Is This Time Different?

“[I]n severe financial crises … unemployment increases and housing prices decline for five or six years. The question is whether this will happen now when more flexible monetary policies are in place and our global exchange rate is also more plastic.” -- Carmen M. Reinhart and Kenneth S. Rogoff, This Time is Different Reviewing a book that is not-so-hot off the press can be beneficial. This is the case with "This Time is Different: Eight Centuries of Financial Folly," by Carmen M. Reinhart and Kenneth S. Rogoff. However, I must tell you that navigating the book is similar to the underwater snorkeling trail at Truck Bay in St. John, the Virgin Islands. There is a lot that requires attention. The signposts at the bottom of the water in the snorkeling route are represented by data within the book, and in particular in the appendix.

Nevertheless, that is the point of the book -- it is data driven. The authors make this clear early on in the preface. Here they note that Kindleberger’s 1989 "Mania, Panics and Crashes" is probably the most famous of books of this type and describe it, and other earlier, similar texts, as being supported by thin data. Reinhart and Rogoff’s book, on the other hand, is the opposite — it’s based on lots of information.

The Economic Signposts

Reinhart and Rogoff tread through the initial chapters of the book laying the way for the finale, our present crisis. Their groundwork includes definitions and concepts; consideration of government debt and a cataloging of overt defaults. Next they take on crises interrelated to banking, currency and inflation, culminating in a reflection on the current crisis.

Those most interested in the 2007-2008 fiasco should fast-forward to chapters 13 through 16. It is here that Reinhart and Rogoff talk about what should have alerted people to this crisis. They say it was the large run up in housing prices supported by leverage -- in 2008, the overall sum of mortgages in the U.S. was 90% of gross domestic product, the book notes.

Whatever the cause, the fallout from the crises is now upon us. The authors state that in severe financial crises after war, unemployment increases and housing prices decline for five or six years. The question is whether this will happen now, when more flexible monetary policies are in place and our global exchange rate is also more plastic. Reinhart and Rogoff seem to suggest that it could, noting that V-shaped recoveries in the stock market are more common than the same contour revitalization in real housing pricing or employment. Also, their data show that “defaults in emerging market economies tend to rise sharply when many countries are simultaneously experiencing domestic banking crises.”

One of the most important concepts in the book, from my point of view, is the chart of the sequencing of a crisis, a prototype that appears on page 271. It encompassed work from several authors, including the present ones, to compose a flow chart to show how a financial crisis could evolve. Bank liberalization leads to initiation of a currency crash, followed by inflation. Then, if there is no default, the peak of the banking crisis follows. However, if there is a default on external and/or domestic debt, the inflation crisis worsens and only then does the peak of the banking crisis take place.

The Final Signpost

The authors naturally want to prevent another crisis going forward by illustrating what has happened in past crises. They don’t want people saying again, “This time is different.” One constructive comment they make is that keeping track of housing prices and debt calculated against historical benchmarks is a start. (Pages 289-290 provide more specific guidelines, too detailed to be summed up here.) In sum and summary, the book is comprehensive and almost tiresome. It is meant for a serious reader -- perhaps Allan Greenspan, but then I’m thinking he must know this stuff already … or does he?

Update: For follow up on the author’s current opinions, please see “Armageddon Can Wait” by Rogoff and Reinhart’s unemployment forecast.