This Time It’s Different

In an interview on Crashes

Is there a difference between the two books?

Well, Kindleberger tells a very rich narrative of crashes, but the great thing that Rogoff and Reinhart have done is they’ve assembled this huge database. They’ve gone back 800 years and you can see roughly what’s been going on with government borrowing and lending over that time.

Eight hundred years?

Eight hundred years. We’ve been having banking crises for a long time. I did not put a book of mine on this list – Money, Greed and Risk – but it says the same kind of thing. It sort of shows the cycles and shows that all these things are essentially the same.

A point to make is that nothing gets really crazy unless at first it’s a good thing. So there’s some innovation that makes the market work better and the guys who think of that get very rich because finance is always done with other folks’ money. So when you make an innovation, the first, second and third movers make a lot of money. Then everybody else rushes in to try to do it too, and the reason banking and finance is so risky is that it’s highly leveraged. It’s playing with borrowed money. You’re not putting up your own cash, or you’re putting up a little bit and getting the bank to provide the rest. So if you can invest in an innovative way then you’re making buckets. If you’re making something real, like steel, you might overproduce it, but you can’t have such a wild kind of production that you do in banking.

What was the crisis 800 years ago?

It was something in China. But a good example is from the 14th and 15th centuries when a merchant trader would load a ship up with goods and he would sail around the world, sometimes for years, trading the goods he had for the goods he wanted. It was goods for goods and it was a slow process.

Then the Italians invented the paper bill of exchange – basically a cheque, drawn on a banking house back in Venice or Genoa. And for the first time the trader could give a piece of paper in return for goods. Trade boomed. This was a brilliant invention. So other banks came in and started issuing these pieces of paper and in 60 years there was a huge crash that brought down the Italian and Dutch banking houses.

In an interview on The West vs The Rest

Let’s go on to This Time Is Different, which covers the history of financial folly. China has no advantage here – its stock and property markets suffer from bubbles as much, if not more, than anyone’s.

If you travel around the US, the UK and Europe, people say “China this, China that…” and I find myself constantly having to remind people: China is still a very poor country! On a per capita income basis, they’re still number 99 in the world. Their financial markets are not developed at all. At the moment, there are all sorts of risks that we are seeing – the property markets in China are just one example. The property bubble we saw in Japan was a killer, as we all know. It’s affected the country economically for the last few decades. All of that is still a possibility in China, because they’re not functioning at a developed market level and are working super-hard to avert structural decline or stalling that we have seen in Japan.

I think the more interesting story in This Time Is Different is what happens in the aftermath of bubbles, which links to what we were talking about before. In the case of the US, it’s still very reliant on tried and tested formulas to try to sort out economic busts – ie let’s just reflate this bubble by using relatively loose monetary policy and fiscal policy (think low interest rates, tax breaks, government spending increases, quantitative easing). In a similar vein, the Chinese moved very quickly, with strong political will, to finance and build massive infrastructure projects and construct massive cities. They have a lot of flexibility in what they can do in the aftermath of a financial crisis and how they can execute it, because they’ve got the political will and the political ability.

Is the book a lot about that – how you deal with bubbles?

Yes, but it also details what happens in their aftermath. It talks about the fact that countries almost always have these bailouts and end up with massive debts. And it points out that if you have 90% debt-to-GDP ratios, you invariably end up in a marked slow-growth period for several years. So, according to Reinhart and Rogoff’s book, we can expect that the US and western Europe are now in a long-term type of decline.

Tell me more.

I think the key point I would argue is that the US in particular – and many countries in Europe as well – have not yet understood the fact that they now have structural unemployment. They are no longer dealing with cyclical unemployment. In the past, when the US had a recession, or Britain had a recession, they would do exactly what the US is doing now. They would reflate the economy and things would ostensibly be fine. Why this is not working this time, and why I don’t think it will work longer-term, is because you’ve got competition. In the past you had no competition. America made all the computers, it made all the T-shirts. This time is different because there’s global competition. The fact that America is not producing computers does not mean the world can’t buy computers, because the Chinese are producing them.

The way you deal with structural unemployment is quite different from the way you deal with cyclical unemployment. Dealing with structural unemployment means the US has to be much more aggressive than I would argue policymakers have been. You have to have the wiggle room, the flexibility, to be able to implement long-term structural policies. You have to have everyone on board. Which China has but the US doesn’t, because of the demands of democracy. If we were in China, I think they would know how to deal with structural unemployment much more aggressively than policymakers do in the West, who are hamstrung by short-term politics as discussed earlier.

