Harvard University professor and former IMF chief economist Kenneth Rogoff said bad financial crisis result in deep political divisions and it takes a decade to heal it.
According to Rogoff, the effects of the financial crisis is fading away in Europe and it has not completely resolved the problems in the banking system in the European Union.
Watch:
"I certainly would have liked to have seen at least one of the major banks beyond Lehman put into some kind of accelerated bankruptcy, nationalised and then quickly privatised as part of sending a very strong signal that this isn't allowed and I think it might even have been good policy," Rogoff said in an exclusive interview with CNBC-TV18.
Edited excerpts:
Q: Can we say that the crisis has ended now and we are at normal times?
A: Yes, the crisis in the US has ended. The US is actually growing very well. The crisis in Europe is still fading and they haven't completely resolved the problems in the banking system - the European Union. In some sense, we are moving on to what might be a third leg of the crisis. You might even call it debt super-cycle, if that is not too fancy, which is hitting emerging markets and we wonder whether it's something will happen someday in China.
Q: There are lot of people who say that the crisis was not resolved properly. In that even, where criminality was proved the bankers just compounded and paid the money out of their banks. No one personally paid for excessive derivatives, excessive risk taken and putting the entire system to risk. Would you agree with the charge that the banking community went scot-free?
A: I certainly would have liked to have seen at least one of the major banks beyond Lehman put into some kind of accelerated bankruptcy, nationalised and then quickly privatised as part of sending a very strong signal that this isn't allowed and I think it might even have been good policy. So, you are right, they protected the banking as an entity, as corporations and it's certainly sits very uncomfortably with people that there were no serious penalties on some of the bankers.
I think that some of the populism we have had after the crisis, would have been attenuated had they done that. However, it wasn't that easy to do in the heat of things.
Q: It isn't just a cry of nationalism in the United States or populist nationalism, we have seen that for instance in Brexit. Would you say that we may see more of populist nationalism and much of it can be traced to the failure of the liberals during the financial crisis?
A: It's a well-established empirical regularity that after you have a bad financial crisis, you get much more division in the political system. That is something that has happened in the past and I think we are seeing it again.
I think in the United States, the economy really is growing pretty well. It's interesting to see how it will play out. Right now, the political divisions just get worse and worse and you are right, Brexit could just be the beginning of what we see in Europe. So of course, it's the financial crisis, it's other things like growing inequality, technology, the way global trade has been handled, I think it's many things, but the financial crisis made it a lot worse.
Q: If we can extend this point a little further, how much time does it take to get over these divisiveness. Does it take a very long time?
A: When you have a normal recession, a year. When you have a deep financial crisis like this - a systemic financial crisis, a decade. So in fact, what has happened in the US, what is happening in Europe, it's kind of typical for the 100 worse financial crisis over the last century and a half, the average time to just get back to where you started, a good eight-nine years. So in some sense, this was typical that it's not a fixed point of nature. Some countries like Sweden, some of the Asian countries in the 90s did better. There are countries that have done worse. Greece has done much worse. There are nowhere near getting out of their crisis.
Q: Let us come to that then. Are you not at all convinced that Europe has come out of the crisis? Just a little earlier you told me that it's extremely tentative, the way in which Europe has healed from the crisis, do you see them slipping back to some kind of a sovereign crisis?
A: The thing that is holding up Europe at the moment, more than anything, is that global inflation, adjusted interest rates are very low, by some measures and historic or near historic lows. It's not easy to have a big debt crisis blow up in your face, when interest rates are that low.
Argentina is doing it, Turkey seems to be doing it and there has been fallout. I know that it has hit India and other emerging markets. But to actually have a full blown debt crisis, when lending rates are so low, probably it's not going to happen and I think that is what is propping up Europe. But we don't really know why interest rates are so low. We have a lot of reasons, but we don't know which ones and how much. If interest rates were to rise, I think Europe would suddenly find itself under a lot of pressure, because there are countries like Italy and Portugal. We spoke about Greece, which are not out of the woods, but they are able to tread water very nicely, because they hardly have to pay anything on their debts.
So, Europe is not out of the woods and in fact, I think if there was another major crisis of some sort in the world economy, Europe would have a very tough time with that. Eurozone is a house half built, where they integrated monetary policy but little less.
Q: Let me come to the point you just made about if there is a rate hike, do you think that the Fed's rate hiking cycle can be more than what the markets are prepared for and do you see that as an imminent threat?
A: I absolutely do. I think the US is really booming and eventually, it's going to start bringing so many people into the labour force and pushing up productivity. But it's also going to be pushing up wages and the Fed might have to start hiking more aggressively. I don't see that in the near-term, but I don't see this boom in the US ending anytime soon. It's certainly possible, but best case is, it goes on for at least another couple of years and yes, the Fed will have to raise interest rates more.
