Carmen Reinhart has been studying the impact of debt on economies since taking her first job as an economist at Bear Stearns Cos. in 1982, just as the Latin debt crisis was unfolding. She gained further experience in subsequent stints as an economist at the International Monetary Fund. Reinhart collaborated with former IMF chief economist Kenneth Rogoff to publish the 2009 business best-seller This Time Is Different: Eight Centuries of Financial Folly, which shows how the U.S. subprime crisis fits an established pattern of debt crises extending back some 800 years and why recovery is likely to be prolonged and painful. She recently spoke with II’s International Editor, Tom Buerkle.
1 Greece is in the hot seat. Can the country repay its debt without a rescheduling?
It might not be impossible, but it’s certainly improbable. Greece has two major problems: It has lost competitiveness within the euro zone, and it has a debt overhang problem. Fiscal austerity, which includes sizable cuts in government wages, is tailor-made for repairing the competitiveness problem, but it’s a deflationary policy that makes the debt overhang worse. Debt-to-GDP is going to just keep looking worse. Greece can’t inflate the denominator; it’s going to have to deal with the numerator. That’s where the restructuring comes in. Haircuts of between 20 and 50 percent are not unheard of.
2 Does the European Union bailout package strengthen or weaken the euro area?
If it’s a first step to greater fiscal unity, it strengthens it — but right now there is so much overarching concern about political unity. We thought we’d put currency risk to bed with the euro, but it is coming back with a vengeance. I don’t think it’s a big plus, other than to buy time.
3 What does the European crisis say about the U.S.? Could the bond vigilantes turn on the Treasury market?
What it should say to the U.S. and what it’s actually doing are different. We should be saying, “Ah ha!” Adverse debt dynamics sooner or later come back to bite you. What is actually happening is that it’s buying us time to dawdle. The euro was the only serious contender to the U.S. dollar as a reserve currency. That expectation is quickly dismantled. So it has prolonged the life of a more benign attitude toward U.S. Treasuries, yet it’s also postponing the day of reckoning.
4 How do debt issues affect the balance of power between advanced economies and emerging markets?
The emerging markets are at a crossroads. There’s a lot of search for yield going on, and emerging markets are attracting capital like magnets.
If they manage it well — if they don’t fall into the temptation of borrowing too much when markets are tripping over themselves to lend to them — then they are well poised to continue growth. If they behave as they often have and believe that this time is different and that they’re really going to be able to borrow without consequences, then all bets are off.
5 Why is it so hard to recover from debt crises, and what does that say about economic recovery today?
Our key finding is that growth rates are about 1 percentage point lower in periods of high debt. One percent doesn’t sound like a lot, but if you have a population that’s growing at 1 percent a year, 2 percent growth rather than 1 percent means your income per capita is going up, not stagnating. So it actually makes a big difference.
U.S. real estate peaked in the first quarter of 2006. This is our fourth year here. If you look at private debt in the U.S., we haven’t had these kinds of levels since the roaring ’20s. The deleveraging episode after that lasted over a decade.
