“More debt restructurings in the euro area are most likely” — Kenneth Rogoff

Kenneth Rogoff, professor of the Department of Economics of Harvard University is surprised by the amount of time spent by the euro area to call upon more diverse solutions to solve the wave of public debt crises in the “peripheral” countries. Europe’s “slowness” is highly risky, he warns. And, adds that the “toolbox” to deal with these crises is historically documented. You just don’t need an amnesia, he points. Avoid the state of denial.

His outlook is simple: the political message from Brussels that the solutions applied to Greece were «unique», “will not work”. To Kenneth Rogoff it seems highly unlikely that the debt restructurings in the Eurozone remain confined to the case of Greece. But in the interview he didn’t specifically mention Portugal or Ireland. He was interviewed at his office in the imposing Littauer Center, of gray granite, not far from Oxford Street in Cambridge, on the other side of Boston.

Related: Interview with Carmen Reinhart about “This Time is Different” (2010)

INTERVIEW by Jorge Nascimento Rodrigues (March 2013)

Q: What will come out from this debt crisis in the Eurozone?
A: The most likely outcome could be a period of 15 years with very, very low growth. Sometimes positive, sometimes negative, just as happened in Japan.

Q: In short, the “peripheral” countries of the euro zone are poised to a long period of stagnation or low growth due to the large debt burden?
A: Yes, without a write-down from the bondholders, you should expect such a situation. One can hardly imagine that what is happening in some euro zone countries, with recessions that exceed the levels during the Great Depression (the 30s of the last century) is sustainable. Look at the unemployment rate, for example. I asked senior Europeans officials: do you really think there will be social stability in these countries? Without debt defaults, how do you foresee the next ten years? How will you restore growth? Will you exit Greece and push it into the hands of the Russians and the Chinese? It doesn’t seem to me that the strategy that is being followed is a serious one. This European policy, moreover very slow, is highly risky.

Q: Debt forgiveness from bondholders? But debt reduction through internal deflation and strong deleveraging, the therapy of austerity, as required by the troika, isn’t the best policy? Being in the euro leaves other alternative?
A: I’m a little Euroseptic, no doubt, but to blame everything on the euro is wrong. Even with a floating exchange system, with the level of public and private debt overhang in these countries, the same serious problems would occur. Therefore, given the magnitude of the problem, I say it is inevitable to face the problem of deep restructuring of the debts, much beyond what has been discussed in public. The idea that Greece is a “unique” case will not work.

Q: But that is the cornerstone of Brussels political message: what was done in extreme conditions with Greece was an exception, and won’t be repeated.
A: The European Union would be crazy to kick Greece out. It would become vulnerable. Therefore, acted. But what I find is that more debt restructurings- not necessarily transparent- are most likely in the euro zone.

Q: What do you mean by non-transparent restructuring?
A: Lower interest rates are a form of restructuring. Or, implied warranties given by the European Central Bank (ECB). Or financial repression on a Eurozone scale.

Q: One of the remarks that you have been highlighting is that History shows that there is a toolbox to tackle this kind of debt crises in debt overhang countries. Why does Europe insist just on internal deflation, something that has showed such tragic results during the Great Depression in Europe in the 30s?
A: There are actually several tools for dealing with over-indebtedness, as Carmen Reinhart and I have appointed, and they are not just for emerging markets. One is more inflation. Another is what we call financial repression. Another is write-down of debts, which can have various forms. The latter seems to me the best solution. Internal deflation and deleveraging are socially highly stressful.

Q: In your work of historical research conducted with Carmen Reinhart you pointed that substantial forgiveness of sovereign debt is not abnormal or sinful. Besides, in the 30s, the United States forgave debt to 17 European countries, write-downs that reached 17% of GDP…
A: Absolutely. We analyzed the case in a paper recently published. But history continues to surprise me. For example, in March 1989, the Brady Plan was created by the Secretary of the U.S. Treasury, Nicholas Brady, to developing countries with debt crises over the 80s. The plan decided a debt haircut of 30-35%, almost identical for all countries involved. And, that shocked me at the time. But an option for making it case by case was difficult and generator of conflicts. It is undoubtedly the most remarkable case. Well, there’s no easy answer for the problem.

Q: But the austerity therapy promise growth if structural reforms are implemented.
R: Structural reforms help in any scenario that is true. I’m not saying it’s impossible. Structural reforms are, indeed, difficult to measure. But the level of a large public debt overhang is very problematic, and may require renegotiation. What is wrong is to think that with this policy [austerity], growth will resume shortly. That is not correct- it will not happen. They systematically pretend that growth is just around the corner. Why are they waiting for the future to act? What happens in the meantime? It’s a very vulnerable position, for example, if in the meantime something goes wrong, somewhere- if China has a crisis, if there is a war in the Middle East, or other event.

Q: Will we watch a change in guidance?
A: My prognostication is simple: the current policies in the euro zone will have to be modified. I may be wrong, of course. The Germans will end up concluding, in a slow and painful way that or they will lose money in a continued recession and with crises, or they simply have to write-down losses.

