A Decade of Debt

Carmen M. Reinhart

Harvard University

Universidad del País Vasco

November 15, 2013

Reinhart

The challenges of global setting

in the sixth year after the crisis

The advanced economies: Public and

private debt overhang, deleveraging, lower

growth and persistent high unemployment

The emerging markets: Large capital inflows

and their recent reversals, inflationary

pressures, bubble and crisis risks

Reinhart Reinhart 3 Reinhart 3

Preamble and definition:

Financial repression

… includes directed lending to government

by captive domestic audiences (such as

pension funds), explicit or implicit caps on

interest rates, heavier regulation (including

of cross-border capital movements, i.e.

capital controls), and (generally) a tighter

connection between government and banks.

It is a tax on bondholders and more generally

savers…

Reinhart

Financial de-globalization

since the crisis

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Banking Crises, Financial Globalization

and Its Reversals: 1870-2013

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Per

cen

t

Inde

x

2013

Capital Mobility

0 to 1 Index

(left scale)

Share of CountriesBanking Crisis-

first year

3-year Sum(right scale)

1914

1945

1980

2006

1918

High

Low

Gold Standard--heyday of

financial globalization

WWI

capital

controls

The Great Globalization

Crisis,

depression

and WWII

The era of

financial repression

1931

Reinhart

Where are the advanced

economies in the current

conjuncture?

Reinhart Reinhart 7 7 7

Real per capita GDP growth

Real per capita GDP growth rates are

significantly lower during the decade

following severe financial crises and the

synchronous world-wide shocks.

The median post-financial crisis GDP

growth decline in advanced economies is

about 1 percent.

(from about 3.1 to 2.1 percent per annum)

Reinhart Reinhart 8

In 7 of 15 episodes there was a

double dip

Reinhart Reinhart 9 9 9

Unemployment rates

In the ten-year window following severe

financial crises, unemployment rates are

significantly higher than in the decade that

preceded the crisis.

The rise in unemployment is most marked for

the five advanced economies, where the

median unemployment rate is about 5

percentage points higher.

(from 2.7 to 7.9 percent)

Reinhart Reinhart 10 10

Unemployment Rate in the Decade Before and the

Decade After Severe Financial Crises: Post-WWII,

Advanced Economies

Probability density function, five advanced economies

Big five: Spain, 1977; Norway, 1987;

Finland, 1991; Sweden, 1991, Japan 1992

t-10 to t-1 t+1 to t+10

median 2.7 7.9

min 1.1 2.5

max 6.1 21.2

obs. 50 50

0

5

10

15

20

25

30

35

40

45

50

1 3 4 6 7 9 10 12 13 15 16 18 19 21 22

Unemployment rate, percent

Pre-crisis, (t-10 to t-1)

Post-crisis (t+1 to t+10)

Reinhart Reinhart 11 11 11

In ten of the fifteen post-crisis episodes,

unemployment has not fallen back to its

pre-crisis level, not in the decade that

followed…

This was also the case for past systemic

crises in the US.

Post 2008 is the third peak in

public debt—the two previous

episodes (especially post WWII)

were marked by a lengthy

period of negative interest rates.

Reinhart

Public debt as a percent of GDP:

Advanced Economies: 1900-2013

0

10

20

30

40

50

60

70

80

90

100

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Unweighted Average

Advanced economies

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Gross external total debt (public

plus private) is in uncharted

territory….deleveraging,

especially in Europe, has been

halting.

For a contrast in external

deleveraging—see post crisis Asia

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Gross Total (Public plus Private) External Debt as a

Percent of GDP: 22 Advanced and 25 Emerging

Market Economies, 1970-2013:Q1

15

0

50

100

150

200

250

300

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

Unweighted Average

Advanced Economies

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External Total (Public plus Private) External Debt:

Six Asian Economies, 1970-2013:Q1

(percent of GDP)

Reinhart

15

25

35

45

55

65

75

85

1970 1975 1980 1985 1990 1995 2000 2005 2010

Banking crises in at least three

countries (shaded)

Average for India, Indonesia,

Korea, Malaysia, Philippines,

and Thailand

Percent

Sources: International Monetary Fund, World Economic Outlook, Reinhart and Rogoff (2009), Reinhart (2010), World Bank

