31614810 Niall Ferguson on Fiscal Crises Defaults and Inflation

7/28/2019 31614810 Niall Ferguson on Fiscal Crises Defaults and Inflation

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Fiscal Crises, Defaults and

Inflations: HistoricalPerspectives

Morgan Stanley, Florence, May 15, 2010


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Were witnessing a debt explosion in

the developed world

Source: IMF


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With the power to scare governments

into emergency action


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Such crises are nothing newtheyre

as old as the bond market

Source: Larry Neal


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War and revolution are the traditional

causes of crisis

Source: Larry Neal

Seven Years' War,

1756-63

American War of

Independence, 1775-

83

French

Revolutionary

Wars, 1792-1815


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A pattern consistently to be found for

more than a century

Source: Alan Taylor


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Unlike lightning, they tend to strike the

same places twice

Source: Alan Taylor


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Latin America, Central, Eastern and

Southern Europe and the Middle East

Source: Alan Taylor


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But advanced economies arent

exempt

Source: Reinhart and Rogoff (2009)


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It happens to the best of us

Source: Reinhart and Rogoff (2009)


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Source: BIS

Debt/GDP projections


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Source: BIS

Debt/GDP projections


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The metrics of doom 1

Source: BIS


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The metrics of doom 2

Source: IMF


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Out-pigging the PIGS

Source: BIS

Memo: CBO extended baseline for total

federal revenues in 2040: 22.3% of GDP


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What causes these crises?

Excessive debt

Measured by debt to GDP or to tax revenue or toexports

Excessive interest payments Measured by debt service to GDP or to tax

revenue

Excessive reliance on foreign capital

Measured by debt to exports or net internationalinvestment position


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What causes these crises?

Economic weakness

Low growth in productivity

Low returns on private sector investment

Political weakness

Excessive expenditure and insufficient taxation are

politically determined

Irrational exuberance

Investors keep forgetting to learn from history


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Some people

Source: NBER/GFD


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never learn

Source: NBER/GFD


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No matter how often

Source: NBER/GFD


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it happens

Source: NBER/GFD


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Sovereign debt: A history of hopes

dashed by outcomes

Source: Lindert and Morton


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Sovereign debt: A history of hopes

dashed by outcomes

Source: Lindert and Morton


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What are the ways out of a debt crisis?


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In theory, 6 ways out

1 A higher growth rate of GDP

2 A lower interest rate on the public debt

3 A bailout, meaning either a current transfer paymentor a capital transfer from abroad

4 Fiscal pain, meaning an increase in taxes and/or a cutin public spending

5 Increased recourse to seigniorage (revenues frommonetary issuance) by the central bank

6 Default, including every form of non-compliance withthe original terms of the debt contract, includingrepudiation, standstill, moratorium, restructuring,rescheduling of interest or principal repayment etc.

Source: Buiter (2010)


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Usually, only 3 ways out

1 A higher growth rate of GDP

2 A lower interest rate on the public debt

3 A bailout, meaning either a current transfer paymentor a capital transfer from abroad

4 Fiscal pain, meaning an increase in taxes and/or a cutin public spending

5 Increased recourse to seigniorage (revenues frommonetary issuance) by the central bank

6 Default, including every form of non-compliance withthe original terms of the debt contract, includingrepudiation, standstill, moratorium, restructuring,rescheduling of interest or principal repayment etc.

Source: Buiter (2010)


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Cut, Print or Default

Cutters are few and far

between

Only Britain 1815-1914

reduced debt burdenexclusively through

budget surpluses, lower

interest rates and higher

growth

And Britain had the

advantage of the

industrial revolution

Printers

States with monetary

sovereignty

States with own-currency debt

Defaulters

States with limited

monetary sovereignty States with foreign

currency debt


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Two great Anglosphere debt reductions

Source: Musson


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How we did it last time

Source: Buiter


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Lessons of history (1)

What do governments NOT* do with world

war size debt burdens?

Slash expenditure on entitlements

Reduce marginal tax rates on income and

corporate profits to stimulate growth

Raise taxes on consumption to reduce deficits

Grow their way out with out defaulting ordepreciating their currencies

*One exception: Britain 1815-1913


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What do governments USUALLY do with world

war size debt burdens?

Oblige central bank and commercial banks to hold

government debt

Restrict overseas investment by firms and citizens

Default on commitments to politically weak

groups and foreign creditors Condemn bond investors to negative real interest

rates


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Bondholders beware

Source: GFD


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Get ready for currency volatility

Source: GFD


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Sometimes it is different

With relatively short debt term-structures and

bond vigilantes, nominal yields may well rise

aheadof inflation That could mean rising real long rates

Which would be seriously negative for growth in

highly leveraged economies in the Western world Leading to intense domestic political conflicts and

ultimately to defaults


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Its quite a short ride from here


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to here

31614810 Niall Ferguson on Fiscal Crises Defaults and Inflation

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