The phrase This Time Is Different has often been cited as the four most dangerous investing words in the English language. It’s also the title of a new book on the history of financial crises. Carmen Reinhart and Kenneth Rogoff make the compelling case that it’s almost always not different. I put it somewhat differently: “The only thing you don’t know about investing is the investment history you don’t know.”
The authors present eight centuries of financial folly, demonstrating the common theme that excessive debt accumulation regardless of the source — government, business or consumer — poses greater systemic risks than it seems at the time of the boom. (MoneyWatch recently interviewed Reinhart for her views on the current state of the economy.)
- Infusions of cash make a government look like it’s providing greater growth than is actually being provided.
- Private-sector borrowing binges inflate housing and stock prices beyond sustainable levels and make banks seem more stable and profitable than they really are.
- Large-scale buildups of short-term debt make an economy vulnerable to crisis of confidence.
They demonstrate that financial crises are protracted affairs that share three characteristics:
- Asset market collapses are deep and prolonged. Declines in real housing prices average 35 percent and stretch over six years. Equity prices collapse an average of 56 percent over a downturn lasting three-and-a-half years. Thus, the most recent crisis seems quite typical.
- The aftermath of banking crises is associated with deep declines in output and employment. Unemployment rises an average of 7 percent over cycles lasting more than four years on average. Output falls more than 9 percent over two-year periods, and it has taken about four-and-a-half years for output to fully recover.
- Government debt surges an average of 86 percent in real terms. The main cause is not spending but a decline in revenues.
The bottom line is that the aftermath of crises has a deep and lasting effect on asset prices, output and employment. Unemployment increases and housing price declines have extended for five and six years, respectively. The authors also note that V-shaped recoveries in equity prices are far more common than V-shaped recoveries in real housing prices or unemployment. (2009 is certainly not an exception.) And finally, the authors noted that the global nature of the most recent crisis has made it more difficult for individual countries to grow their way out of the problem through higher exports or to smooth the consumption effects through foreign borrowing.
I recommend this book for those interested in the history of financial folly, though just about anyone could benefit from learning a little more about past financial crises. As Spanish philosopher Santayana stated: Those who cannot remember the past are condemned to repeat it.