(2013), International Debt Statistics, Washington DC http://data.worldbank.org/data-catalog/international-debt-statistics,

and World Bank, Quarterly External Debt Statistics, (QEDS),

http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/EXTDECQEDS/0,,menuPK:1805431~pagePK:64168

427~piPK:64168435~theSitePK:1805415,00.html

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Domestic private indebtedness

indicators point to a

comparable internal debt

overhang. Private debts migrate

to the public sector balance

sheet…

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Private Domestic Credit as a Percent of GDP:

Advanced Economies, 1950-2013: August

18

40

60

80

100

120

140

160

180

1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

Unweighted Average

Advanced Economies

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Domestic Credit to the Private

Sector, Six Asian Economies 1955-2013:Q2

(as a percent of GDP)

Reinhart

15

35

55

75

95

115

135

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Banking crises in at least three

countries (shaded)

Average for India, Indonesia,

Korea, Malaysia, Philippines,

and Thailand

Percent

Reinhart

Throughout history, debt/GDP ratios have been

reduced by:

(i) economic growth;

(ii) fiscal adjustment/austerity;

(iii) explicit default or restructuring;

(iv) a sudden surprise burst in inflation; and

(v) a steady dosage of financial repression that is

accompanied by an equally steady dosage of

inflation.

(Options (iv) and (v) are only viable for domestic-

currency debts).

The first of these is relatively

rare and the rest are difficult.

Reinhart

Reinhart

Crisis Resolution: How different are

advanced economies and emerging

markets???

Not as much as widely believed.

There is an extensive “forgotten”

history of pre-WWII credit events

in advanced economies (default,

restructurings, conversions and

other forms of confiscation…)

Reinhart Reinhart 23

Debt relief (based on haircuts) as a percent of GDP

55.6

43.4

41.6

36.2

35.6

34.3

31.2

24.4

24.2

24.0

22.9

22.2

22.1

21.6

19.1

18.5

16.6

15.7

15.1

14.3

14.2

13.8

13.3

12.0

11.3

10.2

9.2

8.9

8.1

5.3

3.3

2.9

2.1

2.1

1.7

1.6

Bulgaria, 1990-1994

CostaRica, 1983-1990

Venezuela, 1983-1990

Mexico, 1982-1990

Chile, 1983-1990

Uruguay, 1983-1991

Ecuador, 1982-1995

Jamaica, 1978-1993

France, 1934

Argentina, 1982-1993

Panama, 1983-1996

United Kingdom, 1934

Bosnia and Herzegovina

Dominica, 2003-2005

Italy, 1934

Seychelles, 2008-2010

United States, 1933

Average EMs 1978-2010

Poland. 1981-1986

Brazil, 1983-1994

Argentina, 2001-2005

Peru. 1980-1997

Dominican Rep., 1982-1994

Ecuador, 1999-2000

Russia, 1991-2000

Grenada, 2004-2005

South Africa, 1985-1993

Greece, 1934

Serbia & Montenegro, 2003-2004

Jordan, 1989-1993

Belgium, 1934

Ecuador, 2008-2009

Macedonia, 1992-1997

Uruguay, 2003

Austria, 1934

Trinidad & Tobago, 1988-1989

Reinhart

A global issue

The return of financial

repression?

Reinhart Reinhart 25

Financial repression as a tool for

public debt reduction

In the heavily regulated financial markets of

the Bretton Woods, restrictions facilitated a

sharp and rapid reduction in public

debt/GDP ratios from the late 1940s to the

1970s.

Low nominal interest rates reduced debt

servicing costs while a high incidence of

negative real interest rates liquidated the

real value of government debt.

