Tuesday, March 16, 2010

Roubini: Greece Only the Tip of a Sovereign-Debt Iceberg

He's a Keynesian, but Nouriel Roubini sure understands the sovereign debt crisis:
...as a consequence of fiscal stimulus and socialization of part of the private sector’s losses, there is now a massive re-leveraging of the public sector. Deficits in excess of 10% of GDP can be found in many advanced economies, and debt-to-GDP ratios are expected to rise sharply – in some cases doubling in the next few years....

In countries that cannot issue debt in their own currency (traditionally emerging-market economies), or that issue debt in their own currency but cannot independently print money (as in the euro zone), unsustainable fiscal deficits often lead to a credit crisis, a sovereign default, or other coercive form of public-debt restructuring.

In countries that borrow in their own currency and can monetize the public debt, a sovereign debt crisis is unlikely, but monetization of fiscal deficits can eventually lead to high inflation. And inflation is – like default – a capital levy on holders of public debt, as it reduces the real value of nominal liabilities at fixed interest rates.

Thus, the recent problems faced by Greece are only the tip of a sovereign-debt iceberg in many advanced economies (and a smaller number of emerging markets). Bond-market vigilantes already have taken aim at Greece, Spain, Portugal, the United Kingdom, Ireland, and Iceland, pushing government bond yields higher. Eventually they may take aim at other countries – even Japan and the United States – where fiscal policy is on an unsustainable path...

In most advanced economies, aging populations – a serious problem in Europe and Japan –exacerbate the problem of fiscal sustainability, as falling population levels increase the burden of unfunded public-sector liabilities, particularly social-security and health-care systems. Low or negative population growth also implies lower potential economic growth and therefore worse debt-to-GDP dynamics and increasingly grave doubts about the sustainability of public-sector debt...

Provision of liquidity by an international lender of last resort – the European Central Bank, the International Monetary Fund, or even a new European Monetary Fund – could prevent an illiquidity problem from turning into an insolvency problem. But if a country is effectively insolvent rather than just illiquid, such “bailouts” cannot prevent eventual default and devaluation (or exit from a monetary union) because the international lender of last resort eventually will stop financing an unsustainable debt dynamic, as occurred Argentina (and in Russia in 1998).

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