The International Monetary Fund (IMF) is delivering harsh words to the world’s two largest advanced economies, the US and Japan. Their debt levels are at a point where things can turn and turn fast.
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But safe-haven flows into both countries are making investors and policy makers complacent, increasing the potential for an even greater sovereign debt crisis than Europe’s.
In both countries, debt levels are rising but interest rates are at historic lows. Investors have flocked to the two countries as safe havens from the European crisis.
But if Europe manages to temper its crisis and officials in the US and Japan fail to reduce their budgets, those inflows could become outflows.
This would endanger the financial systems of both countries, whose currencies have long been considered the world’s safest.
Long-term interest rates in the US are about one percentage point lower than they would be without the euro crisis. Market metrics say that is too low.
Risks to both countries’ systems may not be realized in the near term but action should be taken
soon to decrease both systems’ vulnerabilities. An increase in interest rates would attract foreign buyers, reducing the value of bank holdings and increase stress on bank balance sheets.