BOOK REVIEW : “This Time is Different: Eight Centuries of Financial Folly” by Carmen M. Reinhart & Kenneth S. Rogoff (2011)

This Time is Different: Eight Centuries of Financial FollyA few weeks ago this book would have been read quickly, given an A+ with a little gold star and a request from the teacher for a “Show and Tell” from two of her best pupils. Thomas Herdon, a graduate student at the University of Massachusetts, Amherst has dented the myth though by identifying the errors in their calculation. This has coincided with increasing criticisms of the current policies even in academic circles. Mark Blyth at Brown University has just published “Austerity: The History of a Dangerous Idea.” In this context, “This Time is Different” is certainly worth another critical read.

Key words

Finance, history of finance, financial crisis, economics


Professors Kenneth S. Rogoff & Carmen M. Reinhart

Professors Kenneth S. Rogoff & Carmen M. Reinhart

“The essence of the this-time-is-different syndrome is simple.” say Professors Reinhart and Rogoff. “It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times; crises do not happen to us, here and now.” This Time is Different certainly shows their expertise in analyzing financial data despite any errors.

Perhaps it should be said from the outset that as Bill Connolly points out in Forbes magazine “Every spreadsheet contains an error.”  Collecting data of this nature is not easy. The authors point out that “export data are subject to chronic misinvoicing problems because exporters aim to evade taxes, capital controls, and currency restrictions.”  (Indeed, today Reinhart and Rogoff announced that this error had been corrected.)

The book is not an easy read if you do not have an economics or finance background. It is packed full of data and the tables at the end make up more than half of the entire book. As Thomas Herdon has shown, unless you have the time and the skill to redo the models that have been produced, you will have to accept them on face value.

The Ascent of Money

Check the book review of The Ascent of Money

That said, This Time is Different gives an excellent understanding of the working of international finance. To begin with, the authors take us back to the Middle Ages to understand the origins of finance itself and how debt was dealt with. In fact, even for the most autocratic of kings (who could borrow and default with little fear of impunity) there was an incentive to honour debts where “A king’s promise to “repay” could often be removed as easily as the lender’s head.” However, this might have an adverse long term effect on trade and the political stability of the country. “Fourteenth-century England depended on selling wool to Italian weavers, and Italy was the center of the trade in spices, which England desired to import. Default implied making future trade with and through Italy difficult, and surely this would have been costly.” Surprisingly, given their ability to reproduce the same errors, there are times when financial markets can have rather long memories. In 1918 the Bolsheviks defaulted on their external debts but Russia was still required to repay a token amount of this after the fall of the communism regime in the 1990s.

There is an interesting discussion as to what extent a country can actually go bust in a way that an individual can. Individuals can have their assets seized by angry creditors; the same does not apply to countries. “During Russia’s financial crisis in 1998, no one contemplated for a moment the possibility that Moscow might part with art from the Hermitage museum simply to appease Western creditors.”

Countries that slip into defaulting they often maintain high and levels of debt and graduating to the status of a non-defaulter can be long and arduous. This is often achieved only through the aid of an external stimulus. Again, history is not kind with the two Harvard scholars as they then cite help that the European Union had given to Portugal and Greece to enable them to break out of this cycle.  Of course, this was written before Greece found itself in its current situation.

Carmen M. Reinhart on A Decade of Debt

From here Reinhart and Rogoff go on to discuss banking crises which no developing country has ever avoided.

 “In effect, for the advanced economies during 1800-2008, the picture that emerges is one of serial banking crises.”

 Here the reader will get some useful insights into the current policies as one of the most influential studies of the 1980s was written by Bernard Bernanke, the now Chairman of the US Federal Bank. Bernanke claimed that it was the collapse of the financial system in the 1930s that led to the Great Depression being prolonged. Given this, the Federal Bank invested huge amounts of money post 2008 to ensure that this did not occur again. Indeed, the authors suggest that it is the very assurance that the Federal Reserve gave to the financial industry in the famous “Greenspan Put” that led them to take the extraordinary risks.

Their final message despite any errors in their spreadsheets still seems a relevant one.

“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.”

Financial crises will occur again as they have done repeatedly in the place. From there, the question remains as how to deal with them.

