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Bloomberg News, May 18, 2020
Harvard's Reinhart and Rogoff Say This Time Really Is Different.
(Bloomberg Markets) -- When Carmen Reinhart and Kenneth Rogoff published
their heavyweight history of financial crises in late 2009, the title
was ironic. This Time Is Different: Eight Centuries of Financial Folly
reminded readers that the catastrophic 2008-09 credit crisis was far
from unique. The authors became the go-to experts on the history of
government defaults, recessions, bank runs, currency sell-offs, and
inflationary spikes. Everything seemed to be part of a predictable pattern.
And yet a little more than a decade later, we're experiencing what
appears to be a one-of-a-kind crisis. The Covid-19 pandemic has
catapulted the world into its deepest recession since the Great
Depression, provoking an unprecedented fiscal and monetary response. The
International Monetary Fund is already warning that the outlook has
deteriorated since it predicted in April that the world economy would
shrink 3% this year. To figure out what might be next, Bloomberg Markets
spoke to Reinhart, a former deputy director at the IMF who's now a
professor at the Harvard Kennedy School, and Rogoff, a former IMF chief
economist who's now a professor at Harvard. It turns out this time
really is different.
BLOOMBERG MARKETS: How are you faring during the lockdown?
CARMEN REINHART: My husband and I are among the lucky ones because we
can work from home. We came to Florida, where we've had a house for a
decade. Our son lives in this area. Vincent's brother lives in this
area. So we wanted to be close to family. It's a very busy period even
though you're always at home.
KENNETH ROGOFF: I'm with my wife and 21-year-old daughter in our house
in Cambridge, quarantining, so to speak. It's been a very intense period
partly because I was teaching a lot. And there was the shift to Zoom,
which created more work because you're trying to prepare differently and
do your lectures differently. It's obviously a surreal experience overall.
BM: I will start with the clichéd question. Is this time different?
CR: Yes. Obviously there are a lot of references to the influenza
pandemic of 1918, which, of course, was the deadliest with estimated
worldwide deaths around 50 million—maybe, by some estimates, as many as
100 million. So pandemics are not new. But the policy response to
pandemics that we're seeing is definitely new. If you look at the year
1918, when deaths in the U.S. during the Spanish influenza pandemic
peaked, that's 675,000. Real GDP that year grew 9%. So the dominant
economic model at the time was war production. You really can't use that
experience as any template for this. That's one difference.
It's certainly different from prior pandemics in terms of the economy,
the policy response, the shutdown. The other thing that I like to
highlight that is very different is how sudden this has been. If you
look at U.S. unemployment claims in six weeks, we've had [job losses
that] took 60 weeks in terms of the run-up. If you look at capital flows
to emerging markets, the same story. The reversal in capital flows in
the four weeks ending in March matched the decline during the [2008-09]
global financial crisis, which took a year. So the abruptness and the
widespread shutdowns we had not seen before.
KR: Certainly the global nature of it is different and this highlights
the speed. We have the first global recession crisis really since the
Great Depression. In 2008 it was the rich countries and not the emerging
markets. They [the emerging markets] had a "good" crisis in 2008, but
they're not going to this time, regardless of how the virus hits them.
The policy response is also different. Think about China. Can you
imagine if this had hit 50 years ago? Can you imagine the Chinese state
having the capacity to shut down Hubei province? To feed nearly 60
million people, give them food and water and concentrate medical
attention? So there is a policy option that we have and I think most
countries have. It's the choice that had to be taken to try to protect
ourselves. Obviously, this has been done to differing degrees of
effectiveness in different countries, with Asia reacting much quicker
and with much better near-term outcomes than Europe and the U.S.
BM: How do you regard the economic policy response?
KR: It's a little bit as if you were in a war and saying, "I'm not going
to grade how you're doing on the battlefield. I'm just going to grade
how you're hiring extra workers at home." Obviously how you're doing on
the battlefield is driving everything.
The economic policy response has been massive and absolutely necessary.
You can quibble between the European style of trying to preserve firms
and workers in their current jobs and the U.S. version, which is to try
to address it as a natural catastrophe and try to subsidize people but
allow higher unemployment. They're actually not that different. If this
thing persists, a lot of those European firms will end up having to let
their workers go when the crisis passes. Some of the U.S. firms will end
up rehiring their workers. But certainly the aggressive crisis response
reflects lessons learned in 2008.
