Willem Buiter on Dubai World

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Willem Buiter on his FT blog about why Dubai matters:

The massive build-up of sovereign debt as a result of the financial crisis and especially as a result of the severe contraction that followed the crisis, makes it all but inevitable that the final chapter of the crisis and its aftermath will involve sovereign default, perhaps dressed up as sovereign debt restructuring or even debt deferral. The Dubai World and Nakheel debt standstill and possible default is of systemic significance only because it may well be a harbinger of future sovereign financial distress, in Dubai and elsewhere.

From Dubai to Iceland, Ireland, Greece, Hungary, Italy, Portugal, Spain, Japan, France, the UK and the USA, the sovereign debt burdens have been at current levels during peacetime only on the way down from even higher public debt burdens incurred during wars.  Watching the pubic debt to GDP ratios rise to levels likely to reach or exceed 100 percent of GDP by 2014 is deeply worrying, especially with structural primary (non-interest) deficits as high as they are.  The political economy of fiscal burden sharing, inside nations and between nations, will be a major field of enquiry for economists and political scientists during the years to come. I am pessimistic in that regard about countries characterised by deep polarisation and political gridlock.  This includes nations as different as Greece and the USA.

It is clear that nations whose public debt is mainly denominated in domestic currency and whose central bank is either not very independent or can be make dependent by the government of the day are likely to choose inflation and exchange rate depreciation over default as a way out of fiscal-financial unsustainability.  That category would include the USA and, to a lesser extent, the UK.  Because the ECB faces 16 national governments and national ministries of finance, the power and independence of the ECB are much greater vis-a-vis any Euro Area member state than the power and independence of any central bank facing a single national government and Treasury.  That is regardless of the formal independence criteria laid down in laws, treaties or constitutions.

The practical implication of this is that the ECB will not monetise the government debt and deficits of small European Area member states... For small peripheral European nations, the threat of sovereign insolvency is therefore a real one, unless EU fiscal solidarity can be relied upon to bail them out.



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