This Time It's Still Not Different Enough to Really Be Different

Please read Drs. Reinhard and Rogoff's op-ed today from the Financial Times titled:
Why we should expect low growth amid debt.

Here are the intro and the conclusion:

As government debt levels explode in the aftermath of the financial crisis, there is  growing uncertainty about how quickly to exit from today’s extraordinary fiscal stimulus. Our research on the long history of financial crises suggests that choices are not easy, no matter how much one wants to believe the present illusion of normalcy in markets. Unless this time is different – which so far has not been the case – yesterday’s financial crisis could easily morph into tomorrow’s government debt crisis. . .

Markets are already adjusting to the financial regulation that must follow in the wake of unprecedented taxpayer largesse. Soon they will also wake up to the fiscal tsunami that is following. Governments who have convinced themselves that they have done things so much better than their predecessors had better wake up first. This time is not different.

Ms Reinhart is professor of economics, University of Maryland, and Mr Rogoff is professor of economics, Harvard University. They are co-authors of ‘This Time is Different: Eight Centuries of Financial Folly’ (Princeton)

There is a reason why one-month T-bills are trading around 0.00% interest. Much smart, conservative money doesn't trust much else.

Copyright (C) Long Lake LLC 2010

More on Debt, as the Markets Issue Their Verdict

While the Asian markets implode as this is written with only modest price upticks for gold and Treasuries, a prominent historian and author of The Ascent of Money, Niall Ferguson, has an op-ed that addresses the major themes of this blog, in "The Great Repression".  Here's an important section from it:

The aim must be not to increase debt but to reduce it. In past debt crises - which usually affected emerging market sovereign debt - this tended to happen in one of two ways. If, say, Argentina had an excessively large domestic debt, denominated in Argentine currency, it could be inflated away. If it was an external debt, then the government simply defaulted on payments and forced the creditors to accept a rescheduling of debt and principal payments.

Today, Argentina is us. Former investment banks and German universal banks are Argentina. American households are Argentina. But it will not be so easy for us to inflate away our debts. The deflationary pressures unleashed by the financial crisis are too strong (consumer prices in the US have been falling for three consecutive months; the annualised rate of decline for the last quarter of 2008 was minus 12.7 per cent.)

Nor is default quite the same for banks and households as it is for governments. Bankruptcy can be a complicated business. Understandably, monetary authorities are anxious to avoid mass bankruptcies of banks and households, not least because of the knock-on effects on asset prices of distressed sales of assets.

The solution to the debt crisis is not more debt but less debt. Two things must happen. First, banks that are de facto insolvent need to be restructured, a word that is preferable to the old-fashioned nationalisation. Existing shareholders will have to face that they have lost their money. Too bad; they should have kept a more vigilant eye on the people running their banks. Government will take control in return for a substantial recapitalisation after losses have meaningfully been written down. Bondholders may have to accept either a debt-for-equity swap or a 20 per cent "haircut" - a disappointment, no doubt, but nothing compared with the losses suffered when Lehman Brothers went under.

There are precedents for such drastic action, notably the response to the Swedish banking crisis of the early 1990s. 

Unfortunately, the mind-set in Washington and the City of London remains firmly with the Merchants of Debt.  Just as conventional thinking helped lead to the Great Depression, so may conventional thinking fail now.

Copyright (C) Long Lake LLC 2009