BM: Does that explain the stock market surge, which seems at odds with
the state of the economy?
CR: How much of the resilience, if not ebullience, in the market is
policy driven? I think a lot of it. Let's take monetary policy before
the pandemic. U.S. unemployment was at its lowest level since the 1960s.
By most metrics the U.S. was at or near full employment. It's very
possible that the path was toward rising interest rates. Clearly that
has been completely replaced by a view that rates are zero now and that
they're going to stay low for a very long, long, indeterminate period of
time, with a lot of liquidity support from the Federal Reserve. So
that's a big game changer, discounting futures.
Let me just point out another issue in terms of the policy response. The
Fed has established a lot of facilities that are now providing support
not only to corporates, but to the fallen angels, the riskier corporates
that certainly were not envisioned at the outset of the pandemic. What
this does mean is that the market is really counting on a lot of
rescues. The blanket coverage by the Fed is broad, and that is driving
the market. And expectations are that we're going to have this nice
V-shaped recovery and life is going to return to normal as we knew it
before the pandemic. And my own view is that neither of those are likely
to be true. The recovery is unlikely to be V-shaped, and we're unlikely
to return to the pre-pandemic world. Although I do think that that's
part of the reason why we see this incongruence between the economic
numbers and what the market is doing.
KR: Of course, the "Fed lower forever" is part of it. I also feel the
markets have a very sanguine view of the virus and what's going to
happen and how quickly we can return to normal or maybe how quickly we
will choose to return to whatever normal is. It seems very uncertain to
me. I don't know how we're coming back to 2019 levels [in the economy]
in any near term. The true fall in GDP, economic historians will debate
for years. It's probably much larger than the measured fall. It's not
just the people not working. What's the efficiency of the people who are
working? The monetary response has been done hand in hand with the
Treasury. The market is banking on this V-shaped recovery. But a lot of
the firms aren't coming back. I think we're going to see a lot of work
for bankruptcy lawyers going across a lot of industries.
BM: So what does the economic recovery look like?
CR: There is talk on whether it's going to be a W-shape if there's a
second wave and so on. That's a very real possibility given past
pandemics and if there's no vaccine. One thing that's clear is the
numbers are going to look spectacularly great in some months simply
because you're coming out from a base that was pretty devastated. That
doesn't imply that per capita incomes are going to go back in V-shape to
what they were before.
The shock has disrupted supply chains globally and trade big-time. The
World Trade Organization tells you trade can decline anywhere between
13% and 32%. I don't think you just break and re-create supply chains at
the drop of a hat. There are a lot of geographic changes that are being
necessitated because, if the economic downturn has been synchronous, the
disease itself hasn't been synchronous.
Another reason I think the V-shape story is dubious is that we're all
living in economies that have a hugely important service component. How
do we know which retailers are going to come back? Which restaurants are
going to come back? Cinemas? When this crisis began to morph from a
medical problem into a financial crisis, then it was clear we were going
to have more hysteresis, longer-lived effects.
KR: In our book, Carmen and I use the definition of recovery as going
back to the same income as the beginning. That, by the way, is really
not the Wall Street definition of recovery, where recovery is going back
to where the trend was. So we use a much more modest version of
recovery. And still, with postwar financial crises before 2008-09, the
average was four years, and for the Great Depression, 10 years. And
there are many ways this feels more like the Great Depression.
And you want to talk about a negative productivity shock, too. The
biggest positive productivity shock we've had over the last 40 years has
been globalization together with technology. And I think if you take
away the globalization, you probably take away some of the technology.
So that affects not just trade, but movements and people. And then there
are the socio-political ramifications. I liken the incident we're in to
The Wizard of Oz, where Dorothy got sucked up in the tornado with her
house, and it's spinning around, and you don't know where it will come
down. That's where our social, political, economic system is at the
moment. There's a lot of uncertainty, and it's probably not in the
pro-growth direction.
Also you probably need a debt moratorium that's fairly widespread for
emerging markets and developing economies. As an analogy, the IMF or
Chapter 11 bankruptcy is very good at dealing with a couple of countries
or a couple of firms at a time. But just as the hospitals can't handle
all the Covid-19 patients showing up in the same week, neither can our
bankruptcy system and neither can the international financial institutions.