Can you tell me a bit more about Reinhart and Rogoff’s book specifically?

It’s the only book I have seen that provides, with great detail and over 800 years, clearly defined, analytical, data-driven evidence of what the impact of a post-financial crisis period is and hence what we can anticipate. In all my reading during my PhD, in all my reading in general, I’ve never seen anything that comes close in terms of being comprehensive. It’s a tour de force.

Do they have a solution?

One thing they point out is that a lot of countries have defaulted. They talk about Germany, for example, and about a lot of other countries. I think that’s quite interesting, because I’ve talked about how a US default is not off the table. A lot of people get their hackles up when I say that, but reading this book you realise many countries have got out of post-financial crisis aftermath periods by defaulting. Reinhart and Rogoff are not saying America should default, but there are many countries that have defaulted.

In an interview on the Financial Crisis

Before we get to that, let’s go through your other books. Your first choice is by Carmen Reinhart and Ken Rogoff and it’s called This Time is Different.

Reinhart and Rogoff are two macroeconomists who have done a marvellous job in bringing together a lot of historical and international data about how unstable financial systems are. The title of their book, This Time is Different, tells you the whole theme. In many respects, the Wall Street crisis was not at all different from Argentina or Britain in the early 1990s or any number of other crises that have been fuelled by credit bubbles and mismanaged macroeconomic policy. The reason that it was so surprising is that a lot of Americans in the 2000s believed that the US financial system was so deep and well developed that it would never be subject to the kind of instability that happened in Latin America during the 1980s. In a way they were victims of complacency. The other thing that is disturbing about the book is that it really shows how long it takes for a country to recover from this kind of a crisis. This suggests that the US and Europe, which is involved in a separate financial crisis of its own, are in for a prolonged period of low growth and stagnation.

I’ve had the book on my shelf for a while, but I’ve found it quite hard to get through. It has this wonderful empirical data to dip into, but it’s pretty dry economics, isn’t it?

That’s one of its advantages. It’s written by two academic economists, it’s got a lot of data and you’ve got to plough through that. It’s a good reference, but it’s not the easiest book to read and it presupposes a certain amount of knowledge of macroeconomics.

How does the book tie into the bigger question that you raised earlier? One thing you homed in on in an article in The American Interest last year is that hasty liberalisation of the financial sector is very dangerous.

One of the great ironies that the book points to is the fact that a lot of the Asian governments were a lot wiser than the US. The US – through the US Treasury and its proxies, like the International Monetary Fund – put very heavy pressure on a lot of the emerging economies in Asia in the 1990s to liberalise. That had the effect of leading to a big influx of liquidity into Asia as a result of the Asian miracle, which then flowed out again in the mid-1990s and led directly to the Asian crisis in 1997. The American reaction to that was to say, “Oh, this shows that the Asian governments are involved in crony capitalism! There’s not enough regulation, they don’t have mature institutions.” They patted themselves on the back that our system was much better than that. But in fact, in many respects, the financial crisis was simply a repeat of the Asian crisis. Instead of the money coming from the outside world into Asia, it flowed from Asia into the US, particularly from surplus countries like China. So there has been a certain amount of poetic justice. Just like these Asian governments, we didn’t have an adequate regulatory system in place, and we got into even bigger trouble than they did as a result. I don’t think there’s ever been a full acknowledgement of that on the part of Western policymakers. What’s happened in Asia is that all of those countries have gotten much more cautious about allowing free financial flows into their economies since 1997. That history – which we’ve managed to forget – is one that is pretty well covered in the Reinhart-Rogoff book.

Also, you mention that the Asians were accused of crony capitalism, but wasn’t a lot of the pressure for Asia to liberalise coming from Wall Street?

Yes, it was coming from the IMF, but the real pressure behind that was Wall Street. So, for example, in Korea, what we call the Asian financial crisis they labelled the IMF crisis. There is still a lot of bitterness. They believe that essentially the IMF took advantage of their liquidity crisis – that’s really what it was, it wasn’t fundamentally an economic crisis – and used that as an excuse to force open capital markets in Korea to the benefit of all the Goldman Sachses, Citigroups and so forth that wanted access to that market. All the American policymakers – Larry Summers, Bob Rubin – still swear that they had very pure motives in doing all of this, that this was just what was good for Korea. But behind that was, in fact, a tremendous amount of lobbying on the part of these big banks that had a direct self-interest in Asian financial liberalisation.