Governments and central banks around the world have instituted aggressive fiscal and monetary policies in their efforts to cushion the impact of the recent economic downturn and financial crisis. Non-traditional monetary policies and outsized fiscal stimulus programs have been prevalent in recent years. These actions have also brought about a substantial expansion of public debt and central banks’ balance sheets. A clear understanding of the impact of the public debt burden on economies and markets and identifying policies to minimize its undesirable effects are crucial, especially at the current stage of the interest rate cycle and as central banks prepare for “exit strategies.”

Research, Policy Papers and Books

The Sovereign Crisis: When Debt is No Longer Risk Free
January 30, 2012

I highlight four key points made at a recent presentation in Washington, DC.

Distortions in the policy arena and financial markets dominate the global macro landscape:

• Policy matters more than ever for advanced economies, as they now embody traits of emerging markets (pages 5 - 9).
• The appetite for Treasury debt is weakening. The refunding of US Treasury debt presents an equal challenge to the oft-discussed budget deficits. Fiscal policy is poorly understood in the US (pages 15 - 22).
• The role of the US dollar as a reserve currency is changing (page 24).
• European officials should prioritize future growth via a three-pronged strategy to reduce debt, remove the threat of contagion, and limit the use of official resources (pages 11 - 14).

View the presentation.

Argentina Could Halt Capital Flight Easily
January 20, 2012

The Wall Street Journal this morning printed the following letter written at the CFS:

Mary Anastasia O'Grady's “Argentina's Capital Flight” (Americas, Jan. 9) highlights fragilities associated with “hot money” outflows. Capital is already leaving Argentina at half the rate experienced during the depths of the peso crisis—a whopping $5.5 billion between January and November 2011.

Many emerging economies can reverse capital flight via investment-promoting policies...

View the full letter.

Click here for the CFS calculation of capital flight (or reversal) from 1991 to 2011.

View the similarities and differences between the US and Argentina.

Does Math Support Euro Survival?
December 5, 2011

Persistent pressure in both sovereign debt markets and funding spreads in Europe naturally raises questions regarding the risk of a serious currency crisis and sustainability of the euro.

A quantitative approach to evaluate the relative competitiveness of nations participating in the euro is essential for gauging whether the unified currency can survive.

Based on CFS currency valuation models for eleven of the legacy currencies of nations that joined the euro, our view is “yes.” The euro can survive.

However, euro membership should be restructured. Failures to reorganize euro membership and resolve the debt overhang in Italy could unravel into an unneeded and unnecessary currency crisis.

Click here for the full report.

Click here for the euro component currency data.

Urgent Course Correction: Lessons for Argentina and the US
November 2, 2011

Perhaps odd at first glance, comparisons between the United States and Argentina more frequently surface. Today, the respective relevance of each nation for the other is no accident. Emerging market nations such as Argentina provide critical economic policy case studies for advanced economies and vice-versa. Many advanced economies now confront challenges once witnessed largely in less developed countries, such as a dramatic expansion in government spending in excess of revenues, an unusually large creation of money, and specter of default on sovereign obligations.

So, there are unfortunately many parallels between the US and Argentina. Each nation confronts a serious growth challenge. Fortunately, examination of history over a nearly four decade period offers actionable solutions to the growth quandary for each nation.

Click here for the full report.

Emerging Markets, Argentina and Lessons for the US
September 16, 2011

Stress on sovereigns will remain in coming days-to-months as many “risk-free rates” in advanced economies are no longer “risk-free.” The associated uncertainty among sovereign credits rightfully prompts observers to seek lessons from other nations or history – as witnessed by the resurgence of interest in the Great Depression.

To be sure, emerging markets also offer vital lessons and useful blueprints for solving debt and solvency problems.

Unfortunately, some reports are highly misguided.

Click here for the full report.

Changing Inflation Won‘t Solve Budget Woes
July 26, 2011

With the debt ceiling deadline fast approaching, suggestions as to how to resolve the budget deadlock in the US are being offered at a frenzied pace. One such suggestion has been to alter the index that determines cost-of-living adjustments for entitlement programs such as social security and Medicare as well as the rates at which tax brackets are adjusted.

Desperation is rarely a setting through which good policy can be achieved.

In this note, Robin Lumsdaine argues that proposals to address the near-term budgetary woes by changing the way inflation is measured are misguided.