So there are going to be phenomenal frictions coming out of this wave of
bankruptcies, defaults. It's probably going to be, at best, a U-shaped
recovery. And I don't know how long it's going to take us to get back to
the 2019 per capita GDP. I would say, looking at it now, five years
would seem like a good outcome out of this.
BM: I'd like to focus on the debt issue. The Group of 20 has already
agreed to freeze bilateral government loan repayments for low-income
nations until the end of 2020. How else do we deal with what developing
and emerging economies owe?
CR: The problem in emerging markets goes beyond the poorest countries.
For many emerging markets, we've also had a massive, massive oil shock.
Nigeria, Ecuador, Colombia, Mexico—they've all been downgraded. So the
hit to emerging markets is just very broad. Nigeria is in terrible
shape. South Africa is in terrible shape. Turkey is in terrible shape.
Ecuador already is in default status, as well as Argentina. These are
big emerging markets. It's going to be enormously costly.
For the G-20 initiative, I indeed hope it is the G-20 and not just the
G-19. China needs to be on board with debt relief. That's a big issue.
The largest official creditor by far is China. If China is not fully on
board on granting debt relief, then the initiative is going to offer
little or no relief. If the savings are just going to be used to repay
debts to China, well, that would be a tragedy.
We've not mentioned Italy, and that brings us to the euro zone. This is
very, very destructive within the euro zone. If it drags on, the forces
that are pulling the euro zone apart are going to grow stronger and
stronger.
BM: What is the appetite at the IMF for coming to the rescue?
KR: The IMF at this point is all-in on trying to find a debt moratorium,
recognizing there's going to be restructuring in a lot of places. But I
don't think the U.S. is by any means all-in, and a lot of the contracts
of the private sector are governed under U.S. law. And if the U.S.
government is not in, if China's not in, it's not really enough. But
it's far easier to go the route of the G-20. If the G-20 says it's in
the global interest that debt moratoria be widely respected by all
creditors for the next year, then that carries a lot of force, even in
U.S. courts. But if they don't say that, and every country's left on its
own to work something out, I think we get back to my Covid-19 hospital
analogy where the system just gets overwhelmed.
BM: What about the debts in the major economies, given they have been
run up so aggressively?
KR: It's not a free lunch, but there was no choice. This is like war.
There is no debate that they should be doing all they can to try to
maintain political and social cohesion, to maintain economies. But what
lies at the other end? I go back to my Wizard of Oz analogy. The
financial markets think there's no chance interest rates will go up.
There is no chance inflation will go up. If they're right, and if
another shoe doesn't drop, it'll be fine. But we could have costs from
this. We're talking about economies shrinking by 25% to 30%. And those
[declines] are just staggering compared to the debt burden costs,
whatever they are. So certainly we would strongly endorse doing what
governments are doing. But selling it as a free lunch, that's
stupefyingly naive.
CR: I actually wanted to go back to the Italy issue. If you look back to
2008-09, nearly everybody had a banking crisis. But a couple of years
later, the focus had moved from the banking problem to the debt problem.
And it was the peripheral Europe debt problem with Portugal, Ireland,
Iceland—most notoriously Greece—having the largest, by a huge margin,
IMF programs in history. I would point out that Greece, Ireland, and
Portugal combined are a little over a third of Italian GDP. And if
there's a shakeout that involves concerns about Italy's growth, then we
could have a transition again from the focus on the Covid-19 crisis this
time to a debt crisis. But Italy, as I said, is on a different scale
than the peripheral countries that got into the biggest trouble in the
last crisis. It potentially also envelops Spain. So I think that if you
were to ask me about an advanced economy debt issue, I think that is
where it is most at the forefront.
KR: We argued at the time that the right recipe was to involve
writedowns of the southern European debts. And I think that would have
been cheap money in terms of restoring growth in the euro zone and would
have [been] paid back. And we may be at that same juncture in another
couple of years where you're looking at just staggering austerity in
Spain and Italy on top of a period of staggering hardship. Advanced
countries have done this all the time—finding some sort of debt
restructuring or writedown to give them fiscal space again, to support
growth again. If the euro zone doesn't find a way to deal with this,
maybe eurobonds might be in the picture to try to indirectly provide
support. Again, we're going to see huge forces pulling apart the euro zone.
BM: What about China, which also has leverage challenges?
