Sensible Perspectives

Rick is Reading…

Posted by on October 2, 2013

This Time is Different by Carmen Reinhart and Kenneth Rogoff reviews financial crises throughout modern history. While the authors are professors, and the book is full of tables of data and graphs that support the argument, it is much more accessible than most academic books.

The basic thrust of the book is very simple: while there are several varieties of financial crisis (sovereign debt defaults, banking crises, exchange rate crises, and hyperinflations), all share certain basic similarities. The authors make this point by cataloging and describing as many crises since 1800 as they can find data for (although they reference a few very well-known crises dating back as much as 800 years).

The relevance for our current life and times becomes apparent in a quote from the preamble: “What one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does. When countries become too deeply indebted, they are headed for trouble. When debt-fueled asset price explosions seem too good to be true, they probably are. But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.”

While I don’t believe that the US is too deeply indebted now, I do believe that the current trajectory of adding to the debt is unsustainable. I also believe that more focus on this issue is essential if we are to avoid reaching the point where we are powerless to prevent default. Such a default probably would dwarf the Great Recession, doing much more damage and lasting much longer. It’s important to add that the formal default that might occur if the Congress and President can’t agree on increasing the debt ceiling would probably have a much smaller impact than one that would result from unsustainable debt. The government could fix a formal default with the stroke of a pen.

By the way, the title of the book is a quote from a trader with a long memory who said, “More money has been lost because of four words than at the point of a gun. Those words are ‘This time is different.’”