Financial crises are Harvard professor Carmen Reinhart’s core area of expertise. She expects the global economy to suffer a series of shocks in the years ahead – with the dangerously high level of U.S. debt as the likely cause.
The current economic environment is ripe for accidents and economic shocks, says Harvard economist Carmen Reinhart.
Ms. Reinhart, you specialize in the study of global financial crises. We are currently experiencing massive upheavals globally that seem very chaotic. Do you see a pattern behind it all?
The key issue for me is the increase in uncertainty. In a period of upheaval, many things suddenly seem unstable. In such a world, people no longer know what to use as a point of reference. We saw a similar situation in the 1970s, when high inflation rates led to a severe loss of confidence. But one thing has changed significantly: Debt levels at that time were only a fraction of what they are today.
Debt has exploded and, at the same time, the pace of economic growth has slowed. This is making it increasingly difficult to grow out of this debt.
What makes today’s debt so dangerous is that the world has benefited from the «Great Moderation» in recent decades. Economic fluctuations have been more moderate than in the past and, in parallel, interest rates have fallen dramatically. As a consequence, taking on debt has cost us less and less.
Will we lose these advantages going forward?
In the early 1980s, we initially experienced a period of high market volatility and low debt. We then entered a phase of declining volatility, but with rising debt levels. Now, however, both volatility and debt are on the rise. This combination lays the groundwork for accidents and economic shocks. We are then adding the increasing levels of geopolitical hostility, a factor that worries me greatly.
Let’s come back to the dangers of high levels of debt. U.S. President Donald Trump is fueling the country’s national debt with his «Big, Beautiful Bill.» If passed, this budget bill is likely to result in an ongoing budget deficit of more than 6% of GDP.
That is highly problematic. The government should actually be looking at how it can reduce the debt burden. But it is very far from doing so. The bill under discussion does not even recognize the urgent need to at least stabilize the debt. It is also worrying that the government is counting on tariff revenues as a substantial source of funding for the national budget, even though it remains completely unclear how high these revenues will actually be.
The United States is one of the richest countries in the world and has a strong economy, so the country can afford to take on more debt.
Nevertheless, that debt is costing us an enormous amount of money. Last year, the U.S. government spent 12% of its budget on interest payments. This is by far the highest such share among Western countries. To find a similarly high debt-service burden, we have to look back to the situation in Greece 10 years ago. Even if the U.S. has enjoyed higher levels of prosperity, this development does not come free of charge. Ultimately, someone has to pay for it.
Who will foot the bill? Primarily savers?
There have been only four periods in history when real interest rates were negative: during the two world wars, in the 1970s due to high inflation rates, and since the financial crisis of 2008. From a historical perspective, the current situation is therefore a special case. There is a risk that this creeping erosion of savings will develop into lasting financial repression. This will depend, for example, on whether central banks are able to maintain their independence in the future or are instead instrumentalized by the state.
But can’t the low interest rates also be explained by natural factors, such as demographic aging and slower productivity growth? Some economists speak of an era of «secular stagnation.»
I don’t deny that these forces have an influence. However, there is another important factor: Following the financial crisis, central banks explicitly set out to achieve low interest rates. To this end, they resorted to extraordinary measures, such as purchasing government bonds. This is why the independence of central banks is such a key issue.
Is there a risk that the markets will at some point abrupty rebel against rising government debt levels? The United Kingdom experienced this in 2022 with its «Liz Truss moment.» When she announced tax cuts as prime minister, interest rates on government bonds shot up uncontrollably, ultimately forcing her to resign. Could something like this happen in the United States?
Absolutely. A market rebellion could also lead to an abrupt devaluation of the currency. Take Japan, for example. The weakening of the yen in 2022 met the Reinhart-Rogoff definition of a currency crash, with a loss of more than 15% within a year. The markets reacted similarly to Trump’s tariff plans in April. Normally, money flows into the United States when uncertainty increases. Instead, investors have withdrawn their capital. In today’s environment, we have to expect an increase in such accidents.
