The Telegraph has an artcle this morning on a new paper for the IMF from Harvard professors Carmen Reinhart and Kenneth Rogoff. Now these two have an unfortunate reputation as a result of a simple Excel error, but I am assuming they have got the data right this time (you somehow expect that they might have improved the quality control now). In that case this graph is telling:
That's a debt balloon if ever there was one. And, if I read the Telegraph's interpretation of the paper correctly (I stress, in fairness, that I have not read the original in full, at least as yet) then what Reinhart and Rogoff are actually saying is that one person's debt is another one's asset (a simple point, often overlooked) and that the only way out of this debt crisis is for some people, somewhere, and preferably sometime soon, to take a haircut on their asset values. More formally, in the abstract they say:
Even after one of the most severe multi-year crises on record in the advanced economies, the received wisdom in policy circles clings to the notion that high-income countries are completely different from their emerging market counterparts. The current phase of the official policy approach is predicated on the assumption that debt sustainability can be achieved through a mix of austerity, forbearance and growth. The claim is that advanced countries do not need to resort to the standard toolkit of emerging markets, including debt restructurings and conversions, higher inflation, capital controls and other forms of financial repression. As we document, this claim is at odds with the historical track record of most advanced economies, where debt restructuring or conversions, financial repression, and a tolerance for higher inflation, or a combination of these were an integral part of the resolution of significant past debt overhangs.
Instinctively I want to recoil at that: the idea that the draconian measures imposed by the IMF ion emerging economies should be considered appropriate makes anyone who has witnessed their destructive impact over the last thirty years want to protest, immediately.
But I'm not so sure that these two have not got a point this time. First, one of the very reasons that we recoiled at the harsh treatment of developing countries was that this treatment was so arbitrarily meted out to them alone.
Second, there was the problem that much of the process in those countries was imposed very unjustly: the impact was imposed on ordinary people who had not been involved in any decision to assume the debt burden in the first place and had not benefited from it.
Third, the solution was too often imposed without sufficiently curtailing the claims made externally upon the economy in question.
These three reasons made IMF debt adjustment programmes appear inappropriately harsh precisely because they were.
But Reinhart and Rogoff are right: if developing economies now have a debt problem they also face the problem of having unsustainable asset valuations and there is no way on that basis that we can get out of such massive debt problems without those who own our wealth taking a haircut because austerity is not working, real growth in incomes for the vast majority is not happening (we are suffering another asset bubble instead) and wealth inequality based on accumulating piles of cash, debt and other property rights that actually are not invested and do not generate any real wealth but simply reallocate the existing resources is increasing.
So, of the Rienhart and Rogoff options to solving this, which include 'debt restructurings and conversions, higher inflation, capital controls and other forms of financial repression' which do we choose?
As long term readers of this blog will know, I have always been relaxed about more inflation. Inflation was the basis of the baby-boomers wealth as their property debts were written off by inflation that meant they never had to really repay their mortgages. If inflation now adjusts the resulting imbalance in favour of the next generation bay boomers can hardly complain. I think it inevitable. I said so in my paper on pensions, entitled 'Making Pensions Work'.
I have also argued in The Courageous State in favour of capital controls: how else can a country be in control of its economy?
In addition, in Making Pensions Work I argued that pension funds should be required to invest at least 25% of all new funds the receive in assets directly related to creating employment as a condition of obtaining tax relief. Hypothecated government debt for the creation of infrastructure is the obvious way to achieve that goal. I remain of the view that this is entirely reasonable.
However, none of these things will be as powerful as 'other forms of financial repression', of which Rienhart and Rogoff say:
“Financial repression” includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and generally a tighter connection between government and banks.
They refer to this as a form of tax.
And that's precisely where they miss a trick - probably because of their own ideological bias. If we need a tax let's have a tax. Let's have a wealth tax. Greg Philo has recommended a simple and maybe crude form of tax to achieve exactly the goal Reinhart and Rogoff set out to achieve. I suspect some refinement will be needed to that idea, but as Reinhart and Rogoff note, any tax has distortionary effect; we just have to decide now what is the lesser of the evils available.
The truth is that there is too much debt in too many economies and that debt is the corollary of excess wealth for a few, whether they be individuals or corporations. This issue has to be resolved if there is to be a stable macro-economic future and wealth taxes are, at a micro level, a necessary response to this crisis. The questions is the form that they will take.
That is an issue I hope to spend some time on this year: the grant application is in.