Feed on

I am reading Reinhart and Rogoff’s excellent book on financial crises. In it, they point out that emerging markets suffer from what they call “debt intolerance” – you can get into serious troubles even when you are running what seem to be low levels of debt. To illustrate they show that 50% of defaults on sovereign debt since World War II occurred in countries with debt to GDP ratios that would have met the Maastricht Criteria.

What criteria might that be? It was thought that debt to GDP levels lower than 60% were safe enough for countries to join the EU. What is the U.S. level of debt to GDP right now? It is 67% if you only count the debt the U.S. federal government owes to people other than itself. In Obama’s responsible 2010 budget, the total debt to GDP ratio is over 94%. And this is not exactly expected to shrink any time soon. See tomorrow’s post for an insight into why.

But we are the U.S. – we could never face a sovereign debt crisis? We would never default on our debt, right? By the way, there are two ways to default. One is an outright repudiation of our liabilities – this seems unlikely. The other way is even more sinister, because it is less transparent. We can simply “print” the money to pay off the debts. In a world of competing private currency issuers, this latter option would not really be available to the central bank.

My point? If you read the book, a lesson that jumps out from studying hundreds of years of economic crises is that there are far more similarities between rich and poor countries than differences when it comes to major economic crises. Just because the defaults I discuss above happened in poor countries does not mean that they could not happen in rich ones. I don’t have a probability on this – but if I were a betting man, I would certainly wager that there is a 5% chance of a serious U.S. default. Compare that to how corporate and municipal bonds are rated and you would find that my estimate might very well be on the low side.

2 Responses to “It Can’t Happen to U.S.”

  1. Harry says:

    You broke the code, Mike.let me get to my computer.

  2. Harry says:

    Our debt is denominated in dollars, right? We will never default in dollars. We will not have to resort to the relatively expensive process of printing Federal Reserve notes. Rather someone at Treasury will punch a button, probably often, to create more “notes.”

    Thus will we be reduced to Weimar Germany a mere eighty or so years ago.

    I hope we will not be reduced to such shambles.

    The only alternative is to debase the currency, which will rob you and me, unless interest rates rise to compensate savers. I’ve seen this movie before.

    I have never been sympathetic to the ChiComs, but they have a point. I hope they hold out for, say, 6% for their 5-year treasury paper, and even then I would call them suckers.

    For a while, I’m staying short in maturity, but we all have to run for the door eventually.

Leave a Reply