Could the recent flight from the dollar escalate into an even bigger crash?
Is a dollar crash possible? Absolutely. Would such a sharp decline mean that the dollar would also lose its status as a global reserve currency? Of course not. Take the collapse of the Bretton Woods system: The monetary order created after World War II, with the dollar as the anchor currency and its basis in the gold standard, fell apart abruptly in the early 1970s. At that time, too, the U.S. was suffering from a high current account deficit. The dollar lost half its value in just a few years. However, it has retained its global dominance because no other currency can offer anywhere near the same level of liquidity.
If there is another dollar crash, this would have devastating consequences for foreign owners of currency reserves. The Swiss National Bank alone holds U.S. assets worth $300 billion. In an extreme case, it could lose over $100 billion.
Well, you asked how debt could be reduced. The simple answer is: By allowing its value to erode. For the domestic population, this can be done via inflation. In the case of foreign creditors, however, currency devaluation is a tried-and-tested measure. Often, both happen simultaneously.
Debt crises are her specialty
sal. Born in 1955, Carmen Reinhart has had a long academic career and is one of the most influential economists working today. She co-authored her best-known book, «This Time Is Different,» with Kenneth Rogoff. In it, the two examine the history of financial crises. From 2020 to 2022, the Harvard professor also served as chief economist at the World Bank. Reinhart has been considered a contender for the Nobel Prize in economics for years.
Within the Trump administration, the prevailing opinion is that the dollar is overvalued. According to this interpretation, its status as a reserve currency has driven up the exchange rate, which in turn has undermined the country’s competitiveness and destroyed its industrial sector. Do you agree with that?
In principle, I agree. Other countries’ foreign reserves are effectively a problem for the United States. Switzerland is also familiar with this situation. Your country is also resisting a currency appreciation, which is why the Swiss National Bank has responded with foreign currency purchases.
So is the U.S. a victim of globalization? And are the tariffs a legitimate countermeasure?
It’s not that simple. The United States’ problem relates to its twin deficits, which have both existed for many years but have recently grown significantly. This includes not only the current account deficit with other countries, but also the government budget deficit. This brings us back again to the «Big Beautiful Bill.» The most direct way to get the current account back on track would be to balance the federal budget. This is because the U.S. needs to increase its savings rate, and the government could make a significant contribution to this. Instead, Donald Trump now wants to take on even more debt. Therefore, higher tariffs will not do much to reduce the current account deficit, unless they were to cause a global financial crisis. This would also result in a decline in imports.
Even if you reject Trump’s tariff plans, you support the statement that globalization has gotten out of hand. You pointed this out a long time ago in your academic work. What went wrong?
Many economists have done a really poor job of assessing globalization. They have focused one-sidedly on the fact that trade led to lower prices for consumer goods. They largely ignored the fact that globalization also produced losers. The backlash had therefore been looming for some time. With Trump, however, it has now accelerated significantly.
Is it conceivable that a transition to a new order might succeed without triggering a financial crisis?
That’s difficult to say. In my view, the phase of deglobalization already began with the last financial crisis in 2008. However, the trend toward greater protectionism will increase. This will undoubtedly lead to disruption and shocks. The crucial question for me is whether it will be possible to reduce the twin deficits I mentioned before on a steady basis, or whether there will instead be an abrupt adjustment, as in the case of Greece, for example.
Instead of government deficits declining, we are seeing an unchecked rise. This speaks against a gradual solution to the problem.
Politicians like to spend money. It is much easier to accumulate debt than to reduce it. And there are no magic formulas for getting rid of it. In an ideal world, countries could grow out of their debts. What is more realistic is that there will be a mix of austerity measures, inflation, financial repression and debt-restructuring programs. However, this implies that we must prepare ourselves for uncertain times.
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