I think the markets have been too sold on the idea that growth is dead. The phrase, I don't know if you have ever used that "secular stagnation." My colleague, Larry Summers, they have been oversold on this idea. A lot of what we experienced was the financial crisis and it takes a decade to get out of a financial crisis, but they end, they eventually end. It doesn't mean it's going on forever and I think, we are in that phase, where growth is picking up, investment is picking up, not as much in Europe. But I do think that will come provided there is no major shock and it will put upward pressure on interest rates. How far will it go, I think is a big question, but I do think particularly of a long-end of interest rates, not just about the Fed that is overnight lending, but I think if you look at 10-year rates, 30-year rates, they are well below, where I think they are going to end up.
Q: Some of the experts I spoke to in the series and even outside believe that the US economic growth is indeed like you say, a good to go for maybe a couple of years more at least. What are the odds of that happening, that growth is good, but inflation doesn't climb and therefore, the Fed doesn't have to hike so much?
A: I think it's just a fact that economists have been surprised in Europe and the US that there have not been more pressures on inflation. We have at least, the official level of unemployment is very low and so the idea that you would be booming and workers would be drawn into labour forces all coming out in corporate profits, not so much in wages is certainly surprising.
Is that going to stick? I bet against it. I suspect that we keep booming, eventually you will see wages grow. However, it's a very unusual circumstances. As you said at the outset, we haven't had something like this since the great depression. So, it's not easy to find long historical patterns on which you guess what is going to happen.
Q: What is your own sense? You said that the 10-year yield and the 30-year yield at the moment are almost mispriced, are not reflecting the underlying momentum. 12 months on, a year down the line, how much do you think the yields can rise and how strong do you think the dollar-index can get? It's standing at like 95 these days?
A: The interest rate, I particularly focus on, is the 30-year inflation adjusted interest rate, which is really low at the moment. So, you buy an inflation index bond for 30 years in the US, I think it has been a little under a percent now, plus you get paid for inflation and the nominal, the ordinary interest rate is 3 percent. I think over the next - I want to say more two years, both of those are going to be at least a percent higher and that is very powerful and it's effect on the economy and the 10-year rate, I think will also go up, maybe three quarters of a percent over the next couple of years.
Those are the interest rates that matter the most for the exchange rate and for the global economy. Now, I do think other countries may do well also, so we could go through a period, where despite the fact the US is doing well, other countries are also doing well, so it might not come out in the dollar. This won't go on forever. I want you to be clear, recessions will happen, but at the moment, I don't anticipate another deep financial crisis in the advanced economies.
Q: The issue we were discussing is an imminent rise in US interest rates and probably the global cost of capital. We have already seen dangers or rather eruptions in countries like Turkey, Argentina and now even the Indonesian rupiah is looking extremely skittish. Do you think that in the next 12 months we are going to see continued crisis in emerging markets?
A: I certainly think, we may see continued exchange rate volatility and exactly what that translates into whether we are going to see full blown defaults, which Argentina is likely to have or whether there will be something less I don't know. It's going to be interesting, if we go back few years, the Russian rouble fell from like 30 to the dollar to 90 to the dollar, it just collapsed. The Brazilian real went from 2 to 4, and they had all kinds of problems and yet they didn't default. It didn't lead to a full blown default.
Many people like myself have already for decades said that having flexible exchange rates, it might not be ideal. But it's a cushion against some of these problems. So, it's not pleasant, when your exchange rate collapses, it really puts a dent in domestic consumption. It's painful for consumers, but whether it's short lived than if you have a full blown crisis we will see. There is lot of corporate debt in dollars across the emerging world, so when the exchange rates of emerging markets go down, it makes it harder to service these debts.
But I think right now, it's an open question whether more flexible exchange rates and inflation targeting will prove sufficient. They haven't worked in Argentina, because the regime which came before just ran the country into the ground, they haven't worked in Turkey, I think it's very political. Turkey has the tools not to have debt crisis, but I am not sure they have the political possession to get out of it.
Q: I wanted to move on to China, but it's tempting to stay on with this theme and bring it to India. We put in an inflation targeting framework about two to three years back and at the moment, while inflation targeting seems to working well, we have had higher than digestible trade deficits and a fear that the current account deficit may get closer to 3 percent and along with the emerging market crisis, the rupee also has been one of the worst performing currencies in the past three or four months. Have you studied India and how do you rate the Indian macros, do you think they will weather-the-storm?
