What’s The Problem With High Debt?

When debt becomes excessive (whether in the private or public sector’s hands), countries can no longer grow their way out. Instead, they must begin the painful process of deleveraging.

Regardless of the cultural, political, educational or demographic differences among countries, the economic consequences of over-indebtedness among countries have been remarkably similar.

Carmen M. Reinhart, of the University of Maryland, and Kenneth S. Rogoff, of Harvard University are the authors of a new book, “This Time Is Different: Eight Centuries of Financial Folly” (Princeton, 2009)

According to Reinhart and Rogoff, government actions (even when sizeable) are typically less helpful than they might appear. Trying to solve a debt problem with more debt has not been a successful strategy.

What’s the solution?

Historically, when a country’s total debt rose to unsustainable levels, it typically debased its currency in the interest of boosting exports and “creating” rapid economic growth. This becomes more treacherous and less likely when multiple nations are trying to do the same thing.

Nations have also been saved in the past from post-war “peace dividends,” like in the United States following World War II. Not only are the wars in Iraq and Afghanistan not over, they’re unlikely to offer the kind of peace dividend our economy received after World War II.

Countries can also attempt to inflate their way out of the crisis. Reinhart and Rogoff found this to be the case in about one-third of the countries they tracked that had currency depreciation rates above 15% a year.

This only works for debt denominated in the home currency, and only if the inflation comes quickly and unexpectedly. If investors are forewarned, they will price the inflation into yields.

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