Reinhart Reinhart 26 26

Real Interest Rates Frequency Distributions:

Advanced Economies, 1945-2012

26

1945-1980 1981-2007 2008-2012

0 46.9 9.1 53.2

1 percent 61.6 20.8 87.1

2 percent 78.6 33.3 96.8

3 percent 88.6 52.1 100.0

Real interest rates

Share of observations at or below

0

5

10

15

20

25

30

35

40

-10 -8 -6 -4 -2 0 2 4 6 8 10

1945-1980 1981-2007 2008-2012

Official Holdings of United States Marketable

Treasury Debt, 1945-2013:Q2 (as a percent of total marketable debt outstanding)

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0

10

20

30

40

50

60

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Share of "Marketable Treasury

Securities Held by Foreign Official Intitutions

(i.e. central banks)

Share of Marketable

Treasury Securities held

by All Official

Institutions

The difference between

Total and Foreign is the

Share Held by the

Federal Reserve

Percent

Reinhart

The Re-emergence of Financial Repression, 2008-2011

France, December 2010: Liquidation of Fonds de Reserve Pour Les Retraites (FFR) The French

government changed the law to shift the €37bn FFR from providing long-term financial support to the

French PAYG pension system after 2020 to instead pay an annual €2.1bn to the Caisse d’Amortissement de

la Dette Sociale (CADES) from 2011 to 2024 and at that point transfer all remaining assets to the CADES

in one lump-sum payment. This shift in FFR’s investment horizon has meant a radical shift in asset

allocation from longer-term diversified riskier assets to a short-term LDI-strategy dominated by liability

matching short-term French government bonds. For the duration of its lifespan the FRR has consequently

been transformed into a large captive buyer of French government bonds.

Ireland, 2010: Use of the National Pension Reserve Fund to Recapitalize Banks As a result of the banking

crisis, Ireland National Pension Reserve Fund (NPRF) may have to contribute up to €17.5bn to recapitalize

Ireland’s banks. The NPRF was originally set up in 2001 to help finance the long-term costs of Ireland's

social welfare and public service pensions from 2025 onwards. However, a 2010 law directed the NPRF to

invest in Irish government securities and provides the legal authority for the Irish government to fund

capital expenditure from the NPRF from 2011-2013.

April 2011: Levy on pension funds. The Irish government has further recently suggested to fund job

creation schemes through a special 0.5% levy on private pension funds.

Japan, March 2010: Reversal of Post Privatization and Raising of Deposit Ceiling The new DPJ

government reversed the 2007 plan to privatize Japan Post, the world’s largest financial conglomerate with

more than ¥300tr in assets. Crucially, the DPJ government with the new law also doubled the deposit cap at

Japan Post Bank to ¥20mn and raised the life insurance coverage limit at Japan Post Insurance Co. from

¥13mn to ¥25mn. Given Japan Post’s traditional roughly 75 percent asset allocation to JGBs, and under the

assumption that consumers will transfer deposits to a company certain to enjoy a government guarantee, the

reversal of the Japan Post privatization provides additional incentives to a captive customer of Japanese

government debt.

Reinhart

Portugal, 2010: The transfer of the previously privatized Portugal Telecom pension scheme back to the

Portuguese government, which in the process immediately booked €2.8bn (1.6% of GDP) in extra

revenues. This enabled the Portuguese government to improve its budget deficit in 2010 sufficiently

to cosmetically appear to be in line with annual EU deficit reduction targets.

Spain, April 2010: Interest rate ceilings on deposits. The Ministry of Finance (MoF) requires that

institutions offering deposit interest rates that are considered to be above market rates (determined

by MoF) double their contributions to the Fondo de Garantía de Depósitos.

UK, October 2009, UK Financial Services Authority (FSA) puts a global regulatory liquidity marker. The

proposal by the FSA requires UK banks, investment banks, and subsidiaries or branches of foreign

banks operating in the London market to hold more high quality government securities—at least

around ₤110 billion more (at that time), and cut their reliance on short-term funding by 20 percent

in the first year alone. 2011? Royal Mail privatization, which will see an expected £23.5bn in assets transferred to the UK

treasury ahead of privatization (as well as an expected £29.5bn in liabilities).

Reinhart

Fed proposes new liquidity rules

for banks

October 24, 2013

In emerging markets, financial

repression has been manifested in

steadily rising reserve requirements

(to sterilize inflows) and “prudential

measures” to reduce inflows.

Controls on outflows have just

begun to re-emerge…

Reinhart

Questions and

discussion

Reinhart