Will Countries Be Able To Dig Themselves Out Of Their Debt Hole?

Kenneth Rogoff looks beyond the current crisis and asks how are countries going to cope with the massive debts they’re running up. In his opinion, they won’t do well.

Mr. Rogoff’s thesis is that the growth prospects for many of the countries that are rapidly running up debt as they pursue fiscal stimulus programs are not good once a recovery does set in. He points out that the current low interest rate environment is masking the magnitude of the debt service obligations that many are assuming. His thinking is that as governments try and issue ever more debt, interest rates on that debt are going to have to rise significantly to entice buyers.

Combining increased interest costs with a tepid recovery is in his opinion a developing train wreck.

Many of the countries that are piling on massive quantities of debt to bail out their banks have only tepid medium-term growth prospects, raising real questions of solvency and sustainability. Italy, for example, with a debt-to-income ratio already exceeding 100 per cent, has been able to manage so far thanks to falling global rates. But as debts mount and global interest rates rise, investors will become rightly nervous about the risk of debt restructuring. Other countries, such as Ireland, Britain and the U.S., started with a much stronger fiscal position but may not be much better off when the smoke clears.

Exchange rates are another wild card. Asian central banks are still nervously clinging to the dollar. But with the U.S. printing debt and money like it is going out of style, it would appear the euro is set to appreciate against the dollar two or three years down the road – if the euro is still around, that is.

As debt mounts and the recession lingers, we are surely going to see a number of governments trying to lighten their load through financial repression, higher inflation, partial default, or a combination of all three. Unfortunately, the endgame to the great recession of the early 2000s will not be a pretty picture.

Pretty gloomy and pretty speculative. Things looked this bleak in the early 1980’s and witness what transpired. Rogoff’s contention that countries are placing themselves at risk is correct but that doesn’t mean the only possible outcome is a negative one.

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