Crisis in Context: 'This Time is Different: Eight Centuries of Financial Folly,' by Carmen M. Reinhart and Kenneth S. Rogoff 14 comments
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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.”
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Yes to debt being a common theme. Yes to screw ups by the central banks or equivalents. Yes to hubris, greed, the herd syndrome and general stupidity of the species etc. Yes the emperor has no clothes. Yes You can't see the forest for the trees.
But "THIS TIME IS DIFFERENT" we're going to do something more outrageous than the last bunch of clueless idiots.
And I haven't even mentioned the POLITICIANS yet
seekingalpha.com/artic...
“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.”
Well, this time is different! We are the USA! The world bows at our feet!
Meanwhile China is using our money (from us purchasing the things they make - things we used to make ourselves) to forge relationships with those that hate us and vow to destroy us. Venezuela, Iran, Cuba, countries in Africa that are becoming Muslim dictatorships.
It shouldn't take a genius to figure out the end game in China's expenditures. For the clueless, it isn't our success and well being they are buying.
This is one of the premises of Niall Ferguson's arguments. He views things from an historical perspective and thus, I think, would agree with the conclusions of the authors of this book.
DavidC
The best model I've seen for anticipating major trend changes is the Elliott Wave Principle. It, too, is all about evaluating market psychology. And it's far from perfect, but it's the only model that has identified every significant market top and bottom since its discovery in the 1930s. Better to have some chance than no chance at all.
Alas this time it is indeed different. America is going to go bankrupt under the lunatic Dems spending the country into poverty to follow a leftist dream.
On Nov 07 05:09 AM Roger Knights wrote:
> A recent SA article in a similar vein is "Yet Another Finger of Instability"
> (see link below), which in turn recommends a book by one Buchanan
> (with link).
>
> seekingalpha.com/artic...
1) Government spending including stimulus: "...government debt is far more often the unifying problem across the wide range of financial crises we examine.”
2) Monetary inflation (money-printing): “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 key elements of the Keynesianism (at least the vulgar version practiced currently in the U.S.) are government spending and monetary inflation. I agree with the authors that Keynesianism is folly.
To put it another way, "Everything I see in the world today is a 3-D version of an 80-year old black and white movie" (with a few names and details changed).
The 4 most dangerous words in finance. When will people learn, times change and the little things might be different, but ECONOMIC FORCES DON'T CHANGE. Debt is debt and it doesn't magically disappear. Who are the morons that believe this junk, oh yeah Alan Greenspan.
"Every time is different to the present observer because he or she has no historical perspective." The problem with this observation is a lot of the people who say "this time its different" are typically old enough to know better.
ValueInvestor,
Who again coined the phrase "irrational exuberance"? I remember hearing people scream in response: "This time its different". Maybe the timing on irrational exuberance was off but it was essentially correct.