Harvard’s Rogoff Sees Sovereign Defaults

Harvard’s Rogoff Sees Sovereign Defaults, ‘painful’ Austerity

By Aki Ito and Jason Clenfield | 3 March 2010

Feb. 24 (Bloomberg)— Ballooning debt is likely to force several countries to default and the U.S. to cut spending, according to Harvard University Professor Kenneth Rogoff, who in 2008 predicted the failure of big American banks. 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."

The U.S. is likely to tighten monetary policy before cutting government spending, sending "shockwaves" through financial markets, Rogoff said in an interview after the speech. Fiscal policy won't be curbed until soaring bond yields trigger "very painful" tax increases and spending cuts, he said. Global scrutiny of sovereign debt has risen after budget shortfalls of countries including Greece swelled in the wake of the worst global financial meltdown since the 1930s.

The U.S. is facing an unprecedented $1.6 trillion budget deficit in the year ending Sept. 30, the government has forecast. "Most countries have reached a point where it would be much wiser to phase out fiscal stimulus," said Rogoff, who co— wrote a history of financial crises published in 2009. It would be better "to keep monetary policy soft and start gradually tightening fiscal policy even if it meant some inflation."

Failed Marriage

Rogoff, 56, said he expects Greece will eventually be bailed out by the IMF rather than the European Union. Greece will probably announce an austerity program "in a few weeks" that will prompt the EU to provide a bridge loan which won't be enough to save the country in the long run, he said. "It's like two people getting married and saying therefore they're living happily ever after," said Rogoff. "I don't think Europe's going to succeed."

Investors will eventually demand higher interest rates to lend to countries around the world that have accumulated debt, including the U.S., he said. The IMF forecast in November that gross U.S. borrowings will amount to the equivalent of 99.5 percent of annual economic output in 2011. The U.K.'s will reach 94.1 percent and Japan's will spiral to 204.3 percent.

"In rich countries— Germany, the United States and maybe Japan— we are going to see slow growth. They will tighten their belts when the problem hits with interest rates," Rogoff said at the forum, which was hosted by CLSA Asia-Pacific Markets, a unit of Credit Agricole SA, France's largest retail bank. Japanese fiscal policy is "out of control," he said.

Euro Concerns

So far concerns about the euro zone's ability to withstand the deteriorating finances of its member nations have outweighed the U.S.'s deficit woes, propping up the dollar. "The more they suck in Greece, the lower the euro goes, because it's not a viable plan," Rogoff said. "Clearly the dollar is going to go down against the emerging markets— there's going to be concern about inflation and the debt."

The dollar has surged more than 9 percent against the euro in the past three months. Ten-year Treasuries yielded 3.72 percent as of 10:16 a.m. in New York. The U.S. government will delay any efforts to contain the deficit until Treasury yields reach around 6 percent to 7 percent, Rogoff said. "The U.S. is in a state of paralysis in its fiscal policy," he said. "Monetary policy will tighten first, and I don't think it's the right mix."

Fed Exit

The Federal Reserve last week raised the discount rate charged to banks for direct loans, and plans to end its $1.25 trillion purchases of mortgage-backed securities in March. President Barack Obama's administration is proposing a $3.8 trillion budget for fiscal 2011 to spur the recovery. "When they start tightening monetary policy even a little bit, it's going to send shockwaves through the system," Rogoff said.

In an interview a month before Lehman Brothers Holdings Inc. went bankrupt in 2008, Rogoff said "the worst is yet to come in the U.S". and predicted the collapse of "major" investment banks. His 2009 book "This Time Is Different," co— written with Carmen M. Reinhart, charts the history of financial crises in 66 countries. "We almost always have sovereign risk crises in the wake of an international banking crisis, usually in a few years, and that's happening," he said. "Greece is just the beginning."

Greece's debt totaled 298.5 billion euros ($405 billion) at the end of 2009, according to the Finance Ministry. That's more than five times more than Russia owed when it defaulted in 1998 and Argentina when it missed payments in 2001. The cost of protecting Greek bonds from default surged in January, then declined this month as concern eased over the country's creditworthiness.

Credit-default swaps on Greek sovereign debt have fallen to 356 basis points from 428 last month, according to CMA DataVision. That's up from 171 at the start of December. "Greece just highlights that one of those risks is sovereign default," said Naomi Fink, a strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. Still, "it doesn't justify the situation where we're all in a panic and going back to cash as in the post-Lehman shock."

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