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Roubini: Greece debt crisis is only the tip of the iceberg

The Greece debt crisis should be a warning. History shows that unless this buildup of sovereign debt is tackled eventually by raising taxes and controlling spending, then there are only two outcomes: default or high inflation.

By Nouriel Roubini / April 29, 2010

New York University economics professor Nouriel Roubini says that the Greece debt crisis signals much deeper public-sector fiscal liabilities.

Mike Segar/Reuters/File

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Nouriel Roubini, a professor of economics at New York University and chairman of Roubini Global Economics has come to be popularly known as “Dr. Doom” for having predicted the recent financial crisis. He is author of “Crisis Economics: A Crash Course in the Future of Finance.” His comments here, which touch on the Greece debt crisis are adapted from remarks at the Milken Global Conference in Beverly Hills, Calif., on Wednesday, April 28.

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Financial crises have occurred very often in history. They are caused by unsustainable bubbles that go bust, and from excessive risk taking and debt leveraging by the private sector during the bubble. Then, in the wake of, and as part of the response to, the economic downturn, government debts and deficits grow to unsustainable levels that can lead to default or inflation if not corrected. The crisis we are going through now follows this pattern.

Today there is a lot of talk about “deleveraging,” yet the data shows that deleveraging has barely begun. Debt ratios in the corporate sector as well as households in the United States have essentially stabilized at high levels.

At the same time, we are seeing a massive “releveraging” of the public sector with budget deficits on the order of 10 percent of gross domestic product. The International Monetary Fund and Organization for Economic Cooperation and Development are projecting that the stock of public debt in advanced economies is going to double and reach an average level of 100 percent of GDP in the coming years.

This is all actually quite typical of what happens in a financial crisis. What explains this releveraging?

First, “automatic stabilizers” (such as unemployment compensation) came into play during the recession.

Second, countercyclical fiscal policies (such as tax cuts and spending increases) have been implemented by government to avoid depression because private demand is collapsing.

Third, we have decided to socialize some of the private losses in the financial, corporate, and housing sectors and put them on the balance sheet of the government.

So, there is a massive buildup of public debt. And the lesson of history is that unless this buildup of sovereign debt is tackled eventually by raising taxes and controlling spending, then there are only two outcomes: default or high inflation.

Historically, we have seen a series of defaults and sovereign debt crises in both advanced and emerging market economies. If you are a country like the US, the UK, or Japan that can monetize its fiscal deficits, then you won’t have a sovereign debt event but high inflation that erodes the value of public debt. Inflation is therefore basically a capital transfer from creditors and savers to borrowers and dissavers, essentially from the private sector to the government.

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