By John Mauldin

And, as Rogoff and Reinhart showed through their massive data collection and work on sovereign debt crises, published in This Time Is Different and elsewhere, debt is not a problem until it becomes one. And then it reaches a critical mass and you have what they called the Bang! moment.

I want to review some of their work, which will help us understand the reasons for austerity, but first let’s deal with the controversy of the moment. There has been some considerable debate this week among economists about a paper Rogoff and Reinhart published after they wrote their book. Recent detailed work suggests the analysis in that paper is flawed and that there are actual programming errors in their spreadsheets. My inbox almost exploded the last two days as friends and colleagues sent me links to multiple sources talking about the problems with Rogoff and Reinhart’s work and asked for my thoughts. Given that I find This Time Is Different one of the more important books of the last decade, let me provide some context.

In 2010, economists Carmen Reinhart and Kenneth Rogoff released a paper, “Growth in a Time of Debt.” Their main result was that “… median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.” The work suggested that countries with debt-to-GDP ratios above 90 percent have a slightly negative average growth rate.

This has been one of the most cited stats in the public debate during the Great Recession. Paul Ryan’s Path to Prosperity budget states that their study “… found conclusive empirical evidence that [debt] exceeding 90 percent of the economy has a significant negative effect on economic growth.” The Washington Post editorial board takes the R&R conclusion as an economic consensus view, stating that “… debt-to-GDP could keep rising – and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth.” (from the Next New Deal site and many other links sent to me)

Next New Deal ( had this analysis:

In a new paper, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts, Amherst successfully replicate the results. After trying to replicate the Reinhart-Rogoff results and failing, they reached out to Reinhart and Rogoff, and they were willing to share their data spreadhseet. This allowed Herndon et al. to see how how Reinhart and Rogoff’s data was constructed.

They find that three main issues stand out. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. All three bias in favor of their result, and without them you don’t get their controversial result.

(You can get further details at And there are other sources here and here.)

I and many others who are concerned about the growth of debt quoted that research. As we approach that 90% level in the US, it has become a prominent feature in certain circles. But I want to emphasize that The Rogoff and Reinhart paper mentioned above is a later work than their book. To my knowledge, no one is disputing the work in their book. Their book, This Time Is Different, is basically just an analysis of their very large and masterful accumulation of data about sovereign debt crises.

For the last two weeks I have talked about economists and their use of data. I pointed out that inflation as measured by the CPI is an average for the country and not reflective of any one person’s actual experience.

Something similar can be said about the later work of Rogoff and Reinhart. Yes, there was an unfortunate formula in one cell of their rather complex spreadsheet; but more importantly, they made assumptions about what is important and what is not in creating their analysis, and the assumptions in their model gave one set of results. If you make different assumptions, you get other results that show that 90% is not all that bad. Just as economists argue about how we should compute inflation, there will now be arguments about what the debt-to-GDP numbers really mean. I am willing to bet that by this time next year we will see several studies, all arriving at different conclusions.

But in any case, whether in their original work or in the later paper, R&R describe a problem with excessive debt that is true on average. Actual experience shows that in some countries debt will create a problem at quite low levels, while Japan climbs toward 250% debt to GDP (and will get there all too soon) and hardly anyone blinks. Different pokes for different folks.

I’m going to toss in a quick note as I sit here in Hong Kong waiting for my next plane. I read the Financial Times while on the way up here from Singapore. There were several articles that seemed to rejoice in the fact that Rogoff and Reinhart’s later paper has some flaws. They jumped on those errors to discredit the whole idea of austerity, the association between too much debt and a lack of growth, and the need to bring one’s fiscal house into order. Why pursue austerity when it does not lead to growth, which everyone knows is the only real way to deal with debt?

You can almost hear the critics wanting to dismiss Rogoff and Reinhart’s entire book, which clearly establishes the link between excessive debt and sovereign debt crises – a pattern that has played out some 266 times over the last few centuries, if I remember correctly. The point is that there is no magic number that says “This far and no farther.” There is a mythical line where confidence and trust is lost, but no one knows where that line of demarcation is until it is crossed. And right up until the last minute, there are always those who look for ways to add more debt, who assure us, “This time is different.” But it never is. A country can restore its fiscal house to order, pay back its debt, and grow its way out of the problem over time; there are numerous examples. But continuing to grow that debt-to-GDP number is to court a disaster that looms right in front of you.

If politicians want to keep the borrow-and-spend party going “just one more election cycle” and if no one takes away the punchbowl, the Bang! moment will most certainly arrive. That is the clear lesson of history. It is almost irrelevant whether that number is 90% or 120% or 80%. It will be a different number for each country, depending on the confidence that investors have in the ability of a country to pay back its debt. Investors in sovereign debt are almost by definition the most risk-averse investors there are. You do not invest in a country’s debt to increase your risk exposure; you expect to get paid. There are other factors at play in determining the critical threshold, too: What was the purpose of the debt? How fast is the economy growing?

Can Italy, beset by recession, high unemployment, and a political crisis, grow its debt-to-GDP to Japan’s 240% level? I think any serious observer would say no. Can it get to 130%? 140%? Maybe. We will not know until it’s too late whether Italy or any other country (Spain, Japan, France, or the US) has more debt than the market is willing to absorb. But that is a line any politician should want to avoid crossing.

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