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Reinhart and Rogoff think the main danger to the US is slow growth

15 Jul 2011 by Jim Fickett.

As is well known, Carmen Reinhart and Ken Rogoff have spent many years studying the aftermath of financial crises. Their opinion, therefore, on how the current situation in the US may develop, is uniquely valuable. In a recent Bloomberg article, they say that, although high inflation is a danger, the greater danger is probably slow growth combined with long-term financial repression:

Even though politicians everywhere like to argue that their country will expand its way out of debt, our historical research suggests that growth alone is rarely enough to achieve that with the debt levels we are experiencing today.

While we expect to see more than one member of the Organization for Economic Cooperation and Development default or restructure their debt before the European crisis is resolved, that isn’t the greatest threat to most advanced economies. The biggest risk is that debt will accumulate until the overhang weighs on growth. …

In our study “Growth in a Time of Debt,” we found relatively little association between public liabilities and growth for debt levels of less than 90 percent of GDP. But burdens above 90 percent are associated with 1 percent lower median growth. Our results are based on a data set of public debt covering 44 countries for up to 200 years. The annual data set incorporates more than 3,700 observations spanning a wide range of political and historical circumstances, legal structures and monetary regimes.

We aren’t suggesting there is a bright red line at 90 percent; our results don’t imply that 89 percent is a safe debt level, or that 91 percent is necessarily catastrophic. Anyone familiar with doing empirical research understands that vulnerability to crises and anemic growth seldom depends on a single factor such as public debt. However, our study of crises shows that public obligations are often hidden and significantly larger than official figures suggest. …

In addition to ex-ante or ex-post government guarantees and other forms of “hidden debts,” any discussion of public liabilities should take into account the demographic challenges across the industrialized world. Our 90 percent threshold is largely based on earlier periods when old-age pensions and health-care costs hadn’t grown to anything near the size they are today. Surely this makes the burden of debt greater.

There is a growing sense that inflation is the endgame to debt buildups. For emerging markets that has often been the case, but for advanced economies, the historical correlation is weaker. Part of the reason for this apparent paradox may be that, especially after World War II, many governments enacted policies that amounted to heavy financial repression, including interest- rate ceilings and non-market debt placement. Low statutory interest rates allowed governments to reduce real debt burdens through moderate inflation over a sustained period. Of course, this time could be different, and we shouldn’t entirely dismiss the possibility of elevated inflation as the antidote to debt.

Whether high inflation or persistent financial repression, the investing environment is unlikely to be an easy one.

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