3 Takeaways - Is This Time Different? Eight Centuries of Financial Folly with Famed Economist Ken Rogoff (#114)

Episode Date: October 11, 2022

Harvard economics professor and former IMF Chief Economist Ken Rogoff is one of the world’s preeminent economic thinkers. Here he brilliantly dissects today’s U.S. economy and bluntly explains what must happen to tame inflation and sustain growth – and the major role China may play. He is the co-author of This Time Is Different: Eight Centuries of Financial Folly.

Welcome to the Three Takeaways podcast, which features short, memorable conversations with the world's best thinkers, business leaders, writers, politicians, scientists, and other newsmakers. Each episode ends with the three key takeaways that person has learned over their lives and their careers. And now your host and board member of schools at Harvard, Princeton, and Columbia, Lynn Thoman. Hi, everyone. It's Lynn Thoman. Welcome to another episode. Today, I'm excited to be with Harvard professor Ken Rogoff. He was previously chief economist of the IMF, and he is the co-author of This Time is Different, Eight Centuries of Financial Folly, which is wonderful. I'm excited to find out if he thinks this time is actually different.

The U.S. government has spent trillions of dollars dwarfing the losses due to COVID, and the Fed has also held interest rates at near zero for many years. Welcome, Ken, and thanks so much for our conversation today. Thank you for having me, Lynn. It's a great podcast that you have, and I'm honored to be a guest on it. My pleasure. Ken, what are the key lessons from your book, This Time is Different? The key lesson is this time is never as different as you think it is, that there are cycles that really have to do with human nature that we go through that lead to debt crises, inflation

crises, financial crises. We thought recently enough for many people that, hey, we're never going to have inflation again. This time is different. It's the 21st century. We buy stuff on the web and we trade with China and we're never going to have inflation. And hey, what do you know, we've got huge inflation, and who knows where it's going. And before the financial crisis of 2008, people said, well, yeah, they had the Great Depression, but that's never going to happen again. And they look over the course of history, this pattern repeats itself. The book itself, by the way, is actually quite quantitative and tries to look at actual patterns you get over 700 years. And it's just amazing at looking across time and space and different legal systems and political systems, how human nature pushes through to have rather similar things happen under extraordinarily different circumstances.

Can you tell us about how government spending during the last few years has dwarfed the losses from the impact of COVID? The reason to have a good balance sheet where you can borrow a lot when you need to is stuff happens. There are people who see things in peacetime and say, oh, we can borrow a lot when you need to, is stuff happens. There are people who see things in peacetime and say, oh, we can borrow a lot more. Let's just make this free and make that free. And I'm all in favor of that. But the problem is that you can run into these situations like the pandemic, where we really need to do that. And people couldn't go back to work. I mean, I don't have to explain it. Everyone lived through it. And it made a lot of sense. It's

a natural catastrophe. That's exactly when the government wants to step in, also a war. I'm not saying it's the only case where the government wants to step in, but nobody else can. And so I think the spending made a lot of sense. I supported it. It is true that as things got better, there was a question of when do you turn the spigot off? And here, the politicians were finding a lot of positive reinforcement for doing these grand scale programs, the likes of which we never even imagined until recently. And I think it's clear that they went too far, not just in the US, but all around the world. It's very easy to say these things with hindsight. Things got better, the pandemic didn't get worse and worse. So it isn't easy to know when to head for the exits. So we are in a situation where we have spent a lot, we have a lot higher debt, and interest rates are going up. They're much higher. Interest rates had fallen incredibly after the 2008 financial crisis on mortgages, on consumer credit,

on businesses, and especially for the government. And everybody looked around and said, oh, wow, this is a free lunch. We can just make everything free. And I think it was very prominent on both parties. This is not a Democratic-Republican thing. I mean, admittedly, the Republicans said, oh, great, we can cut taxes and don't have to pay for everything. And the Democrats were more on the side of, oh, great, we can raise spending and don't have to pay for everything. And the Democrats were more on the

side of, oh, great, we can raise spending and don't have to raise taxes. That's politically harder. And I think some of it made sense, but it was also a sense in which it was short-sighted because interest rates fell so much, he shouldn't have believed it would always stay that low. And now we have more problems. I don't want to say they're dire, insurmountable, but it's a lot more fun to be borrowing the money than it is to be owing a lot of money. You've looked at countries' debt compared to their GDP. what is the limit to what governments can borrow? Well, it varies. So if you're talking about emerging markets, they often run into default problems at what we would think of as relatively modest levels of debt to GDP, say 50%, as low as 30%. Although it's very important whether it's borrowed from

home or abroad, if it's borrowed from home, they inflate it, which is bad. Do you want to have 20% inflation? No, that's also very bad. In advanced countries, we don't know of any limit where you run into some instant problem, but you have less space in order to fight financial crises, pandemics, wars, what have you, and not to mention pay for Social Security and Medicare. But actually, if one actually reads our work, we're very careful about saying this. Advanced countries graduated. They don't default. That's not even really an issue on the table.