Q: The use of unconventional measures of monetary policy as the announcement that the European Central Bank (ECB) could put in place a program to purchase unlimited public debt (OMT) is convincing to stop investors from charge high interest rates to finance the “peripherals”?
A: Mario Draghi played well his cards, the cards that he could play, like OMT program. He was very successful with his attitude quite “emotional”. But the ECB cannot replace a European political system that works. What Draghi is doing is allowing temporary relief, undoubtedly possible for several years, but not forever. People expect too much from Draghi. What he can do is buy time, and he is doing it quite well, removing panic from the system.

Q: The Europeans were taken by surprise with the burst of the sovereign debt crises after the peak of the financial crisis. Even senior officials thought that the risk of bankruptcy didn’t exist in developed countries that these situations were “things of the Third World.” How could this happen?
A: Many countries suffered from amnesia about the past. We got feedback that many people do not know about the past debt defaults in Europe and the solutions that were adopted. Even in the United States some are unaware that there was a default in April 1933. My research work with Carmen Reinhart demonstrated that, historically, waves of international banking crises are almost invariably followed, albeit with a delay of several years by waves of sovereign debt crises and debt restructuring.

Q: This amnesia generated some preconceived ideas …
A: Yes, the common idea is that developed countries do not need to resort to the toolbox of emerging markets to deal with the problem. But as we have documented, this idea has nothing to do with the history of the developed countries. Restructuring and conversion of debt, tolerance for higher inflation, financial repression, or a combination of these options was part of the resolution of debt crises in developed countries in the past.

P: Professor Rogoff, you are an international chess grandmaster and your youth was spent in front of chessboards. What have you learned from this passion that moved you from the age of six?
A: Many lessons. First, the importance of keeping me calm in difficult situations, even after making a mistake. Second, that regardless of whether you think you understand very well a given position, you must have in mind that there are several hidden levels of complexity. For economists, this second lesson implies that it is important to be humble and understand well the difference between having a strong opinion well reasoned and be too confident about yourself. Third lesson, the importance of having a strategic plan for long-term rather than focusing exclusively on short-term problems.

Q: After thirty years, back in August last year, you returned to the chessboard to play against the current Norwegian prodigy Magnus Carlsen, in the New York restaurant Per Se. What memory do you have from this meeting?
A: The conversation over dinner, after the game.

Q: One of the highlights of your career were the years in the International Monetary Fund (IMF), where you became economic adviser and director of the Research Department, a role of significant intellectual projection in the macroeconomic landscape. What’s your assessment of that experience?
A: It was a great experience. I learned a lot about macroeconomics, how to deal with economic situations of great challenge, and how to exercise leadership. I worked with a significant number of remarkable economists, from inside and outside the IMF, and that’s when I started working with Carmen Reinhart.

Q: In 1977, still a young economist, you came to Portugal as a consultant to the Bank of Portugal, when the country requested the first IMF intervention. What do you recall from that experience?
A: I learned a lot from dr.Silva Lopes, then governor of the Bank of Portugal.

HIGHLIGHTS
“Without a write-down from the bondholders, you should expect a long period of stagnation or low growth”

“My view is simple: the economic policies in the Euro-zone will have to be modified”

“Restructuring and conversion of debt, tolerance for higher inflation, financial repression, or a combination of these options was part of the resolution of debt crises in developed countries in the past”

“The Germans will end up concluding that they either lose money in a continued recession, or they simply have to write-down losses”

“It doesn’t seem to me that the strategy being followed in the Euro-zone is a serious one. This European policy, moreover, very slow, is highly risky”

“Mario Draghi played well the cards that he could play, like the OMT program. He was very successful with his quite “emotional” attitude.”

“The economist should be humble and understand the difference between having a strong and well-reasoned opinion, and being too confident about himself.”

BOX 1
ONE MONTH BEFORE THE LEHMAN BROTHERS
“They thought I had gone insane”

On August 19, 2008, his wife that was on vacation with the children in a small town in southern Spain, called him, surprised, when she saw a headline in “Le Monde” quoting him at a conference in Singapore where he said that “the worst is yet to come” and that “one of the big banks or investment banks could collapse in the coming months”.

The next day, the influential “American Banker” headlined “Rogoff anticipates bankruptcy of large banks.” On September 15th, 2008, Lehman Brothers filed for bankruptcy. For the history, it became known as the “Lehman moment”.

Kenneth Rogoff said later that when he made the announcement in Singapore, he “didn’t have a specific name in mind”.

Like his wife, world leaders, U.S. senators and policymakers called him hastily after reading the front pages news. “My friends and the world financial community thought I had gone insane” recalls Ken Rogoff with a smile. “But world leaders, some finance ministers, some central bankers I spoke with were interested in hearing me.”

