IMF WARNS DEBT BURDENS IN DEV NATIONS REQUIRE
HAIRCUTS
IMF paper warns of 'savings tax' and mass write-offs
as West's debt hits 200-year high
Debt burdens in developed
nations have become extreme by any historical measure and will require a wave
of haircuts, warns IMF paper
Much of the Western world will require defaults, a savings tax and
higher inflation to clear the way for recovery as debt levels reach a 200-year
high, according to a new report by the International Monetary Fund.
The IMF working paper
said debt burdens in developed nations have become extreme by any historical
measure and will require a wave of haircuts, either negotiated 1930s-style
write-offs or the standard mix of measures used by the IMF in its “toolkit” for
emerging market blow-ups.
“The size of the problem
suggests that restructurings will be needed, for example, in the periphery of
Europe, far beyond anything discussed in public to this point,” said the paper,
by Harvard professors Carmen Reinhart and Kenneth Rogoff. The paper said policy
elites in the West are still clinging to the illusion that rich countries are
different from poorer regions and can therefore chip away at their debts with a
blend of austerity cuts, growth, and tinkering (“forbearance”).
The presumption is that
advanced economies “do not resort to such gimmicks” such as debt restructuring
and repression, which would “give up hard-earned credibility” and throw the economy
into a “vicious circle”.
SEE GRAPH 1
But the paper says this mantra
borders on “collective amnesia” of European and US history, and is built on
“overly optimistic” assumptions that risk doing far more damage to credibility
in the end. It is causing the crisis to drag on, blocking a lasting solution.
“This denial has led to policies that in some cases risk exacerbating the final
costs,” it said.
While use of debt pooling in the
eurozone can reduce the need for restructuring or defaults, it comes at the
cost of higher burdens for northern taxpayers. This could drag the EMU core
states into a recession and aggravate their own debt and ageing crises. The
clear implication of the IMF paper is that Germany and the creditor core would
do better to bite the bullet on big write-offs immediately rather than buying
time with creeping debt mutualisation.
The paper says the
Western debt burden is now so big that rich states will need same tonic of debt
haircuts, higher inflation and financial repression - defined as an “opaque tax
on savers” - as used in countless IMF rescues for emerging markets.
“The magnitude of the
overall debt problem facing advanced economies today is difficult to overstate.
The current central government debt in advanced economies is approaching a
two-century high-water mark,” they
said.
Most advanced states wrote off
debt in the 1930s, though in different ways. First World War loans from the US
were forgiven when the Hoover Moratorium expired in 1934, giving debt relief
worth 24pc of GDP to France, 22pc to Britain and 19pc to Italy.
SEE table 1
This occurred as part of a
bigger shake-up following the collapse of the war reparations regime on Germany
under the Versailles Treaty. The US itself imposed haircuts on its own
creditors worth 16pc of GDP in April 1933 when it abandoned the Gold Standard.
Financial repression can
take many forms, including capital controls, interest rate caps or the
force-feeding of government debt to captive pension funds and insurance
companies. Some of these methods are already in use but not yet on the scale
seen in the late 1940s and early 1950s as countries resorted to every trick to
tackle their war debts.
The policy is essentially a
confiscation of savings, partly achieved by pushing up inflation while rigging
the system to stop markets taking evasive action. The UK and the US ran
negative real interest rates of -2pc to -4pc for several years after the Second
World War. Real rates in Italy and Australia were -5pc.
Both authors of the paper have
worked for the IMF, Prof Rogoff as chief economist. They became famous for
their best-selling work on sovereign debt crises over the ages, This Time is
Different: Eight Centuries of Financial Folly.
They were later embroiled in
controversy over a paper suggesting that growth slows sharply once public debt
exceeds 90pc of GDP. Critics say it is unclear whether the higher debt is the
problem or whether the causality is the other way around, with slow growth
causing the debt ratio to rise to faster.
The issue became highly
politicised when German finance minister Wolfgang Schauble and EU economics
commissioner Olli Rehn began citing the paper to justify eurozone austerity
policies, over-stepping its more careful claims.
Critics says extreme austerity
without offsetting monetary stimulus is the chief reason why debts have been
spiralling upwards even faster in parts of Southern Europe.
The weaker
eurozone states are particularly vulnerable to default because they no longer
have their own sovereign currencies, putting them in the same position as
emerging countries that borrowed in dollars in the 1980s and 1990s. Even so,
nations have defaulted through history even when they do borrow in their own
currency.
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