Click here to read the full report.

Brief Thoughts on Debt Proposal for Greece
July 22, 2011

The EU and private sector offering for Greece will likely fall short of providing requisite relief and lifting pressures on neighboring nations. Our recent piece Solving the Greek Crisis was designed to identify specific steps to solve the Greek crisis as well as provide a path toward regional stability.1 In this piece we re-examine these thoughts within the context of the recent proposal.

The present program falls short, due to:

• The debt relief offered by the private sector is only 21%. This is on the low end of the 20% to 40% reduction we previously identified as requisite for success. In order for relief on the lower end of the spectrum to spark success, a more active reform and privatization program by the Greek authorities should be put into action.
• The program envisions that 90% of private sector institutions with Greek exposure will participate in the proposed plan. This will likely prove a bit of a stretch, as many of the largest banks in the world with Greek exposure have yet to support the private sector offer.2 Additionally, a portion of the bank debt was likely already sold into the secondary market to participants less willing to voluntarily restructure claims.
• The program contemplates the purchase of 30-year zero coupon bonds to collateralize restructured bonds. This approach mimics a scheme used in many Brady Plan debt restructuring agreements. Unfortunately, the cost of purchasing zero-coupon bonds today is substantially higher, due to low global interest rates. In other words, the cost of securitizing a bond 30 years into the future increases, as interest rates fall. Today, the cost of purchasing a 30-year EU zero-coupon bond is roughly 35 cents for every EUR. In contrast, the price of collateral during the Brady days was a relatively scant 7 to 9.5 cents. Likewise, resources spent on the purchase of collateral divert funds from addressing Greece's overall financing need.
• The plan contemplates a EUR20.6 billion loss for European banks. This is slightly low based on our original estimate of a EUR23.2 to EUR46.4 billion loss depending on the extent of debt reduction.

Click here to read the full report.

¹ Goodman, Lawrence, "Solving the Greek Crisis" - Center for Financial Stability, Inc., June 24, 2011.
² See "Financial Institutions in Support" in Greece Financing Offer - Institute of International Finance, July 21, 2011

Budget Solutions: Then and Now
July 19, 2011

The stakes for the U.S. economy are growing with each passing day of inaction on the fiscal front. Europe‘s deep distress is a wake-up call for America. The time is now for a meaningful and lasting solution to unchecked fiscal deficits.

Susan Hering and I evaluate history to uncover the most successful strategies to tame unchecked deficits. We draw the following conclusions.

• First, although both “discretionary” and “mandatory” spending have fueled the U.S. deficit explosion, entitlement spending is the primary source of future deficit expansion. A budget deal that does not contain “mandatory” spending will fail.
• Second, the lesson from previous deficit reduction efforts - Gramm-Rudman-Hollings (GRH) and the Budget Enforcement Act (BEA) – is that BEA‘s budget rules provided more effective fiscal discipline than GRH‘s deficit targets. Such rules will face a greater challenge this time around, though. The deficit is deeper now. Mitigating factors that enhanced rules‘ success in the 1990s are absent now. Most critically, it will be harder to design and enforce rules to control entitlements than to contain discretionary outlays.
• Third, the greatest deficit reduction historically has been achieved not by rules, but by bipartisan agreements to permanently reform spending and taxes.

Click here to read the full report.

Solving the Greek Crisis
June 24, 2011

A solution to the Greek debt dilemma exists.

• The Economic Subcommittee (ESC) to Bank Advisory Committees during the Brady Debt restructuring era provides a blueprint for identifying common ground, deepening communication, and paving the way for the benefit of creditors and debtors alike.
• Greece must reverse an economic slide - already in its third year. Greece is now ripe for a "Brady" moment.
• A Vienna Initiative approach will likely prove woefully insufficient, as the relief falls short of providing what is needed and incentives differ between Greece's creditors and those participating in the Vienna Initiative.
• History shows how debt reduction coupled with significant reform can spark growth. Brady Plan recipients all demonstrated superior growth in the five years after plan implementation - with the exception of Ecuador.
• Preliminary calculations based on limited publicly available data suggest that Greece could achieve 2% to 3% growth on an annual basis with a 20% to 40% reduction of debt, principal payment re-profiling, and a meaningful reform effort. The European banking system would likely experience a manageable loss of EUR23.2 to EUR46.4 billion.
• Today, the Greek situation is vastly more complex. Yet, principles from the ESC provide a framework for an honest assessment of the present situation as well as a potential pathway for resolution to the Greek debt dilemma.

