Thursday, October 3, 2013

Rogoff on UK Defaults

Ken Rogoff wrote a very interesting FT oped on UK finances (FT original, Rogoff webpage if you can't see FT.)

The issue: Should we worry about huge sovereign debts of advanced countries? Or was the only problem with fiscal stimulus that it was not big enough?

A little history:
Yes, from the 1800s until the first world war, the UK was a global superpower that commanded vast colonial resources and investments. Over long periods, these foreign assets yielded returns well in excess of interest on debt. But comparing government debt ratios back then, when the UK was a massive net creditor, to debt ratios today, when British foreign liabilities exceed foreign assets, is utterly misleading. Moreover, back in the 1820s, the UK was pioneering the industrial revolution; things are not quite the same today. Back then, the UK did not have to worry about pension liabilities or existential threats to the banking system that could require massive injections of cash to fix. ...

During the 1930s, Britain defaulted on debt to the US accumulated during the first world war and its aftermath. ...

It is often stated that after the second world war the UK debt reached almost 250 per cent of gross domestic product and was brought down merely through growth and inflation. This is a myth ...

Then there is the high-inflation era of the 1970s – another de facto default. Last but not least, what about the UK’s serial dependence on International Monetary Fund bailouts from the mid-1950s until the mid-1970s? This is hardly a country with an indestructible credit status. ...

Being a UK bondholder has had its ups and downs.

Looking forward, an important point: a country needs to be substantially below its ultimate borrowing limit, or it loses its ability to fight crises going ahead.
..a euro collapse would have triggered a stampede out once investors realised that the UK banks and trade would be savaged, a flexible currency notwithstanding. In that scenario, UK leaders would have been forced to close massive budget deficits almost overnight. That would have been truly catastrophic austerity. ...

We now know the euro did not collapse. [yet -- JC] With 20-20 hindsight, yes, the UK could have borrowed more. But we do not have hindsight at the moment decisions have to be taken. 
Kan and Carmen Reinhart have been at the receiving end of Paul Krugman's tender commentaries lately, and I'm interested to see Ken taking up the issue. Krugman likes to lambaste people for "predictions" that he imagines they made which didn't come out. On the euro blowing up, Ken seems to be offering a taste of his own medicine, made more bitter by the fact that Krugman actually did say what Ken says he said:
...This was the big call – the one that everyone was focusing on. To state that credit risk was gone by 2010 is ludicrous. None other than The New York Times columnist Paul Krugman prognosticated the euro’s early demise regularly from April 2010 to July 2012. His big call has turned out – so far – to be dead wrong.
I will be curious if we see more of that from Ken. Stay tuned.


  1. "Looking forward, an important point: a country needs to be substantially below its ultimate borrowing limit, or it loses its ability to fight crises going ahead."

    Ugh... Wrong on so many levels. There are plenty of good reasons a government should limit its borrowing. Threat of bankruptcy or insolvency is not a good one. A "lost" ability to fight "crises" going forward is not a a good one either.

    1. Since the statement referers to "a country", for the statement to be wrong "at all levels", I would think all Mr. Cochrane needs to do is find one example where a sovereign's constrained borrowing capacity has not limited its ability to fight a crisis to refute the objection. (I think he could cite at least 50 episodes, and if not I will help him.)

      If you interpreted the statement as "any and every country", I think the article did suggest that Japan and the US have a lot but not unlimited leeway.

    2. There are some extra negatives, but yes, sometimes I hold back and leave wrong comments as problem set exercises.

      Greece, for example, ran out of borrowing authority to fight its recession after the financial crisis and recession. (Leave aside whether that helps, Greece certainly wanted to borrow more.)

      If the states go under or the eurozone explodes, or (let's hope not) the US fights another war, we're going to have to start borrowing an extra trillion or so per year.
      There is a limit somewhere.

      Please, chime in with your own examples.

  2. Just out of curiosity: Is there anyone shorting US bonds, thinking about the medium run (1-5 years)?

    1. There are inverse ETFs on Treasury Bonds, and just one of then, TBT,trades about 3m a day, so yes, I think you would conclude there is active shorting.

    2. The spread on credit default swaps on US sovereigns has drifted up about 12 basis points in the past month, from about 22 to about 34. That market is not open to individual investors, however.

  3. Re Rogoff’s reference to “huge sovereign debts”, UK and US debt is not yet up to half the level it was at just after WWII.

    As to “pension liabilities”, that has NOTHING TO DO with the debt issue. Most of the UK’s pensions (particularly the state pension) is “pay as you go”. I.e. pensions in 2013 are paid for by taxpayers and other pension fund contributors in 2013.

    “a country needs to be substantially below its ultimate borrowing limit, or it loses its ability to fight crises going ahead.” Not true. If no one wants to lend to a country, and the country needs stimulus, it can just print money. That won’t be inflationary as long as there’s spare capacity. Alistair Darling, the UK’s finance minister at the height of the crisis, created £60bn out of thin air for the benefit of two insolvent banks RBS and HBOS. Inflation didn’t skyrocket.

    John Cochrane cites Greece as an example of a country that has reached it’s borrowing limit (in his comment above). Greece is a completely different kettle of fish to a country like the US, UK, Japan, etc which issue their own currencies.

    1. "UK’s finance minister at the height of the crisis, created £60bn out of thin air for the benefit of two insolvent banks RBS and HBOS."

      Of course there was no inflation. If a bank is insolvent they are not going to turn around and lend out that newly created money.

      Instinctively we all know that printing money ad finitim is not going to solve problems past the next crisis. That which is not sustainable will not be sustained. Sure baby boomers like yourself are happy to take on debt and print money and leave the problems to the younger generations to deal with. That's the disgusting selfishness of your generation.


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