A: There has been a lot of structural reform going on India, which hopefully will sustain long term growth and hopefully make things better. The GST was a huge political and economic reform, financial inclusion and there has been a lot going on in India that I think will help. Although, there is a lot of dollar debt and you are not at the level, where many of the other Asian economies are, you are not at the level Turkey is at. So I tend to think, if the exchange rate is allowed to move, it will prove a pretty powerful cushion. That is actually central to inflation targeting you. You try to stabilise inflation, but not necessarily the exchange rate, that is the opposite of what countries did just 20-30 years ago.
So, I tend to think it's going to prove to be a pretty affective cushioning mechanism. But one of the things that can get in the way is that the government, whoever is in power gets cold feet as the exchange rate is falling and says no, stop doing what you need to do with interest rates, stop inflation targeting then things can spin out of control and that is easy for me to say as economist not to do that. But if you are sitting there and trying to manage the politics and manage what is going on, it is not easy. So, I am not saying India is going to have an easy time here, but I do think you have the right framework in place, that moving to inflation targeting and a more independent central bank even more importantly it is going to prove very helpful here.
Q: Would the lesson for India from Turkey and others be that don't push the central bank too much allow it the autonomy it deserves?
A: I think once you are integrated with financial markets they are very sensitive how you are treating the central bank. I am not going to sit here and say never, never overrule the central bank. There are times where things gets so bad you have to allow inflation to increase a lot, you have to allow what we call heterodox policies, but I think at this moment in time India is very well served by the framework that it has. Look at Donald Trump, he is having a hard time in the United States leaving the Federal Reserve alone it is very painful. I think that for the moment the best policy is to let the central bank do its job.
Q: Let me come back to the Lehman crisis and the way it played out in the big economies - China and India. Here perhaps there was a delayed reaction in terms of too much debt. You alluded to China, how do you see the Chinese economy, do you see a hard landing, do you see problems that might unsettle even the global economy?
A: I think it is probably the biggest single risk in the global economy. China is a very opaque economy. Everyone has a view that while the government will fix everything but there is a lot of debt out there, there is a lot of asset price inflation and the government needs growth. If the government could just squeeze the economy for a couple of years in a crisis and not have a problem, that would be fine but I think that is very hard to do. I think the sort of compact between the Chinese leadership and its people is that we will give the Communist Chinese leadership a lot of power but they are going to keep making things better for everybody and you go through a prolonged recession that could be very tough, that is the kind of dynamic that could blow up into a bigger crisis. Of course China will use state assets, still use the central bank balance sheet, they will do whatever it takes to try to prevent it from blowing up. However it is not that easy to grow at 6 or 7 percent and try to contain this credit bubble. I don't think that can go on forever.
Q: We have had fairly good rally across equity markets both in emerging markets and in developed markets over the past 24-36 months, which are the biggest red flags that investors should be worried about?
A: This issue of what is happening to global inflation adjusted interest rates, if they stay this low, stock prices can stay high, housing prices can stay high, growth can stay very strong but if we start to see interest rates picking up for whatever reason, it can happen just because people feel less worried than they were, so they shift out of bonds into riskier assets, it can happen because growth is faster than people are expecting. I actually think growth will be better particularly in the US than people are thinking and saying, that could push up interest rates and then someone who had a lot of debt whether be it Turkey or Italy or Indonesia, South Africa, they could have problems.
Q: At the moment, emerging markets are more worried about growth not staying so good, simply because of the tariff wars. You don't see that having the potential to cool down growth? How do you rate the progress of tariff wars?
A: As an economist, we think trade should be pretty much free and that everyone would be better off. I think a lot of Trump and tariff wars is political theatre. Most of his actions are playing to his base, he is making a lot of noise and the final changes are kind of minor tweaks. The big question is for China, whether something more serious will happen. However, I think for the moment, trade wars are more theatre in the Trump administration than they are actually something substantive. I must say, it's so hard to opine on his policies, because they change by the week and so it's hard to have a strong opinion. However, I tend to think that tariff wars are more rhetoric than necessarily reality. If Trump puts 25 percent tariff on everything and all the other countries retaliate, then that is going to be a mess.
Q: One of the results probably of global financial crisis has been the rise of larger than life leaders. Do you think the very fact that there are these all powerful leaders can lead to some kind of crisis because of ego politics?
A: If you concentrate power, you can end up with a bigger mistake than if you don't concentrate power. So, the sort of retreat from more democratic leadership is something that for someone like me is very disconcerting and I don't regard it as a good trend for the long run but it's here. I don't think it's something that is reversing anytime soon. I think a lot of countries are looking at China and saying that is not so bad. They looked at the United States and democracy, but I think, a lot of what was attractive was that the US was wealthy as much as that it was democratic. So, we have definitely had a stunning move away from democracy in Europe, China. It's certainly a very difficult period.
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First Published: Sept 14, 2018 10:05 PM IST
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