Taking him seriously, wasn’t so easy. There was no “consensus” between economists and analysts about the credibility of such a pessimistic prediction. Only a very restricted group of “Cassandras” repeated it around the world.

The political and financial community was living wrapped in the financial “bubble” and in the myth of the “Great Moderation” of economic cycles since the 80s of the twentieth century, as discovered by the eminent economist Ben Bernanke. A replay of the Great Depression of the 30s was something unimaginable. What prevailed at the time was the “Bernanke Doctrine” of “great moderation” and not the “hypothesis” that a great crisis, as the one of the 30s could be repeated, just as a relatively unknown economist, Hyman Minsky, had studied and warned decades before.

Couldn’t even buy pencils

In fact, the Harvard professor was the one surprised at the reaction of many people: “My speech in Singapore was seen as too radical. But I had been saying that for some time. Months before I made the same speech in Sweden, but the media ignored it. And, the research conducted with Carmen Reinhart, the charts we had, pointed clearly to the fact that the world was already in recession, despite many people did have not recognized it at the time. It was very clear to us since the summer of 2007 that something quite wrong was happening in the credit markets. I was not being sensationalist in Singapore, but talking about facts. I’m not in the business of ‘creating’ crises, I study crises.”

Moreover, Rogoff was gathering information, critical signals on the ground: “I spoke with people in the middle levels in major investment banks, who told me that they even had to struggle to buy pencils … It was clear that there was a liquidity problem. They couldn’t do anything that involving cash.”
The reason so many people got surprised and reacted with indignation is due to the “psychology of too much ignorance and arrogance,” refers Rogoff. “People did not expect that to happen, but that’s typical.” And with a smile, he commented: “It was a very interesting moment to me. But, I confess, also very stressful because I am in the business of studying crises, not creating them.”

BOX 2
The chess champion that became an economist

Kenneth Rogoff turned 60 on March 22nd. Born in Rochester in upstate New York, his passion from an early age was chess, which he began learning with his father at the age of six. When he was 13 received a chessboard and a year later he was master and champion in the state of New York. He even played blindfolded against 25 players. At age 16 he represented the country at the world championship in Sweden, where a marathon against the British Arthur Williams sets a record that was recorded in Guinness. Left school for chess and moved to Europe, living from what he earned playing chess in Zagreb and Sarajevo, (then in Yugoslavia).

Later he decided to go back to school, earned a master’s degree at Yale University in 1975 and in 1980 a Ph. D. in Economics from the Massachusetts Institute of Technology (MIT), in Cambridge, Boston. In 1977 he was a consultant to the Bank of Portugal.

He didn’t stay away from chess and fought against the Soviet Anatoly Karpov. In 1974 earned the title of International Master and in 1978 Grand Master (the highest title) from the World Chess Federation. In 1982 he moved away from chessboards. But in August 2012, he played against the current Norwegian prodigy Magnus Carlsen, in the New York restaurant Per Se. Carlsen, 22, currently the fastest player in the world, said that Rogoff played a good match.

The chess Grand Master moved his attention to research in international finance, political economy and macroeconomics. He began his career as an economist in the Division of International Finance at the Federal Reserve and served as an economist at the International Monetary Fund.

Rogoff began teaching economics in 1985 in several universities until he becomes Professor of Economics at Harvard University in Cambridge, Boston, in 1999, where he still stands. One of subjects that called his attention was the international financial crises. Between August 2001 and September 2003 Rogoff served as Economic chief economist and Director, Research Department of the IMF.

BOX 3
‘This Time is Different’- a title of a book that should be read exactly on the contrary

In 2009, when still few people imagined that debt crises could arise in the tail of a financial crisis, Kenneth Rogoff, with his research colleague and co-author Carmen Reinhart, published the bold book ironically titled “This Time Is Different”. But the title is to be read on the contrary. This time will be no different (in substance) from the eight centuries of history of financial folly that the book addresses, with the most complete listing of global financial crises and bankruptcies since the fourteenth century. The “this time” on the title refers to the current crisis.

The book fell like a bomb; it came against the collective historical amnesia and state of denial of European policymakers.

They forgot, or ignored, the episodes of past bankruptcies in the developed Europe and the “tools” that were used. They ignored (and still ignore) the disasters that followed the austerity policies during the Great Repression. “The state of denial, says Rogoff, led to policies that in some cases risk exacerbating the final cost of deleveraging. If Europe does not grow, it will be very, very difficult to pay off debts with budget cuts. This will lead to years and years of recession. No country, no voters will tolerate it.”
Ken Rogoff is very critical of the austerity policy in the Eurozone. This official policy, he says, relies on the idea of a state of “exception” of developed countries, where debt sustainability is ensured by means of austerity. These countries – unlike the emerging or developing economies – wouldn’t have to resort to the historical “toolbox” to deal with the debt crises, point the advocates of austerity.

(c) JNR and JPO, 2013. Interview by Jorge Nascimento Rodrigues. Edited by João Proença Oliveira.

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