Kenneth S. Rogoff on This Time is Different

Interesting Quotes

 The buildup to the emerging market defaults of the 1930s: Why was this time different? The thinking at the time: There will never again be another world war; greater political stability and strong global growth will be sustained indefinitely; and debt burdens in developing countries are low.

 Ultimately, default often occurs at levels of debt well below the 60 percent ratio of debt to GDP enshrined in Europe’s Maastricht Treaty. Safe debt thresholds turn out to depend heavily on a country’s record of default and inflation.

fiat money

Inflation became the modern-day version of ancient currency “debasement”.

Following the rise of fiat (paper) currency, inflation became the modern-day version of currency “debasement,” the systematic degradation of metallic coins that was a favored method of monarchs for seizing resources before the development of the printing press.

Former Citibank chairman (1967-1984) Walter Wriston famously said, “Countries don’t go bust.” In hindsight, Wriston’s comment sounded foolish, coming just before the great wave of sovereign defaults in the 1980s. Yet, in a sense, the Citibank chairman was right. Countries do not go broke in the same sense that a firm or company might. First, countries do not usually go out of business. Second, country default is often the result of a complex cost-benefit calculus involving political and social considerations, not just economic and financial ones. Most country defaults happen long before a nation literally runs out of resources.

More than half of defaults by middle-income countries occur at levels of external debt relative to GDP below 60 percent, when, under normal circumstances, real interest payments of only a few percent of income would be required to maintain a constant level of debt relative to GDP, an ability that is usually viewed as an important indicator of sustainability.

North and Weingast argue that a government’s ability to establish political institutions that sustain large amounts of debt repayment constitutes an enormous strategic advantage by allowing a country to marshal vast resources, especially in wartime. They argue that one of the most important outcomes of England’s “glorious revolution” of the late 1600s was precisely a framework to promote the honoring of debt contracts, thereby conferring on England a distinct advantage over rival France.

Banking crises in advanced economies significantly drag down world growth. The slowing, or outright contraction, of economic activity tends to hit exports especially hard, limiting the availability of hard currency to the governments of emerging markets and making it more difficult to service their external debt.

Today’s emerging markets can hardly claim credit for inventing serial default.

Spain’s defaults established a record

Spain’s defaults established a record that remains unbroken.

 Spain’s defaults established a record that as yet remains unbroken. Indeed, Spain managed to default seven times in the nineteenth century alone after having defaulted six times in the preceding three centuries.

 The French finance minister Abbe Terray, who served from 1768 to 1774, even opined that governments should default at least once every hundred years in order to restore equilibrium.

 Only China, India, Indonesia, and the Philippines spent more than 10 percent of their independent lives in default (though of course on a population weighted basis, those countries make up most of the region). Africa’s record is far worse, with several countries having spent roughly half their time in default.

The average length of time a country spends in a state of sovereign default is far greater than the average amount of time spent in financial crisis. A country can circumvent its external creditors for an extended period. It is far more costly to leave a domestic banking crisis hanging, however, presumably due to the crippling effects on trade and investment.

The world’s financial centers—the United Kingdom, the United States, and France—stand out in this regard, with 12, 13, and 15 episodes of banking crisis since 1800, respectively. The frequency of banking crises dropped off markedly for the advanced economies and the larger emerging market alike after World War II. However, all except Portugal experienced at least one postwar crisis prior to the recent episode.

Periods of high international capital mobility have repeatedly produced international banking crises, not only famously, as they did in the 1990s, but historically.

 The this-time-is-different syndrome has been alive and well in the United States, where it first took the form of a widespread belief that sharp productivity gains stemming from the IT industry justified price-earnings ratios in the equity market that far exceeded any historical norm. That delusion ended with the bursting of the IT bubble in 2001.

Winkler gives a particularly entertaining history of early default, beginning with Dionysius of Syracuse in Greece of the fourth century B.C. Dionysius, who had borrowed from his subjects in the form of promissory notes, issued a decree that all money in circulation was to be turned over to the government, with those refusing subject to the pain of death. After he collected all the coins, he stamped each one drachma coin with a two-drachma mark and use the proceeds to pay off his debts.

No emerging market country in history, including the United States (whose inflation rate in 1779 approached 200 percent) has managed to escape bouts of high inflation.

 The top employees of the five largest investment banks divided a bonus pool of over $36 billion in 2007. Leaders in the financial sector argued that in fact their high returns were the result of innovation and genuine value-added products, and they tended to grossly understate the latent risks their firms were taking.

