David R. Francis

An 800-year history lesson: big debts, long recovery

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    Kenneth Rogoff, a Harvard economist and author of "This Time is Different - Eight Centuries of Financial Folly," speaks at a conference in Copenhagen, Denmark, Oct. 10, 2009.
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If the past can foretell the future, a recent book on 800 years of financial crises is rather scary. It suggests that the United States and other countries will emerge only slowly from what is often dubbed the “great recession.”

The stock market will take two to three years to get back to its peak before the crisis, the book reckons. Employment will need more than four years to creep back. House prices will need seven to 10 years to return to their earlier level.

That’s a slow-growth scenario that could make the “jobless recovery” of the last recession look benign.

Over the past two centuries, financial crises have been followed within two or three years by a wave of sovereign debt crises, often bond defaults. Nations have piled up too much debt and have trouble paying back their bondholders.

That’s the case today with Greece, notes Kenneth Rogoff, one author of the book and a Harvard University economist.

Financial markets fear similar troubles could flare up in Portugal, Ireland, Italy, and Spain.

Economists, of course, are not famed in general for forecasting accuracy. But so far, says Professor Rogoff, the numbers derived from this analysis of history are “on track.”

Looking at postwar financial crises globally, the mean jump in the unemployment rate was to 11 percent. It reached 10.2 percent in the US. The average fall in housing prices was 33 percent; 36 percent in the US. Stock prices dropped 56 percent on average, just what they did in the US. “It has just been uncanny,” says Rogoff who, with Carmen Reinhart of the University of Maryland, College Park, examined crises in 66 countries for their book, “This Time Is Different – Eight Centuries of Financial Folly.”

Their findings have relevance to current policy debates in Washington, Rogoff adds. He holds that the Obama administration was warranted in pushing a stimulus plan through Congress a year ago. If it hadn’t, the recession “could have been worse.”

That said, it is “probably time” to start (emphasis on start) unwinding the stimulus, he adds.

One element of the Reinhart-Rogoff study grasped keenly by conservatives is its warning that excessive debt damages an economy. On average, Rogoff says public debt rises to 86 percent of gross domestic product (GDP) three years after a financial crisis. If that level reaches 90 to 100 percent, the nation’s growth rate slows down by

1 percent for years, he warns. That is not good.

Federal debt under the Obama budget will exceed 100 percent by 2019, with debt growing “unsustainably” faster than GDP, notes Lacy Hunt, an economist with Hoisington Investment Management Co. in Austin, Texas. Other conclusions Mr. Hunt finds in the crisis study:

  • Once debt becomes excessive, countries must go through time-consuming and often painful debt repayment and increased saving. They can’t merely grow out of the problem.
  • With excessive debt, it’s not critical whether it’s owed to other nations or owed internally.
  • Extreme debt damages not just total output, but also labor markets and prices of assets, such as financial investments.

Some countries have dealt with debt overhangs by inflating their currency. In the US, Hunt sees deflation as the greater risk currently. “Employing those who are out of work and fully utilizing our resources will be a slow process,” he says.

He sees stimulus plans as possibly a “transitory benefit,” but not for long. They just pile up debt. They “work against you,” he says.

David R. Francis writes a weekly column.

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