From Davos, predicting the next economic crisis

Sunday, January 31, 2010

On the same day President Obama defended his handling of the economic meltdown in his State of the Union address, a panel of experts gathered in Davos, Switzerland, to debate where the next global crisis will come from. Their grim forecast: Some of the very measures that governments have taken -- or might take -- to fend off financial turmoil are only setting the stage for more trouble.

Harvard economist Kenneth Rogoff kicked off the Wednesday discussion with a simple, depressing argument: The banking collapse is morphing into a long-term crisis of government debt. Instead of financial panic, we now face an "illusion of normalcy," with governments stepping in to guarantee everything. They've succeeded in fending off another Great Depression -- great! -- but at the cost of skyrocketing debt. And if history is any guide, he said, financial crises are often followed precisely by a wave of sovereign debt crises a few years later. "In countries like the United States and Britain, I'm not talking about default, but we certainly may have to see very painful political crises," Rogoff predicted, "belt tightening, higher taxes, slower growth."

Rogoff, a former chief economist at the International Monetary Fund, believes we're fooling ourselves if we think otherwise: "We may tell ourselves we're better, we've figured things out . . . we're different. I submit to you: We're not."

Lord Peter Levene, chairman of Lloyd's of London, was up next, arguing that the prospect of overregulation poses the biggest threat. "I'm from the government -- I'm here to help," he said mockingly. "You guys in the industry don't know what to do, so we're going to fix it for you." He was followed by Jacob Frenkel, a former governor of the Bank of Israel, who maintained that the threat of trade protectionism looms large.

Yet, even in this World Economic Forum crowd, full of fund managers and chief executives, conventional pro-market arguments didn't seem to resonate. In an anonymous, electronic vote by the members of the packed auditorium, 50.7 percent agreed that government debt poses the biggest threat, 37.3 percent worried most about protectionism and only 12 percent feared overregulation the most.

So, what hard choices could be made to avert a government debt crisis, at least in America? In his State of the Union speech a few hours later, Obama would call for a three-year government spending freeze, not including national security spending or key entitlements. But Rep. Barney Frank, who attended the Davos session as one of the selected "challengers" for the three presenters, called for large cuts in defense spending as well as tax increases -- particularly on wealthy Davos types. "I think almost every American here pays much less in taxes than you ought to. I'm going to go back and try to raise the taxes of most of the people who attended here," Frank vowed.

At the end of the 80-minute session, the Massachusetts Democrat seemed pleased with his performance. "Maria, is this how Simon Cowell does it?" he asked CNBC's Maria Bartiromo, the moderator.

-- Carlos Lozada

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