Bloomberg carried an excellent story about Ken Rogoff and his view of how the sovereign debt problems will ultimately be worked out. As you read it, you have to keep in mind that Mr. Rogoff was the former chief economist of the International Monetary Fund and thus has had a front-row seat to numerous sovereign defaults in the past. In addition, he and Carmen Reinhart wrote what is certainly the most data-heavy treatment of the last 800 years of financial crises and their aftermath, This Time is Different.
Rogoff was speaking at a conference in Tokyo and painted a bleak picture for sovereign debt.
Following banking crises, “we usually see a bunch of sovereign defaults, say in a few years,” Rogoff, a former chief economist at the International Monetary Fund, said at a forum in Tokyo yesterday. “I predict we will again.”
The U.S. is likely to tighten monetary policy before cutting government spending, sending “shockwaves” through financial markets, Rogoff said in an interview after the speech. Fiscal policy won’t be curbed until soaring bond yields trigger “very painful” tax increases and spending cuts, he said.
On the other hand, he suggests that a little inflation might not be so bad given the alternatives.
“Most countries have reached a point where it would be much wiser to phase out fiscal stimulus,” said Rogoff, who co- wrote a history of financial crises published in 2009. It would be better “to keep monetary policy soft and start gradually tightening fiscal policy even if it meant some inflation.”
It’s hard to know how U.S. policymakers will handle the situation, but it is clear that this business cycle is perhaps unusual because of the large buildup of debt in the system. In situations like that, often things happen in an unforeseen way. In the battle for investment survival, now more than ever, it may be important to be able to tactically allocate around the globe.
[...] Ken Rogoff and Carmen Reinhart have written about previous debt-fueled fiscal crises. In almost all of them, bailouts were initially required, followed by austerity. If austerity was not imposed, eventually there was some type of default, through partial repudiation of some obligations (like cutting Social Security or state pensions, for example), through inflation, or through outright default. [...]