CR: Chinese growth has always been very outward-looking, very propelled
by export-led growth. You've also had much of its double-digit growth
come from incredible fixed investment. So I think the settling point for
Chinese growth is going to be well below 6%. I'm not saying they're not
going to have a rebound after the more than 20% crash at the beginning
of this year. But I'm saying that then your settling point is going to
be lower than 6%. And part of the story is debt. It's hard to say in
China what is public and what is private, but corporates in China
levered up significantly, expecting that they were going to continue to
grow at double digits forever. That hasn't materialized. There's
overcapacity in a lot of industries.
China came into this with inflation running over 5% because of the huge
spike in pork prices. So I think initially that the PBOC [People's Bank
of China] has been somewhat constrained initially in doing their usual
big credit stimulus by uncertainty over their inflation. I think that's
changing because of the collapse in oil price. So I do think we are
going to see more stimulus from China.
KR: There will be a pretty sustained growth slowdown in China. We were
on track for that anyway. But who can they export to? The rest of the
world is going to be in recession. I think if they can average 1% growth
the next two, three years, then that will look good. That's not a bad
prediction for China. And let's remember, their population dynamic is
completely changing. So 3% growth in that, with that Europeanizing of
their population dynamics, would not be bad at all. But there's a
big-picture question about their huge centralization, which is clearly
an advantage in dealing with the national crisis but maybe doesn't
provide the flexibility over the long term to get the dynamism that at
least you've got in the U.S. economy.
BM: How does central banking change worldwide? Do we see that blurring
of lines with fiscal policy?
KR: It's fiscal policy that they're doing in this emergency situation.
You can't imagine trying to get these same subsidies passed through the
Senate and the House in real time. So central banks all over the world
are using the fiscal side of their balance sheet. A lot of people don't
properly understand that governments own the central banks. And when the
central bank uses its balance sheet, it's acting as an agent on behalf
of the government, whether it's doing maturity transformation, which is
what pure quantitative easing is, when it buys long-term debt, [or] it's
doing subsidies to the private sector by buying mortgages, by
intervening in corporate debt, by intervening in municipals.
Ultimately I hope we don't see a big change in central banks, but we're
probably going to need an expansion in finance ministries to take on and
regularize and legitimize some of these responsibilities. Lastly I think
we're not in a position to use deeply negative interest rates because
the preparation hasn't been done. And you have to deal with cash
hoarding. That's a shame because I think that would have been a valuable
instrument, and would have been helpful for some municipals and
corporates, and would have reduced the number of patients going into
bankruptcy court. Monetary policy is essentially castrated by the zero
bound.
CR: Central banks were the arm of financing during two world wars,
without question. I think you would have been laughed at if you really
brought up the issue of central bank independence in the context of
either world war. You really can't separate the fiscal story and the
debt story from the monetary story in extreme periods. Central banks
began to do fiscal policy not just this time around, but they began to
do fiscal policy in the 2008-09 crisis. We really can't look
independently at central banks without also looking at the balance
sheet, not just of the government, but the balance sheet of the private
sector, which has a lot of contingent liabilities.
On the issue of negative interest rates, I do not share Ken's views on
that particular matter. When you have, as we do today, very fragmented
markets, markets that became totally illiquid, I think the way I would
deal with that would not be through making rates more negative, but by
an approach closer to the one taken by the Fed, which is through a
variety of facilities that provide directed credit. Sustained negative
interest rates in Europe have led to a lot of bank disintermediation.
And often bank disintermediation means that you end up with the less
regulated, less desirable financial institutions.
BM: There is some question over the future path of inflation. Do you see
an inflationary surge at some point?
KR: We don't know where we will come out. So the probability is, for the
foreseeable future, we'll have deflation. But at the end of this, I
think we're going to have experienced an extremely negative productivity
shock with deglobalization. In terms of growth and productivity, they
will be lasting negative shocks, and demand may come back. And then you
have the many forces that have led to very low inflation maybe going
into reverse, either because of deglobalization or because workers will
strengthen their rights. The market sees essentially zero chance of ever
having inflation again. And I think that's very wrong.
BM: And what scars are left on economies once the pandemic passes?
CR: Some of the scars are on supply chains. I don't think we'll return
to their precrisis normal. We're going to see a lot of risk aversion.
We'll be more inward-looking, self-sufficient in medical supplies,
self-sufficient in food. If you look at some of the legacies of the big
crises, those have all seen fixed investment ratchet down and often stay
down.
Kennedy is executive editor for Bloomberg Economics in London.
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