Bankers with genuine value-added – funny

 In the case of the United States, the ratio of household debt to household income soared by 30 percent in less than a decade.

 Multiyear recessions usually occur only in economies that require deep restructuring, such as that of Britain in the 1970s (prior to the advent of Prime Minister Margaret Thatcher), Switzerland in the 1990s, and Japan after 1992 (the last due not only to its financial collapse but also to the need to reorient its economy in light of China’s rise). Banking crises, of course, usually require painful restructuring of the financial system and so are an important example of this general principle.

 The United States, France, and Austria took 10 years to rebuild their output to its initial pre-Depression level, whereas Canada, Mexico, Chile, and Argentina took 12.

False signal flares from the equity market are, of course, familiar. As Samuelson famously noted, “The stock market has predicted nine of the last five recessions.”

Greenspan putThe famous “Greenspan put” (named after Federal Reserve Chairman Alan Greenspan) was based on the (empirically well-founded) belief that the U.S central bank would resist raising interest rates in response to a sharp upward spike in asset prices (and therefore not undo them) but would react vigorously to any sharp fall in asset prices by cutting interest rates to prop them up. Thus markets believed, the Federal Reserve provided investors with a one-way bet. That the Federal Reserve would resort to extraordinary measures once a collapse started has now been proven to be a fact.

The lesson of history, then, is that even as institutions and policy makers improve, there will always be a temptation to stretch the limits. Just as an individual can go bankrupt no matter how rich she starts out, a financial system can collapse under the pressure of greed, politics, and profits no matter how well regulated it seems to be. 

 There is nothing new except what is forgotten –Rose Bertin

See also:

Other Book Reviews

Book Review: This Time Is Different: Eight Centuries of Financial Folly

IEEE Spectrum: “Reinhart and Rogoff break new ground in providing a quantitative study of financial crises. And by collecting information on a world scale, and over centuries, they show conclusively that such crises have occurred with high frequency.

Recession, You Look Familiar

NY Times: “The essence of their book is that while financial crises come in different varieties, they are not mysteriously born of undersea earthquakes, but frequently occurring events that can be spotted and even controlled if politicians and regulators know what to look for.”

This Time Is Different: Eight Centuries of Financial Folly

Seeking Alpha: “Unfortunately, it is a very incomplete book because it does not attempt to find the default rate of countries. It’s as if I said that there were 7 homicides in city X last year. A good question would be, ‘how many people live in town X?’, because we really want to know the rate, not the number.”


Related Articles

Despite Flaws, Harvard Economists Stand By Research

NPR: “Two prominent Harvard economists have admitted there are errors in an influential paper they wrote on government debt. This paper was widely cited in recent budget debates. But the economists insist their mistakes do not significantly change their research.”

That Reinhart and Rogoff Committed a Spreadsheet Error Completely Misses the Point

Forbes: “The professors (we’ll call them R&R) acknowledged yesterday that there were “Excel coding errors” in the analysis of the data which impacted their conclusions about the relationship between debt and growth. There appears to be some debate among economists about the significance of the error, hinging on R&R’s interpretations of means and medians and an alleged “unconventional weighting of summary statistics.”

Austerity’s Big Bait-and-Switch

HBR Blog Network: “An interview with Mark Blyth, professor at Brown University and author of Austerity: The History of a Dangerous Idea, I’d like to start with where we are now and the problem we’re currently trying to use austerity to solve, which is debt. Specifically, you have written that the debt crisis in Europe is not really a sovereign debt crisis, even though we’re all calling it that.”

Reinhart-Rogoff one more time: why the 90 percent never should have been taken seriously

Real World Economics Blog: “This is the only reason that the Reinhart-Rogoff 90 percent debt-to-GDP threshold was ever taken seriously to begin with. The point that I have tried to make in the past, apparently with little success, is that debt is an arbitrary number. It is not something that is relatively fixed, like the age composition of the population or the supply of land.”


Filed under Book Review, Business, Business Schools, Economics, Finance, USA

2 responses to “BOOK REVIEW : “This Time is Different: Eight Centuries of Financial Folly” by Carmen M. Reinhart & Kenneth S. Rogoff (2011)

  1. Fascinating….Mark, you always give me something to think about that I’ve never considered before!

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