US economists Carmen Reinhart and Kenneth Rogoff say that the good news from their historical study of eight centuries of international financial crises is that, so far, they have all ended. In their new book, This Time Is Different: Eight Centuries of Financial Folly, they say a failure to recognise the historical vulnerability of rich countries to financial crises lies behind the incredible conceit of Anglo-American policymakers that their gold-plated financial systems were invulnerable. Conceit and money are often two sides of the same coin.
Reinhart is professor of economics at the University of Maryland who has previously worked at the IMF; Rogoff is a professor of economics at Harvard University and he is a former chief economist at the IMF.
The authors say the economics profession has an unfortunate tendency to view recent experience in the narrow window provided by standard datasets. With a few notable exceptions, cross-country empirical studies on financial crises typically begin in 1980 and are limited in-several other important respects. Yet an event that is rare in a three decade span may not be all that rare when placed in a broader context.
They say their dataset reveals that the phenomenon of serial default is a universal rite of passage through history for nearly all countries as they pass through the emerging market state of development. This includes not only Latin America, but Asia, the Middle East and Europe. The authors also find that high inflation, currency crashes, and debasements often go hand-in-hand with default. Last, but not least, they find that historically, significant waves of increased capital mobility are often followed by a string of domestic banking crises.
They explore the history of financial crises dating from the mid-fourteenth century default of Edward III of England to the present subprime crisis in the United States.
The book illustrates the near universality of episodes of serial default and high inflation in emerging markets, extending to Asia, Africa, and until not so long ago, Europe. It shows that global debt crises have often radiated from the centre through commodity prices, capital flows, interest rates, and shocks to investor confidence. It also shows that the popular notion that today’s emerging markets are breaking new ground in their extensive reliance on domestic debt markets, is hardly new.
This brings them to their central theme - - the “this time is different syndrome.” They say there is a view today that both countries and creditors have learned from their mistakes. Thanks to better-informed macroeconomic policies and more discriminating lending practices, it is argued, the world is not likely to again see a major wave of defaults. Indeed, an often-cited reason these days why “this time it’s different” for the emerging markets is that governments there are relying more on domestic debt financing.
The authors say such celebration may be premature. Capital flow/default cycles have been around since at least 1800 - - if not before. Technology has changed, the height of humans has changed, and fashions have changed. Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained a constant. They refer to economist Charles Kindelberger who "wisely titled the first chapter of his classic book 'Financial Crisis: A Hardy Perennial.'”
The authors say the recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11–12 percent in 2011.
This paper by the authors, provides a good flavour of their panoramic theme.
