Austerity guru Ken Rogoff tells Boris Johnson to spend, spend, spend his way through Brexit - DT
The high priest of global austerity has advised the British government to throw caution to the winds and let rip on "good" public spending, warning that it would be deeply misguided to persist with belt-tightening as Brexit D-Day arrives.
"The last thing on earth you should be worried about in the UK is the budget deficit," said Harvard professor Ken Rogoff, normally known as a scold of profligate countries.
"You save for a rainy day, and Brexit is a rainy day. You're about to go through something really unpredictable and I think it would be a mistake not to use your national savings to manage the politics," he said, speaking before the World Economic Forum in Davos.
Prof Rogoff said those caviling over Britain's public investment spree have missed the bigger political picture and are traducing his complex debt theories.
"Investing in infrastructure is a no-brainer. So long as a good part of the spending goes on investment with a high pay-off – and that includes some types of education – this isn't risky at all," he said. The net UK fiscal boost is 1pc of GDP spread over several years. He described this figure as almost laughably "tame".
"One per cent is nothing compared to what's happening in the US. We have a trillion dollar deficit (5pc of GDP), and if we get a progressive president, it could easily go to $3 trillion. What the UK is doing is not even noticeable in the global conversation," he said.
Prof Rogoff, an ex-chief economist at the International Monetary Fund, said a host of countries would get into trouble if real interest rates suddenly jump across the world and set off bond market tremors. But the UK is not likely to be one of them.
The British borrow in their own currency, have a sovereign central bank able to take drastic defensive measures in extremis, and have already brought their long-term pension costs under tolerable control.
The greater imperative for the UK at this juncture – when the great liberal democracies are fracturing dangerously – is to bet the farm on social cohesion. "If you don't spend more and spread wealth quickly, there is a risk that voters will turn populist and you'll end up with counterproductive policies that make everything worse," he said.
Prof Rogoff's enthusiasm for a well-targeted fiscal blitz is a valuable endorsement for Downing Street. The Harvard guru is widely seen as the doctrinal author of Europe's post-crisis austerity policies (a fame he dislikes). His magisterial opus with Carmen Reinhart – “This Time is Different: Eight Centuries of Financial Folly” – is a forensic analysis of what can go wrong when countries push their luck too far.
The danger today as global debt reaches an all-time high of 322pc of GDP is that the seemingly inexhaustible supply of ultra-cheap capital will start to dry up, squeezing big borrowers into insolvency. A serious inflation surprise would undoubtedly trigger a sudden lurch upwards in borrowing costs.
"If the global real rate of interest rises 150 basis points over two or three years, anybody saddled with very high debt is not going to be able to pay. A lot of emerging markets are going to default and bond spreads are going to spike much higher in places like Italy," he said.
"It's a tail risk and probably won't happen but when I hear people like Larry Summers and Olivier Blanchard (fiscal enthusiasts) say any shock can only conceivably lead to even lower rates, I have to wonder. We don't really know why interest rates are so low, so we should be very careful about assuming they can't go up," he said.
A further breakdown of the global trading system could transform the calculus. "It is one thing for hedge funds to make a five-year bet, but countries plan to be around for centuries," he said.
Off-shore dollar debt has surged to $12 trillion dollars – some of it to highly leveraged companies in China, East Asia, or Latin America – and may prove the epicentre of the next crisis. The eurozone still has no lender-of-last resort for sovereign states. The European Central Bank would struggle to justify the legal basis for buying Italian, Spanish, or Portuguese bonds in a post-QE reflation scenario.
Prof Rogoff said the new fiscal craze sweeping the world ignores the hidden costs of higher debt. "It's not a free lunch. The debt that we can see in modern states is just a sliver sitting on top of vast debt obligations. Italy's public pensions take 16pc of GDP. That swamps the official debt ratio," he said.
One implication is unpleasant: pensioners will discover that they are "junior creditors" in many states. Their retirement income will be whittled down in real terms by a disguised debt restructuring. Governments will find some way to wriggle out of their commitments.
Ultimately the implication is that insolvent states will impose big haircuts on bond-holders and creditors rather than confront their peoples with endless austerity.
America will be the last one standing because of the central role of the dollar in the international system, even if Bernie Sanders or Elizabeth Warren take the White House in November, and even if they have enough control of Congress to push through a huge unfunded spending blitz.
Growth might even accelerate until the chickens come home to roost. "Populist regimes can do well, for a while," he said.
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