High debt levels translate to slower growth, according to Vincent Reinhart. That conclusion will be disheartening to those who jumped on the errors several University of Massachusetts scholars found last month in Carmen Reinhart (Vincent’s wife) and Ken Rogoff’s research. But Vincent Reinhart is the author, along with his wife and Rogoff, of a study published in 2012 that documented the degree to which high debt-to-GDP levels correlate with slower economic growth in developed countries.
Reinhart is an economist and the co-head of global economic research at Morgan Stanley. He is also an expert on monetary policy, and teamed with Ben Bernanke to research the effects of unconventional monetary policies, prior to when Bernanke became Federal Reserve Chairman in 2006.
He spoke May 23 at a lunch sponsored by the Boston Security Analysts Society.
Reinhart said the U.S. economy is set to grow between 2.75% and 3% over the next several years, which implies that U.S. equities are favorably valued and that unemployment will not deteriorate. But he said that if he is wrong and growth is only 2%, then the U.S. faces big problems.
He also said the aggressive monetary policies undertaken by the Bank of Japan may succeed in producing the desired rate of inflation and economic growth – and the implications for investors are clear.
“It's extremely dangerous to express doubt about macroeconomic policy by shorting a security the central bank can buy,” he said.
Don’t short Japanese government bonds (JGBs), since the Bank of Japan will be buying them, and be equally cautious about shorting U.S. Treasury bonds while the Fed is engaged in quantitative easing (QE), according to Reinhart.
I’ll discuss Reinhart’s outlook for the U.S. and Japan. I’ll then turn to his remarks about the relationship between debt and growth and offer my own thoughts on that issue.
The outlook for the U.S. economy
Reinhart’s outlook for the U.S. is rooted in his research on financial crises and deleveraging. He said that 10 years after a financial crisis such as the one the U.S. experienced in 2008, per-capita GDP is typically 15% below the trend from the prior decade. That takes a significant toll on aggregate demand and supply, and financial intermediaries need to deleverage and de-risk in order for a recovery to take hold.
Fortunately, U.S. financial institutions have done so, partly as a result of regulations and stress tests imposed on banks, according to Reinhart.
“Nowhere is this clearer than in housing,” Reinhart said. House prices are rising, he said, and household balance sheets are improving. He doesn’t expect a smooth recovery in housing, though, because there is too much pent-up supply of houses not yet on the market.