I’m not sure whether this is the time for this book, or this is a book for our time. Either way, you know that if it had been published five years ago a few people would have read it, said so what and carried on looking for the next bubble to invest in. Instead it is a statistical parable of our age, a treasure trove of information accumulated through impressive hard work and a lesson on what we should all have seen coming, but mostly didn’t.
In simple terms they have collected data going back as far as they can (in some cases the 13th Century) on financial crises together with relevant economic data. Together it gives a crushing lesson on the financial mistakes that man has made and his repeated failure to learn from them – each time using the title ‘This time is different’. But it rarely is.
They split the crises into different categories – external sovereign debt defaults, internal sovereign debt defaults, banking crises, inflation and currency crashes. Some of the statistics are truly sobering – for example, Greece has spent half of the last 200 years in default, or that even in our ‘benign’ recent decade between 10% & 20% of the world’s countries have been in default. Occasionally some stories are amusing, such as Gregor MacGregor’s sale in 1822 of £160,000 of debt for the fictional South American country of Poyais.
There many important results and conclusions in the book, far to many to summarise here, but I shall mention two that made a strong impression on me, and I found a little disturbing.
There is a small group of countries who have never defaulted on their external sovereign debt – including the US, most of Scandinavia and a few south east Asian countries. Mostly these are successful growth stories. There is a smaller group of countries (from a sample of over 60) that have graduated from serial defaulters to steadier, stable countries. These are predominantly in ‘old Europe’ – such as UK, France & Germany – with long debt histories. Unfortunately there is insufficient evidence to determine how a country graduates away from being a serial defaulter. Basically very few countries have ever done it and the mechanism in each case seems to have been different each time. It is sobering for those countries with histories of problems – Greece instantly springs to mind – that discarding the legacy of the past is not only hard, but the way to do so is not understood. That the refuge of the Euro for the PIGS economies (Portugal, Ireland, Greece, Spain) may not prove enough has been clear for a while. It is disturbing that noone can really be sure what to do instead.
The second disturbing conclusion is that while at least some countries have managed to stop defaulting on their sovereign debt, none have graduated from banking crises. A mere glance at the US even in my own working career suggests a certain instability – Latin America in the mid-80’s, Saving & Loans in the late 80s/early 90s, Asia/LTCM/Russia in 1997/8 and the most recent crisis. Throw in a few other emerging markets problems and its not hard to get concerned. But Reinhart & Rogoff extend that list to anything I could ever dream up. Its enough to make one wonder if there is something rotten at the heart of fractional banking, something the authors do not discuss. While the authors identify many things that may predicate banking crises, two things seem to crop up with regularity – property price bubbles and deregulation. And both of these can be readily identified in the current crisis. Which does give some cause for optimism – if deregulation is part of the problem then reregulation is part of the solution. Whether the moves made under Basle III and by various governments are the right ones is another topic, but at least its a step in the right direction.
Unfortunately that seems to be where the good news stops. Reinhart & Rogoff show that recessions after bank crises are both longer & deeper than ‘normal’ ones. Although they don’t discuss this, I believe the state of banking matters in this. An example, or rather, a pair of examples. Japan, 1990 onwards – zombie banks with huge unrealised property credit losses with no capital (some survived by capitalising tax credits from their losses that they could use against future profits!) New lending stopped, the grease on the economies wheels disappeared and a lost decade. Scandinavia around the same time – nationalisation, recapitalisation & resolution. The countries moved on & recovered quickly. I know this simplifies things, but I think the comparison matters. And pushing the Basle III capital out to 2119 doesn’t resolve anything quickly. Food for thought.
If you want to understand financial markets then read this book. Its as simple as that. Even if you may need Prozac afterwards!