Click here to read the full report.

Fact Sheet: A Historic New 5Y TIPS Auction
April 20, 2011

Senior Fellow Robin Lumsdaine illustrates how the Treasury auction of new 5Y Treasury Inflation-Protected Securities (TIPS), scheduled for Thursday, April 21, 2011, will be historic for a number of reasons. For one thing, the $14bn offering amount is the largest ever for a TIPS auction.

Many attributes render the TIPS market significantly more complex than nominal Treasuries. Factors such as inflation uncertainty, the optionality embedded in the deflation floor, and tax considerations associated with principal accretion are unique to the TIPS arena. But the mechanics of this particular auction have been made even more complex due to Treasury's amendment that adds new layer of uncertainty.

Click here to read the full report.

Treasury Maturities: The Other Fiscal Problem
March 10, 2011

The US fiscal situation is in even worse shape than conventional analysis suggests. Unfortunately, the deficit is only part of the fiscal problem.

Despite legitimate concerns regarding the budget deficit, large refinancings of debt represent an equally severe - yet lesser known challenge. The experience of Emerging Markets and some advanced economies suggests that as budget deficits widen, it is the repayment of principal that often triggers a crisis rather than simply the size of the debt or deficit.

The US Government is now more reliant than ever on domestic and international market participants.

In order to maintain and bolster the confidence of financial markets, officials must:

• Reduce the near-term budget deficit.
• Prioritize a bipartisan program to put the budget deficit on a long-term path toward sustainable levels.
• Slowly extend maturing US Treasury debt with a move over time to the more prudent US maturity profile of 1946.

Click here to read the full report.

Schuler Reviews Reinhart and Rogoff
March 3, 2011

Kurt Schuler, Senior Fellow in Financial History, reviews Carmen Reinhart and Kenneth Rogoff‘s “This Time Is Different: Eight Centuries of Financial Folly” in the latest issue of the Cato Journal.

The book has received deserved recognition for the wide-ranging data the authors gathered in support of their analysis. Schuler discusses why gathering the data was so important; identifies some remaining gaps; and explains why the absence of overt financial crises is misleading as an indicator of the financial stability of centrally planned economies.

Readers who wish to find statistics on the effects of financial crises will want to look at our Historical Financial Statistics data set, which Schuler edits and to which academics from around the world graciously contribute.

Click here to read the full review.

The New “International Currency System”
Lawrence Goodman
January 21, 2011

Chinese President Hu Jintao remarks that “the current international currency system is the product of the past.” We agree. In fact, market participants including central banks are already building the new international currency system.

Unfortunately, the health of this new system is fraught with the same serious threats as the old system.

• The Chinese yuan is the most undervalued currency in the world. China's heavy management of the currency creates distortions and obstructs development of a new strong and stable international currency system.
• China is reaching limits in its ability to control inflation - due in part to inflows of hot money and trade surpluses.
• Fiscal and monetary policies in the US undermine confidence in the dollar.

Uneven, Uncertain and Unusual Recovery
Lawrence Goodman and Yubo Wang
July 29, 2010

The nature of the present recovery is highly unusual. Uneven interactions among the drivers of GDP threatens a future of weak growth characterized by wide fluctuations and risk of a double dip. To see "Uneven, Uncertain and Unusual Recovery," Read More

Even IMF Lacks This Much Money
Lawrence Goodman
May 21, 2010

Peter Eavis is correct to question the capacity of the International Monetary Fund to serve as the "last lender of last resort," especially in a world characterized by increasingly extreme economic and financial events ("The IMF's Big Wager On Europe," Heard on the Street, May 13)...  Read More

Hidden Risks from Expanding Governments
Lawrence Goodman and Yubo Wang
May 11, 2010

CFS study of 37 countries reveals how enlarged government spending meaningfully dents the efficiency of investment and potential for future growth. In response to the financial crisis, Greece, the UK, and Spain implemented the loosest fiscal policies during the 2008-2010 period, among 37 nations evaluated. The US and Portugal are not far behind. The study includes policy recommendations for the IMF and US. Read More