2010 February 28 Sunday
Kenneth Rogoff On China And Greece

Kenneth Rogoff believes China's asset bubble will pop sometime in the next 10 year.

China, set to surpass Japan as the second-largest economy this year, has helped pull the world out of its deepest postwar slump. Record lending, soaring property values and accelerating economic growth prompted the government to begin retracting stimulus measures implemented during the global recession.

“Their response to the latest financial crisis clearly raised the risk that they have a debt-fueled bubble in the economy,” said Rogoff, who in 2008 predicted the failure of big American banks.

I happen to be reading and highly recommend This Time is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff. It is about the financial bubbles over centuries and the recurring pattern of claims that the bubbles weren't really bubbles because "this time is different". Nope, just another bubble.

For rapidly growing China the collapse of an asset bubble does not mean an economic contraction. Instead of growing at 9-10% per year growth will just slow down to 2-3% for about 18 months. China's long term prospects are very bright.

A collapse would depress output gains to 2 to 3 percent, a “very painful” period which would persist for about a year and a half, Rogoff said. The slowdown won’t lead to a Japan- like “lost decade,” he added. In a speech earlier yesterday, he said China will do “very well this century.”

Now that a big financial bubble has popped with widespread damage to financial institutions Rogoff sees worse troubles for other countries in the form of sovereign defaults.

Following banking crises, “we usually see a bunch of sovereign defaults, say in a few years,” Rogoff, a former chief economist at the International Monetary Fund, said at a forum in Tokyo yesterday. “I predict we will again.”

Europe is getting all the attention in terms of sovereign default risk with the PIIGS (Portugal, Iceland, Ireland, Greece, and Spain) getting the bulk of the attention. But other Eastern European countries as well as countries in Central and South America and Asia certainly must pose some risk. I'd like to know what the top sovereign default risks are globally.

Rogoff thinks the US might face a crisis similar to Greece's within 50 years.

GHARIB: What is the scary part?

ROGOFF: The scary part is we look at what's happening in Greece and we look at what's happening in the budget of our country. We wonder, you know, if within five years we might be having similar problems tightening our belts.

I expect America's coming sovereign debt crisis will follow California's pattern. Years of political gridlock over whether to cut spending or increase taxes will escalate for a few more years. Then a huge increase in sovereign debt costs will cause an acute crisis that forces huge cuts in the US federal budget across most categories of spending. Even entitlements will cease to be sacred. At the federal level tax increases will play a larger part of the solution. But the US government is clearly overextended and cutbacks will come in military spending, old age entitlements, medical spending for the poor, and assorted pork projects.

If the US sovereign debt crisis hits around the time world oil production starts declining then the spending cuts will have to be savage in scope as each year tax revenues plunge even if tax levels are increased.

Rogoff thinks it unlikely Greece will avoid a default in the long run.

GHARIB: What do you think is the timetable? I know it's hard to gauge. What is the timetable to resolve a crisis of this magnitude? Are we talking about months or years?

ROGOFF: Years. This is a drama in many acts. Probably they'll bring in the International Monetary Fund and then have to bring them in again. This tends to take a long time to play out. There will be ups and downs, but I think it's going to be very difficult for Greece to avoid a default in the long run.

GHARIB: So explain this to people who are listening in on this conversation. Is this really a Wall Street issue or is this a Main Street problem?

ROGOFF: Oh, this is a Main Street problem. I mean, we are in a very delicate global recovery. Unemployment is still very high. We don't want the economy to get shaken up. I mean, best guess is this is worse for Europe than the United States, but you don't want your biggest trading partner stumbling just as you're in a fragile recovery.

An excellent article in the New York Times about prospects for a Greece bail-out from Euro zone countries highlights some of the politics of whether Greece will get an EU bail-out or an IMF bail-out.

Germany is reluctant to sanction any bailout knowing that, as the euro zone’s biggest economy, it will bear the brunt of the cost. But France and Germany also believe that any recourse by Greece to the International Monetary Fund would damage the prestige of the euro, highlighting its inability to sort out internal problems.

Moreover, France’s president, Nicolas Sarkozy is said to be particularly reluctant to see a rescue orchestrated by the monetary fund, which is led by Dominique Strauss-Kahn, a Frenchman and a potential rival in the next presidential elections.

The political leaders in Germany need to show Germans that the Greeks are imposing a lot of suffering on themselves in order to justify to the German public a bail-out using German money. Will the Greeks raise their retirement age to German levels? Will they do more cuts in public sector wages and more tax increases? What's within the realm of the politically possible in Greece?

Share |      By Randall Parker at 2010 February 28 04:08 PM  Economics Sovereign Crises

GreenOne said at March 2, 2010 10:01 PM:

China pegs to the dollar, so it would be very difficult for international bankers to bust out China's currency. Also, China has Sovereign banking, not 100% private bankers as in the West.

Sovereign banking allows the government to better control the money supply. As loans are paid off, then money in ciruclation is extinguished. A sovereign bank can issue money straight into the economy if it needs stimulation, as China has done recently.

China does have some private banks, and those are regulated, with usually a high reserve ratio requirement. The high reserve means a run on China's private banks is unlikely to cause bank failure.

China can easily inflate or deflate bubbles, as the "government banks" can directly control the money supply. If there is depressionary unemployment due to money supply contraction (as there is now in the U.S.), then the State Bankers can spend directly into the economy, thus reducing unemployment. When money and economic output rise together, there is no inflation. If the private bankers stop making loans, and hence the money supply contracts, then the State Banks can step up and spend while the private banks sieze up.

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