Can an economist be a celebrity? Usually not.
There are a few exceptions and Carmen Reinhart is one. Certainly after her book “This Time Is Different,” came out in 2009.
“Carmen Reinhart and Ken Rogoff came as close to celebrity status as an economist can ever come,” writes professor Randall Wray.
Why the unusual attention? The answer is what they got right in the punchline of their book: Although contemporaries may say this time is different, financial crises follow historical patterns. Reinhart and her co-author Kenneth Rogoff analyze these patterns over 800 years and find when crisis hits it’s not much different from the last time around.
Six years after the publication of the book, Carmen Reinhart, a professor of the international financial system at Harvard, sees the signs of crisis again.
Epoch Times spoke to her about why China is different and not different at the same time, about a lingering crisis in emerging markets, the International Monetary Fund, as well as higher U.S. interest rates.
Epoch Times: What kinds of scenarios do you see for China?
Prof. Reinhart: Even with a benign scenario, China’s economy is slowing but not imploding. Even without the drama a shift from investment to consumption may mean that a lot of the foreign direct investment projects in emerging markets they so aggressively pursued, especially in connection with boosting commodity supplies, are not a priority anymore.
Whatever happens in China has repercussions in the rest of the world. I think the most pronounced repercussions are not going to be in Europe, not so much in the United States, but in the emerging markets.
Epoch Times: In your book, you analyze the debt profile of countries to predict financial crises. How is the Chinese profile looking?
Prof. Reinhart: If you look at Mainland China its measured external debt was extremely low. But there’s a shadow banking sector in which corporates who had access to international capital markets got into the business of lending to smaller firms, domestic firms that did not have access to international capital markets.
It means there’s this whole layer of debt outside the banking sector that may also introduce an element of currency mismatch into the picture that we’re not capturing.
Absolutely. So you have essentially medium to smaller firms that are in the non-traded area that don’t have direct revenues and hard currency but that have acquired hard currency debt. Over the course of the last couple of years [the BIS] has been writing and trying to quantify this issue.
I think, in my view however, the bigger concerns about China are not external debt but internal debt.
Epoch Times: So is China different?
Prof. Reinhart: Absolutely and that’s part of the story; everybody’s different. Every crisis is different. The problem is that it’s not that all crises are the same, it’s not that all countries are the same, you don’t really get this nice little recipe.
It’s like an illness. If 10 different people have the same illness they’re going to show some common symptoms. Obviously what form it takes depends on whether you’re 70 years old or 10. What your health is like and so on, but there are common symptoms.
China’s internal debts are to a large extent a great mystery. And this is not just to me, they’re a mystery at large. So what do we know and what don’t we know?
So if you look at for example, domestic credit, this is really the activity of banks. That’s something that’s not perfect, but they report data to the IMF, that data on domestic credit shows a surge in credit in the last decade.
A really big credit boom. If you look at the public sector debt, domestic debt you start getting more nebulous because domestic debt data is much harder to come by. Even federal government debt is hard to come by.
Technically those debts were not supposed to exist but we all know that the provinces through third parties and real estate operations were borrowing heavily in connection with the real estate boom and the infrastructure boom.
A lot of those debts were short-term and at pretty high interest rates. When you’re growing rapidly and everything’s great, you’re doing great, you don’t worry about high interest rates and you don’t worry that it’s short term because your lender sees you’re doing great and they’re going to be willing to roll it over.
When things start slowing down and some of the projects start going sour and it’s clear that those projects are not going to be profitable then short term debt is a real problem. Even if they are willing to roll it over, they’re going to roll it over at a very high rate.
They are trying to consolidate a lot of the provincial debts that one would call a floating debt—short term, high yield. They’re trying to create or trying to rationalize an internal market, trying to lengthen maturities.
In other words, they’re trying to restructure the domestic debts. Trying to lengthen maturities, trying to trim interest rates on those debts, and trying also to perhaps write off those that appear unsalvageable. That’s a big challenge.
Banking crisis and currency crisis often go hand in hand usually when the banking sector especially, but not uniquely, has a lot of external debt. That’s not the case in China. In China the debt problem is much more of an internal problem, but that doesn’t mean you can’t have a significant internal debt crisis and indeed they’re moving in the direction of much-needed restructuring.
Epoch Times: Are there any similarities with Japan?
Prof. Reinhart: So is China completely different in this regard? Japan’s banking crisis that began in the early 1990s was not an external crisis. Japan didn’t have, then, and it doesn’t have now, external debt to speak of.
It had a lot of internal debt in connection with the boom in the Nikkei stock market, connected with the boom in real estate prices in Japan, so it had a very significant domestic crisis. That’s really what we’re talking about in the context of China. We are seeing, I think, by most indicators, more capital flight from China.
Japan had a significant slowdown in economic activity. Had a massive correction in the Nikkei, in real estate prices, and entered a period of much slower growth.
None of this, however, was associated with a collapsing yen. The yen did not collapse. Actually the yen appreciated in various points in time because it did not involve external borrowing.
If you are a country that’s borrowed in your own currency and the debt is held by local institutions, you as a government have a lot more leverage on that domestic resident that’s holding your debt.
First of all, you can inflate your debt away to some degree. Second, you certainly can have a lot more sway on how you regulate the financial system to get them to hold the debt, to get them to restructure.
So in other words, as a government you have a lot more clout when your debt is held by domestic residents than when it’s held by non-residents.
Greece is in a situation where its debt at present is held by official institutions that are outside the control of the Greek government.
Epoch Times: What do you think about the change in the trend of capital flows?
Prof. Reinhart: The period in which the bet was one-way, that the tendency for the renminbi to appreciate; clearly that’s not happening.
You do have a shift in capital flows and in fact, that shift has also accelerated purchases of real estate in London, in Boston, in New York. You see that it’s not just Treasurys. We see that from China and we see that from Russia.
You’ve gone form a period which you had this one-way bet—the currency was going to appreciate, capital inflows—to the reverse. Having a period in which your own residents want to diversify into something else is not the same as having an external debt crisis.
So the winds have shifted. Once the real estate boom starts to unwind you see two things. One was some of it going to the equity market and you saw the big boom in Chinese equity.
But you also saw that this was a period in which reserve accumulation stops and you begin to see a decline there. You begin to see some element of portfolio allocation away from China.
Epoch Times: What can the Chinese regime do?
Prof. Reinhart: If you have all these bad provincial debts and you restructure them, you move to restructure them fairly aggressively, fairly quickly, you have a much better shot of a much quicker recovery than if you do what Japan did or what much of Europe has been doing which is avoiding haircuts, avoiding restructurings.
If you contrast, for example, Iceland and Ireland, Iceland was much more aggressive in the write-offs of private debts. Now in China, it remains to be seen like so much. … We’re dealing with an extremely opaque area. It’s not like what we can say about Iceland or what we can say about Ireland where we actually knew the numbers.
Because it’s internal I’m inclined to believe they’re going to be, relative to Japan, relative to Europe, more unfettered and that they will move more aggressively.
Now, let me say something on a historical context. Does this make me really bullish that they’re going to keep growing like they were growing? I don’t think so. I think already, if you look at the United States when the United States was gaining ascendancy in the world economy, it had big cycles.
It had great decades and it also had some pretty meager ones. The 1870’s were really bad. The 1890’s were also pretty bad. I think why markets have also been so shaken they believed the Chinese have somehow had mastered economics, meaning variance in growth was zero.
You already had an exceptional expansion phase. I do think that the next few years there is going to be a downturn in that cycle.
