Major economies must heed Greece lesson, says Reinhart

Major economies need to “come to terms with their debt” if they are to avoid the problems afflicting Greece, a leading economist has warned.

As fears grow over the risk of a sovereign default in the Eurozone, Carmen Reinhart, director of the Center for International Economics at the University of Maryland, said the UK, the US, Japan, France and Germany need to reduce their budget deficits to ward off investor concerns over debt sustainability.

She even raised the spectre of a stagflation environment – similar to that experienced in the 1970s – if decisive action is not taken.

“People should be worrying about these issues today,” she says. “You need to give people the confidence these deficits will be checked down the road by some well-designed game plan. Not having a plan at this stage to exit [from inflated levels of debt] is a real danger.

“We might not end up like Greece but you could very easily envision a scenario like we had in the 1970s, a stagflation environment, and that’s not appealing even if you don’t get to the most extreme credit problem scenario,” she adds.

In 2008, Reinhart collaborated with Harvard professor Kenneth Rogoff to research the historical precedents for sovereign defaults in the wake of economic crises. Their work has assumed additional importance since late last year, following growing concerns over sovereign default risk in Greece and other southern European countries.

Reinhart says the current situation echoes that of the 1930s, when a number of sovereign defaults – including Greece in 1932 – occurred during the Great Depression. She believes a number of defaults are likely in the short term, albeit not necessarily of the kind seen in Argentina in 2001, when the country suspended payment on almost $100 billion of public debt.

A restructuring of debt, resulting in a “partial default”, is the most probable outcome in most cases. “I think we need to see restructurings, both private and public,” she says. “I also think we will see ‘under the rug’ restructurings – and therefore partial defaults – which happen when governments faced with reduced demand for their debt start to cram the debts down the throats of pension funds and banks, and regulate them in such a way that they have to hold the debt, even though it may not pay market interest rates.”

Reinhart also offered some historical context to fears over a double-dip recession. She believes the prospect, though unlikely, must be taken seriously.

“In most of the post-World War II economic crises major currencies, like in the UK, experienced a big depreciation that helped exports. But one thing that helped exports enormously was that these countries were having a crisis that was either unique to them or, at worst, unique to the region. At the time, they were not global crises, so conditions from abroad helped pull you out of it. And those conditions are not present here. So you cannot take lightly a scenario that involves a double-dip.”

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