This time is no different

Carmen Reihhart and Ken Rogoff explain why we are likely to face a wave of fiscal crises in the wake of the banking crises. This stems from the research in their magisterial book. Their point is simple, but important:

In previous cycles, international banking crises have often led to a wave of sovereign defaults a few years later. The dynamic is hardly surprising, since public debt soars after a financial crisis, rising by an average of over 80 per cent within three years. Public debt burdens soar owing to bail-outs, fiscal stimulus and the collapse in tax revenues. Not every banking crisis ends in default, but whenever there is a huge international wave of crises as we have just seen, some governments choose this route.

What will complicate the response is not only the short-term political focus on employment, but also the fact that many emerging economies (which are not in such bad shape) still rely on the US as a market for goods. It is still not clear how the world will re-balance to smaller US external deficits.

While our institutions our better now -- better Central Banks and the IMF -- it is still not clear if governments will respond to this challenge. But beware Reinhart and Rogoff's warning:

Markets are already adjusting to the financial regulation that must follow in the wake of unprecedented taxpayer largesse. Soon they will also wake up to the fiscal tsunami that is following. Governments who have convinced themselves that they have done things so much better than their predecessors had better wake up first. This time is not different.