And what is financial repression? That is a system in which interest rates are controlled and there more directed credit and it was a way in which governments financed high levels of debt. We’re already seeing that. I think we are going to see a return of different forms of financial repression, because it is not just our problem, it is in Europe, Japan is in a similar situation. Japan has been able to carry its debts up to 220 percent of GDP. Because of various forms of financial repression. I think we will also realistically find ways of placing government debts at lower interest rates, not worrying so much about roll-over. I think in light of the fact that it’s not just the US but all the advanced economies, I think that will be in addition to fiscal austerity. I think that will be something that is not improbable.
ERSKINE: Thank you.
(last slide)
RIDDLER: In some ways, Reinhart is scientifically commendable. She and Rogoff accumulated as much long-term data on the questions as they could, even if the premises of what to ask are debatable.
She's timid about going past the brink of telling the suits what her data actually says. At the point where she's asked how runaway debt is overcome, the phrase "fiscal austerity" comes easily to her, because that's what the suits want to hear.
But she goes on, because there she has a second answer (never mind the others that are unthinkable to her and the Commission, such as liquidating the zombie banks).
While I yell "default! default! default!" it takes her a half-minute of nervous filler before she can finally drag out a word the suits don't want to hear, really aren't equipped to hear: restructuring.
Her empirical data clearly suggest that after banking crises, governments go more heavily into debt because bankster and private debts pass into public debts, and that this is what happened in the present case.
This should be a direct challenge to the idea that the banksters then retain command, terrorizing everyone into bailing them out, and later get to enforce fiscal austerity (through the bond markets and the obedient political suits) as though the public debt was solely to blame, or evidence of some kind of unique moral failing on the part of "government." But she doesn't say it to the suits, and she may not dare to think it.
To her credit, she remains a scientist -- I was charmed to hear her say that she has a limited number of cases of willed sustained countercyclical spending not related to war, so she can't reach a conclusion, because most of the people she’s telling that are willing to use the flimsiest apocrypha as the basis for conclusions predetermined by ideology.
As a member in a scholarly community, she's trapped by the language, and perhaps she wants to keep her "credibility," a word sadly confused with conformity to hegemonic opinion. At the end she uses one of the doublethink words of capitalist economics: "financial repression." Which means, when the government starts setting stable interest rates and directs how banks give out credit. Common in the 1950s and 1960s, periods of stability and growth in the capitalist world, prior to the crises and the neoliberal reactions. So when credit is directed by a public entity that may (or may not) make rational decisions, rather than the riotous foolishness of the unregulated financial market -- when the banks are made to follow rules -- this should be called directed, rational investment. But since the banksters make the language, it's "financial repression." Oh, horrors!
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That was my initial reaction, and I posted it in the discussion at Mike Norman’s blog.
http://mikenormaneconomics.blogspot.com ... tlook.htmlSome of the responses:
Matt Franko wrote:
Nicholas,
I think she paints the history with too broad a brush. She treats all govt debt of the past times as the same. While ignoring facts such as whether the govt debt was denominated in a foreign currency, or whether the govt operated a convertable currency regime. These two factors (which are quite different for the current US arrangements vs much of the history she presents) are very important conditional aspects that she ignores/overlooks. (both she and co-author Rogoff).
So I dont think I have as much professional respect for her work here as you seem to Im afraid.
Nah, I just enjoyed some of the stuff she brought to the table that was new to me, like the aggregated debt figures. I don’t think she ignored those facts, but she did downplay them to make her findings on debt and growth seem beefier. The more she differentiates, as she admits at one point, the less data she has to analyze.
Matt Franko wrote:WRT her and Rogoffs book, I wish we could find out how Princeton University Press came to publish (via a grant from whom?) this work by Professors from Harvard and U of MD.
The grant info would be interesting but the fact of publication by PUP is completely irrelevant. University presses publish academics from other institutions all the time.
Matt Franko wrote:You know if you think about it, she and Rogoff focused on this 90% of GDP level where they push the panic button for govt deficit levels; but all of their historic examples are where you had external sources of funding due to either convertability or debt denominated in a foreign currency.
So what they really found was the level (90% of GDP) to which external funding would go before cutting them off. So any nation that would set up their system like that could expect to push it to the 90% level before they would have to shut it down.
Thanks Reinhart & Rogoff, you have stumbled upon the funding constraint of scoundrel nations!
I picked up the fact that they ignored the distinction between soverign issuers vs external funders from other MMT blogs for sure.
but their 90% threshold may be of interest if you used it for forex trading. ie, if you had a govt that had foriegn denominated debt, or external funding, and was at the 90% historic doomsday threshold they (R and R) have come up with, maybe you really short it at that point.
I hope he means scoundrel banksters. But this is an important point. The 90 percent is a signal for the banksters to pile on with the "risk premiums" and ratings downgrades, so there may be something to it.
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Phew! I am an obsessive. I like to think I do this instead of some other private hobby, like painting. But I'm going to post a couple of more relevant articles I ran across while doing the above, and then take another break from this insane thread.
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