It's more like the inflation that you got now, which is not good for growth. And the countries like in Italy or Japan, which owe a lot, they've been constrained. They grow more slowly than the other advanced economies. And yes, you can be a country like Greece, which some people, believe it or not, pointed to as being a great example of proving borrowing is great using what they did up to the financial crisis where they borrowed a lot,

but then they've had a disastrous decade because the markets at some point wouldn't keep giving them more money. I wouldn't say there's a black and white answer to that. For emerging markets, it's pretty clear. For advanced economies, the levels that we're up at now certainly have been ones associated with lower growth. We've seen that over the last 10 years. So it's not like you're driving at 55 miles an hour and suddenly you drive at 56 miles an hour and you're going to have an accident. It's not like that. But your risks of having an accident as you go from 55

to 75 to 95 rise. And I can point to cholesterol levels. I mean, they mean something, but they're just probabilistic. If you drift over 200, you're at risk, but you could have a problem below 200. You could never have a problem when you're above 200. It's a probabilistic thing. And it's the same with debt levels. Can we take for granted market confidence in the U.S. dollar and U.S. debt? Where are you going to hide? I think yes, which doesn't mean that the market's not going to want a higher interest rate in order to roll over the debt. We're experiencing that now.

The interest rates on 30-year borrowing and 10-year borrowing have been steadily rising since the inflation started after the pandemic, and they're going to stay high for a long time. So it's not like the market says, I don't want your debt. It's saying, well, I want your debt, but I'm not willing to pay as high a price as you've been asking. And the whole world is saying that. That's why the rate's been going up. So in the case of an emerging market, particularly when they're borrowing in foreign currency, the markets can just throw their hands up and say, we're fed up with you. This happened to Greece, happened to Argentina multiple times, Brazil, Indonesia. It has happened in the past to today's rich countries. It's happened to France. It's happened to Spain. The United States actually, I think,

technically defaulted on its debt in the 1930s when it went off the gold standard. But mostly what's going to happen is the market's going to say, we still love you, but not quite as much. And we want your debt, but I'm sorry, you need to give us a bigger discount, which translates into a higher interest rate. And that's fine. So it doesn't mean you suddenly have to rush for the exits. But it does mean that you start seeing your debt move up faster. As it moves up faster, the markets might start to say to you, well, we still love you. But in light of the fact that you don't seem to have a handle on things, even as debt is going up, we're going to want even higher interest rates and you can end up having inflation

and so forth. And of course, the U.S. economy got into some of that after the pandemic. There is a belief that interest rates need to be higher than inflation to cool the economy and bring down inflation. We both knew Paul Volcker. He raised the Fed's benchmark interest rate to a record 20% in 1980 to fight inflation. Because the U.S. now has so much more debt, what would happen to U.S. payments of interest on its debt if the Fed raised its benchmark interest rate to 10%?

So, Lynn, you're asking a really good question. I actually worked for Paul Volcker. I mean, I was a pawn in the Federal Reserve, but I was there. It's my first job working in the Federal Reserve when he was there. And he's a great man, absolutely great man. But what he did was a different circumstance. You're really walking on much more delicate ground here, trying to raise interest rates. The markets are much more puffed up and fragile. Debt is much higher. It's harder to do than it was. You can argue there's some things in the other direction. I actually think that it's important not to be overzealous about this.

And here, I'm in a minority among the academic economists who just say, oh, the Fed, you screwed up. You've got to raise interest rates as quickly as possible to get inflation down as quickly as possible. In my own work on this, and I've written on this my whole life, I think I wrote the first paper on why you should have an independent central bank. I always thought the central bank should balance inflation and other things like growth, employment. And frankly, the idea that getting inflation down is the be all and end all of policies, nuts. My gut instinct is that they need to be careful. Now, specifically on your question, my answer is yes. I think, in fact, interest rates in the period before the pandemic

came down much more than inflation. We call them economists, real interest rates, meaning the interest rate adjusted for inflation. They were at levels, yeah, we saw in World War I and World War II and periods where the government was really weighing in on the markets. We've had periods like this, but never so long, never in such calm markets, never in peacetime. It was extraordinary. I will again point to my colleague, Larry Summers, called the secular stagnation, these low interest rates. And I never agreed with that. When I've looked at long historical data, these things come and go. We've had low interest rates before. They don't last.

And I think part of what's happening is they're going back to something more normal. So what I'm saying is even when the Fed finally conquers inflation and raises interest rates, it's not going to lower them as much as I think people might hope. They're going to have to stay higher relative to inflation than they were before the pandemic, simply because we're back to a more normal situation. So I do think they have to raise interest rates above inflation to cut demand. That's probably going to happen. But don't assume they're going to come back to That's probably going to happen. But don't assume they're going to come back to below inflation when this is over. I think that's just a wrong

reading of history. Things that seem secular for five or 10 years often turn out not to be. You talked about default. There's a widespread belief that default by countries on their government debt, apart from World Wars I and II, is limited to Latin America and a few poorer European countries like Greece. But pre-communist China repeatedly defaulted on international debts, and India and Indonesia also both defaulted in the 1960s. With rising interest rates and the record strength in the U.S. dollar, which raises the cost of paying back U.S. dollar denominated debt by other countries, do you see defaults by governments on their debt ahead? And if so, where and what do you think the consequences will be?

