Two weeks ago I wrote about the current debate over the 2010 paper by Ken Rogoff and Carmen Reinhart (hereinafter referred to as RR) on the correlation between debt and GDP growth. I said that the most important part of their work, which is the construction of an enormous database on debt and financial crises over the last few hundred years, was to be found in their book This Time Is Different and elsewhere. And their fundamental conclusion: debt is not a problem until it becomes one. And then it reaches a critical mass and you have what they called the Bang! moment.
They did make an unfortunate error in a few cells of a massive Excel spreadsheet, which subsequent analysis has shown to not be a huge deal, though some have made it out to be. And the more I read of the issue, the more I believe that the bulk of the negative response has political overtones. There are those who wish to find reasons to abandon any move toward balanced budgets and reasonable fiscal policies. They see austerity as a punishment, some type of masochistic conservative Calvinist plot foisted on poor unsuspecting citizens who should not be held responsible for the governments they elect.
As I wrote two weeks ago, austerity is a consequence, not a punishment.
Last Thursday RR published an op-ed in the New York Times. Some were uncharitably dismissive of it, but if you take a careful look at the detailed online version, which is this week’s Outside the Box, I think you'll find their counterarguments thorough and reasonable.
An essay on Bloomberg notes:
The biggest howler is the least consequential. By highlighting the wrong cells in an Excel spreadsheet, Reinhart and Rogoff actually took an average over 15 countries, rather than the full sample of 20. Embarrassing? Yes. Important? No. Of the five missing countries, only one – Belgium – had ever experienced very high debt. Adding it barely changed the findings because Belgium’s economic growth during its high-debt episode was roughly similar to that in other highly indebted nations. [emphasis mine]
While the media loves to focus on the simple (and regrettable) coding error (which RR acknowledge), the main body of their analysis still points strongly in the same direction, and that direction has been noted by other, independent researchers:
Researchers at the Bank of International Settlements and the International Monetary Fund have weighed in with their own independent work. The World Economic Outlook published last October by the International Monetary Fund devoted an entire chapter to debt and growth. The most recent update to that outlook, released in April, states: "Much of the empirical work on debt overhangs seeks to identify the 'overhang threshold' beyond which the correlation between debt and growth becomes negative. The results are broadly similar: above a threshold of about 95 percent of G.D.P., a 10 percent increase in the ratio of debt to G.D.P. is identified with a decline in annual growth of about 0.15 to 0.20 percent per year.” (NYT)
In fact, when you examine the paper and underlying research of the University of Massachusetts trio who discovered and wrote about the error, you find that there is not all that much difference in outcomes if you use their assumptions. The best analysis I have read is in this piece by F. F. Wiley (even if he misspells my name in his links <g>). For those wanting even more detail on this issue, I suggest you read the Wiley piece after you read RR’s response below.
Economics, at least in its predictive and prescriptive forms, is not a physical science, notwithstanding the physics envy of many economists. To try and suggest that major policy differences should be formed on the basis of numbers to the right of the decimal point is folly. It is enough at times to get the direction right. North rather than south. With regard to the present debate, it is clear that a point can be reached at which too much debt is a problem. Is there a bright, unchanging line? This far and no farther? There is not.
Water transmutes from solid to liquid to gas. In physics and mathematics, limits, and indeed singularities, occur; and we can measure and even predict them. With debt-to-GDP ratios, all we know for now is that the Bang! moment exists, but the precise point for any one given country is not something we can calculate. But wherever that line happens to fall, once it is crossed, Bang!Everything changes. And dear gods, that is a fate to be avoided.
This is far more than an academic tempest in a teapot. Understanding the relationship between debt and systemic financial problems is critical to how you construct your long-term portfolio positions. If there is not a relationship between debt and growth, then quantitative easing will have an entirely different effect on markets than if there is. It is really that simple. Can we point to exact figures and immutable relationships? Of course not. Nothing in life is that simple, and RR don’t even attempt to do so, although some of their critics (and to be fair, some of their supporters) try to see bright red lines around the 90% debt-to-GDP number.
I write this note from La Jolla, looking over the Pacific Ocean. I will have dinner with Jon Sundt and the partners at Altegris at George’s later this evening and then move on to Carlsbad, where I will meet tomorrow with my partners and team at Mauldin Economics. The bulk of the team will be in this week for a two-day planning fest before we celebrate our 10th annual Strategic Investment Conference, starting Wednesday evening. I also have writing and reading and a brand-new speech to attend to. And I want to be there for all the speaking sessions. There will also be lots of late-night conversations with great friends on a very wide range of topics, from QE to biotech to geopolitics and all sorts of politically incorrect notions. Can it get any better?
It is about time to get to that next meeting. I hope your week is going well.
Your about as excited as I can get when I think about this week analyst,John Mauldin, Editor Outside the Box JohnMauldin@2000wave.com
Outside the Box is a free weekly economic e-letter by best-selling author and renowned financial expert, John Mauldin. You can learn more and get your free subscription by visiting www.JohnMauldin.com.
Please write to firstname.lastname@example.org to inform us of any reproductions, including when and where copy will be reproduced. You must keep the letter intact, from introduction to disclaimers. If you would like to quote brief portions only, please reference www.JohnMauldin.com.
John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/
To subscribe to John Mauldin's E-Letter please click here:http://www.frontlinethoughts.com/subscribe.asp
Copyright 2013 John Mauldin. All Rights Reserved
Note: John Mauldin is the President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory firm registered with multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS), an FINRA registered broker-dealer. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Millennium Wave Investments cooperates in the consulting on and marketing of private investment offerings with other independent firms such as Altegris Investments; Absolute Return Partners, LLP; Plexus Asset Management; Fynn Capital; and Nicola Wealth Management. Funds recommended by Mauldin may pay a portion of their fees to these independent firms, who will share 1/3 of those fees with MWS and thus with Mauldin. Any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any CTA, fund, or program mentioned here or elsewhere. Before seeking any advisor's services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Since these firms and Mauldin receive fees from the funds they recommend/market, they only recommend/market products with which they have been able to negotiate fee arrangements.
Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs at Millennium Wave Advisors, LLC and InvestorsInsight Publishing, Inc. ("InvestorsInsight") may or may not have investments in any funds cited above.
Disclaimer PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.
John Mauldin Archive
© 2005-2013 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.