Eight Centuries of Financial Folly
Carmen M. Reinhart and Kenneth S. Rogoff Princeton, NJ: Princeton University Press, 2009.
Have you ever encountered a book in your field of inquiry that upon reading, you knew the book should be put on that special shelf reserved for favourites?
That the book was so fundamentally good and strong that you would be reading it again and again and referring others to do the same?
Before explaining why I feel this way, I should explain the unusual name the authors chose for this book.
This Time is Different is a title that might seem more at home on a gothic novel than a public finance treatise. But this is no novel.
The title captures the theme of statements made inevitably by individuals in authority when pontificating about a budding financial crisis.
Whether because of new financial market regulations, an independent monetary authority, wiser and more dedicated political leaders or because of new high speed technology that links together world markets, the thought expressed by those in charge seems always the same. We will make it this time without experiencing undue difficulties. This time is different.
The recurring problem is also always the same: When a country continually borrows so that it can consume more than it produces, credit market chickens eventually come home to roost. What looks like an unlimited expansion of credit will hit its limits.
This Time is Different is a very special kind of book to me for a number of reasons.
First off, the book is obviously the result of a massive research project that involved building data bases on financial crises for hundreds of countries across hundreds of years. Just getting the 58 tables is worth the price of the book. Indeed, the table that gives the dates and brief descriptions of financial crises by country is 48 pages long!
Among the data tidbits is a chart that gives share of world GDP by country for 1917 and 1990. China accounted for 8.80 per cent of world GDP in 1917. Are you surprised that its 1990 share is lower? I was. It was 7.70 per cent. India’s share fell from 7.47 per cent in 1917 to 4.05 per cent in 1990. The United States’ share rose from 18.93 per cent in the first period to 21.41 per cent in 1990. To say the least, the data are interesting, if not surprising.
It is also obvious that the two authors, who are noted scholars in their own right, have rigorously defined terms and conditions to organise and analyse their data. For example, the book’s first part is an “Operational Primer,” which comes to grips with ways to define currency crises, defaults and debasement of currency and to identify critical quantitative thresholds for deficits, debt and monetary expansion.
The authors explain, analyse, compare and draw logic-based conclusions. And there is plenty to consider. Of 66 countries analysed from 1913 to 1990, just 16 have never defaulted on debt: Australia, Belgium, Denmark, Finland, Hong Kong, Korea, New Zealand, Malaysia, Mauritius, Netherlands, Norway, Singapore, Sweden, Taiwan, the United Kingdom and the United States. Incidentally, Greece, much in the news recently, almost holds a blue ribbon as a leading debt defaulter. The country was in default almost continually from the 1800s to World War II.
After building a deep empirical and historical context, the authors devote some 90 pages to the recent US subprime crisis. Unlike books such as William Cohan’s House of Cards and Henry Paulson’s On the Brink, which provide almost novel-like stories about the meltdown or Richard Posner’s A Failure of Capitalism, Thomas Sowell’s The Housing Boom and Bust and Robert Shiller’s The Subprime Solution, which give policy-based explanations of the meltdown, Reinhart and Rogoff provide an explanation that draws on their long and deep analysis of similar past events.
I expect This Time is Different will be read far more frequently 10 years from now than the other good books.
At the end of the book, the two authors give a brief account of what they have learned from their study.
The first lesson is that the “This time is different” attitude still seems to prevail among people in authority. This says that signals of approaching financial disaster will emerge but will tend to be dismissed, because people in charge believe they are either smarter, faster or insured differently.
Put another way, we do not learn from our past mistakes. A second lesson relates to the difficulty of really knowing what governments are doing with money, deficits and debt. Politicians are expert at rearranging balance sheets, using off-budget gadgetry, forming government-sponsored enterprises and in other ways burying financial bad news. The plea is for transparency. A third lesson relates to the length of economic harm done when financial crises hit.
Recovery takes years, not months.
Reinhart and Rogoff have produced a book that will be active for a long time. Those who want to see more data and read more history than stories about financial crises will want this book.