Well, this is a tough call because the world unfolds very quickly and it's very volatile. What we already know is that coming out of the pandemic, the world's poorer countries and counting developing economies and lower income emerging markets are in a catastrophic situation. They're in a catastrophic situation because the pandemic was worse for them. They didn't have vaccines. There was a world recession. And more than half of them are either outright default or borderline default already right after the pandemic ended. It's a very difficult situation. And the point I would like to make is so much of American politics and what you see in many of the rich countries is

very what I would describe as communitarian. So the definition of low income is low income relative to what? Relative to this very rich society. But something like 6 billion people, maybe 6.5 billion people live outside these rich countries in unimaginably poorer circumstances than we have. And they are the ones who have really gotten crushed by the pandemic, by all the financial problems they have afterwards. And I think in addressing the world's problems, whether it be the environment, whether it be having global peace, we really need a new contract with these countries that tries to think about how we give the maid, how we relate to China in giving the maid. So that is, to me, the number one problem.

There are also going to be other defaults, given the timeless nature of this conversation. I don't want to list them all as they happen, but there's no question when U.S. interest rates rise this much, it really creates problems in some places. What else are you worried about? I think if I had to point to the region that concerns me the most, it's actually China. Clearly, the U.S. relationship with China is the dominant relationship of the 21st century, whether we're talking about global peace, whether we're talking about the global economy. And our relationship with China is complicated. A lot of people are bitter at China because

they ate our lunch by taking over manufacturing and selling us all this cheap stuff and driving middle class and good paying jobs away from the United States and Europe. On the other hand, they have become the workshop to the world. If you want to know why everything is so cheap for most consumers, they're a big, big part of that. I'm making a loop in some other regions, but dominantly China. They are in big trouble. And there are many reasons for it. One reason I've studied a lot for many years and have papers on is their over-reliance on real estate. They build houses, infrastructure, commercial real estate really well, but they've been doing it like crazy for years and years and years. And in my work, strongly suggest we reached a point where it's overbuilt. They just can't keep doing this. Real estate, broadly defined accounting, commercial

and the indirect effects of the demand from real estate account for 25% of their economy. It's their big thing. Well, at some point, the house prices can't keep going up. They're going to start going down. They have as much housing per capita as Germany and France, which are much richer countries. This can't go on. And we're particularly seeing that in the poorer regions of China, where they did a lot of building, but they're not a lot of jobs. And the poor regions of China are huge. They actually account for 60% of their income and 50% of the value of their housing. This is a massive problem, even if things were going well, but they're not going well. I think from an economic point of view, it's been extremely

damaging. The centralization of power in China doesn't work. Yeah, it can solve certain problems. They're really good at building a bridge somewhere. Nobody wants it. But if it's trying to have an innovative economy, it doesn't work. And when China slows down, which has not happened until now, it is going to be a massive effect on the global economy. Before I ask for the three takeaways that you would like to leave the audience with today, is there anything else you'd like to mention that you haven't already touched upon? Well, I would just say that we live in this world of incredible artificial intelligence, which I'm very sensitive to

because I've been a professional chess player early in my life. And I represented the US in the world championships a long, long time ago. And the advances are just scary in artificial intelligence. And I think when we're talking about regulation and how to balance this and how to use artificial intelligence constructively, that's an absolutely profound problem, which I think is very much a problem of the next 10 years, not just something in the far future.

What are the three takeaways you would like to leave the audience with? The first takeaway I'd have just is a professional one and applies to people thinking about markets and growth and policy, which is always important to take a long-term perspective. The markets move very fast. Journalists and newspapers want to cover what happened yesterday, but it's very important to think about a very long term. If it seems like the world is coming to an end today and we're never going to get past this crisis, you are. Crises come to an end. If it seems like borrowing is a free lunch because the interest rate you're

getting right now is really low, don't assume that that's always going to be the case. It's important to have a long-term perspective, not just a year, not just five years, but really centuries-long perspective, at least decades. Secondly, I would apply the same thing much more broadly to life to have a long-term perspective to think about, say, in your career for young people, where do I want to go? What's my strategy? What am I trying to learn from this job? Where do I want to be next? And obviously, you can apply this to relationships as well, although it's hard to be a scientific about these things. But it's very important not to be super short term all the time. And thirdly, as someone who's not young and watch both chess and economics

evolve incredibly in my lifetime, it's important always to be humble about what you know and don't know. The world is changing. You may think you completely understood something you don't. And I would always say when you listen to economists who are super confident in the advice they're giving, you can be confident that they're probably going to be proven wrong at some point. Ken, thank you. This has been terrific. Thank you so much, Twitter, and Facebook. Note that 3takeaways.com is with the number three. Three is not spelled out.

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