A reckless path

Economist Vito Tanzi grew up in Italy, gained a Harvard Ph.D., became a senior staff member of the International Monetary Fund for 27 years, and is now honorary president of the International Institute of Public Finance. Here are edited excerpts of our interview.

Was Argentina when you first went there in the 1960s better off than it is now? I was living in Washington at the time, and my first impression of Buenos Aires was that I was going from a village to a metropolis. Argentina started as a welfare state when it was still a very rich country relative to other countries, but once you created a new mentality, you created a lot of vested interests. Argentina had a very wealthy agricultural sector but did not use that money to accumulate resources for bad days. It used it to hire additional people and expand the welfare state—and eventually got into difficulty in the 1970s and 1980s.

Should countries follow some basic rules to avoid economic failure—such as, “Don’t make slicing up pies more important than baking new pies”? Yeah. Some people say keep spending and it doesn’t matter. The U.S. is moving in a very dangerous direction: If it continues to have a fiscal deficit of 4 or 5 percent per year, so the debt keeps going up, at some point there will be problems. But the first responsibility of a country is to keep its macroeconomic data in equilibrium: You cannot run a large fiscal deficit for a long time without paying a price. The second one is related to the first: You cannot spend for welfare more money than you have.

Is Modern Monetary Theory, which is becoming popular among some U.S. politicians, an attempt to rely on magic: run deficits but don’t have to pay up, eventually? Yeah, it’s become a cult. In the last two years we have not had much inflation, so the U.S. government has been able to borrow a lot of money with very little immediate cost. There are problems. Pension funds are not accumulating assets, and people when they reach 65 will find out the problem with that.

What lessons does the experience of Argentina hold for the United States? Bad habits: too much spending in relation to taxes. If you spend too much and don’t have a high savings rate, you have to sell more and more bonds. The public debt of the U.S. is slowly approaching the level of Italy. You project this for 10 years more and you could have a disastrous situation where the debt has grown so much that people would not want to buy it anymore.

The public debt of the U.S. is slowly approaching the level of Italy.

Then comes hyperinflation. Argentina President Juan Perón, who kept expanding the welfare state, dies in 1974. Inflation in Argentina hits 183 percent in 1975, 444 percent in 1976. How does that happen? Two things. First, the central bank creates more and more money to finance the fiscal deficit. People begin to anticipate that prices will be higher next month than they are today, so they buy all kinds of things, essentially running away from money, and inflation starts zooming up. The moment this happens is always uncertain.

In the 1980s Argentine inflation slowed down but then jumped again: 400 percent in 1988, 5,000 percent in 1989. What happened? The bad habits came back. The government started spending more than it should.

Don’t people learn from the past? When the government repeatedly defaults on loans, does that make it difficult to get more loans later, with higher interest rates required? Carmen Reinhart and Kenneth Rogoff, in This Time Is Different, presented lots of historical data related to your question. The answer: People continue to be fooled. They hear lots of good promises. They’re looking for a higher rate of return. Right now many junk bonds are sold in the U.S. because the alternative is to get 0 or 1 percent, but you can get 7 percent by lending to a risky place. The temptation is to do that.

So the U.S. has a big junk bond problem now? Definitely. It’s a huge amount of debt. Investment companies say they spread the risk over many giant bonds so if one goes broke, they still get from the other. That ignores the systemic risk when you have a recession that affects everybody.

You’re saying what has happened in Argentina could happen here? It’s less likely. The dollar is still a world currency. But if you keep drinking too much alcohol, there’s a problem. When you have almost no unemployment and you have a fiscal deficit of 5 percent, you begin to worry. What will happen if unemployment goes to 10 percent?

Keynesian theory allows for deficits in bad times, but we’re now running deficits all the time. Yeah, and most governments don’t spend money on the most productive projects. They fund money for welfare or a group that should not be getting the money, and they’re inefficient.