Edward Chancellor of GMO LLC has a breakdown of why this sovereign debt crisis is different in his latest white paper.
His explanation is that the biggest difference is that the debt problem is in developed economies. He argues that this changes the dynamics of what we usually assume about sovereign debt.
In the past, the sovereign default cycle has tended to involve developing rather than advanced economies. The current crisis is different. In contrast to earlier episodes, in the years leading up to the 2007 credit crunch, developing nations were not the main borrowers in the global capital markets. In fact, emerging markets in aggregate ran current account surpluses, which were recycled to borrowers in developed countries. Leaving aside problems in Dubai and Central Europe, the latest sovereign debt crisis is being playing out in the developed world.
Earlier cases of excessive government debt levels among advanced economies aren't much relevant today. The deleveraging of the Scandinavian countries and Canada in the early 1990s, for instance, occurred against a background of strong external growth and local currency devaluation. Their economies were also relatively small. The recent banking crisis and subsequent explosion of government debt has affected a much larger share of the global economy. While a few countries may attempt to grow exports by devaluing their currencies, this is not a route that everyone can follow.
Some commentators argue that Japan's experience over the last two decades since the collapse of its real estate bubble provides the best analogue. According to this argument, there's no limit to rising government debt levels. As the private sector pays down its debt, funds will become available for governments to borrow. In the age of deleveraging, inflation will also remain low despite zero interest rates and the expansion of central bank balance sheets.
This argument deserves to be taken seriously. However, we shouldn't overlook the profound differences between Japan's condition in the 1990s and our current circumstances. Japan, for instance, enjoyed a very high savings rate compared to the low savings of the US and UK in recent years. The Japanese authorities were also slow to respond to their incipient banking crisis, whereas the authorities in the US and elsewhere turned quickly to innovative monetary solutions and huge fiscal bailouts. Japan's financial crisis was local, our own is global.
Finally, we should note that our financial problems are more complex than ever before. The notional value of outstanding derivatives is several times greater than global GDP. Banking liabilities in several countries, including the UK and Switzerland, far exceed their respective national incomes. Private sector debts remain at unprecedented levels (more than twice GDP in the US, UK, and Australia). This time really feels different.
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