The central premise of “This Time is Different: Eight Centuries of Financial Folly," (Princeton University Press, 2009) is that people need better time series data for studying the history of financial crises. The authors, Carmen Reinhart and Kenneth Rogoff, believe that researchers, as well as practitioners, who have studied instances of financial crises, have neither a long enough nor a broad enough historical perspective to really understand the commonalities that exist in all cases of financial disruption.
In an attempt to correct this deficiency, Reinhart and Rogoff build a database of relevant information which they believe will contribute to the better understanding of what a country, or the world, experiences before, during, and after a financial crises. They have collected data from sixty-six different countries and their sources go back eight centuries.
They then attempt to work with these data in an effort to begin to unlock the nature of financial crises. They humbly argue that their efforts are only the beginning of more complete and extensive studies of this particular subject and hope to see substantial additional work in this area. Their work is very academic and dry in terms of viewing and reading page after page of charts and descriptions of what they have found in the data they have collected.
The basic conclusion that is reached in reviewing so many instances of financial crises is that one of the psychological attitudes that is present in case after case is that those in authority tend to believe that their situation is unique; that “this time is different.” And this hubris contributes to the crises that follows because it lends credibility to the growth in confidence that the good times will continue to continue.
Obviously, I cannot go deeply into the details that are presented in the book nor can I go into many of the tentative conclusions they have reached during their study. So, I will try and summarize some of the points that I believe to be their most important ones.
Reinhart and Rogoff start right out with the following statement: “If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom.” However, “Although private debt certainly plays a key role in many crises, government debt is far more often the unifying problem across the wide range of financial crises we examine.”
And, what is one of the major factors that accompanies this excessive debt accumulation? “A clear inflationary bias throughout history emerges.” Why? “Early on across the world the main device for defaulting on government obligations was that of debasing the content of the coinage.” The modern printing presses have just provided a technologically more advanced and more efficient approach to this process. Consequently, “Starting in the twentieth century, inflation spiked radically higher. Since then, inflation crises have stepped to a higher plateau.”
Inflation, as the authors show, can be found not only in terms of the purchases of goods and services, but can also be seen to take place in asset prices. And, rising asset prices is one of the important precursors to a financial crisis. In all, Reinhart and Rogoff focus on four precursors: markedly rising asset prices, slowing real economic activity, large current account deficits and sustained debt bubbles. And, this buildup continues and is supported by the growing confidence, not only of market participants, but of the leaders and policymakers in government. This is where the title of the book comes from: “This time is different.” This time the bubble won’t burst.
The problem is that it is not different. The growing level of confidence, at some time, collapses. “Economists do not have a terribly good idea of what kinds of events shift confidence and of how to concretely assess confidence vulnerability. What one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does.”
“Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence—especially in cases in which large short-term debts need to be rolled over continuously—is the key factor that gives rise to the this-time-is-different syndrome.”
And, because of this “precariousness and fickleness,” the economist finds it very difficult to build models that include investor confidence, especially in a way that can predict when the confidence bubble is going to burst. Furthermore, the economist has found it very difficult to build debt and debt levels into their models so that their models do not capture the risk buildup that occurs as the use of debt increases and spreads through a society during a period of economic expansion. These problems create the need for developing information on more financial crises in different times and in different places. Discerning a potential financial collapse is still more of an art than it is a science.
As mentioned above, this book is primarily aimed for an academic readership. In the first part of the book, in addition to discussing the data base they have assembled, Reinhart and Rogoff discuss many specific topics of financial crises: things like external debt crises, sovereign debt default, domestic debt, banking crises, inflation and modern currency crashes, among other subjects.
The last part of the book the reader might find more interesting to read and it can be read independently of the first part. Here, Reinhart and Rogoff discuss the United States Subprime Mortgage Market Meltdown and the “Second Great Contraction.” They do not like the terminology surrounding the term depression, and so follow Milton Friedman and Anna Schwartz and write about the Great Contraction of the 1930s and, hence, the Second Great Contraction, because the current downturn is only surpassed by the earlier great contraction and because the situation we are experiencing right now is the only other financial crises, along with the great contraction, to be worldwide in nature.
Thus, the authors examine the current financial crises within the framework that has been developed in the first part of the book. The work concludes with some reflections on what they have learned and the possibility of developing some early warning signals to identify impending disaster. They conclude, however, that “The greatest barrier to success” in developing an effective and credible early warning system, “is the well-entrenched tendency of policy makers and market participants to treat the signals (of distress) as irrelevant archaic residuals of an out-dated framework, assuming that old rules of valuation no longer apply.”
