Saturday, December 17, 2016

Thoughts On "This Time Is Different"

Efforts to justify the most recent market melt-up following the election of Donald Trump are sometimes difficult to comprehend. If memory is correct the general consensus only a few months ago was that such an event would spell certain doom for both the economy and markets in general. Prior to the election, too many articles to count, appeared in the mainstream media denouncing his proposed solutions to America's problems. Wall Street made clear their choice was not to venture down the risky path he proposed and sided solidly with extending what was considered the tried and true course set by our current leaders.

A read of the pdf file rather than the 2009 bestselling book titled, "This Time Is Different" did little to convince me that this time is different unless you are talking about a few degrees or details. It seems it is always different but sadly, it always ends the same way and that is in default. The book written in 2009 by Carmen Reinhart and Kenneth Rogoff chronicles eight centuries of financial follies in which financial meltdowns have typically followed real-estate bubbles, rising indebtedness, and gaping deficits. Despite what those enthralled with our newfangled Modern Monetary Theory, also known as MMT, continue to claim, many of us still question just how well debt cycles can be managed. Simply stated, we do not believe such policy will allow us to avoid the ugly results of the past.

Global Debt Has Surged Since 2008
The charts contained in the working file were frightening and a strong reminder that debt has consequences. One thing that came across as you read the file is that a clear pattern and similarity exists between many of the defaults that have occurred throughout history and the situation developing today as we see debt now growing at an incredible rate across the globe. The economic theory of MMT details the procedures and consequences of using government-issued tokens as the unit of money, i.e., fiat money. According to MMT, "governments with the power to issue their own currency are always solvent which means they can afford to buy anything for sale in their domestic unit of account even though they may face inflationary and political constraints". In short MMT enthusiast feel empowered to avoid future crashes. Of course, looking the vast amounts of historical data on the past financial failures that have taken place we naysayers voice reason for concern.

The failures and meltdowns that are chronicled include state failures, bank crisis, currency crashes and destabilizing outburst of inflation. Several interesting points leaped out to me while I was reading the file. One concern was the strong link found that indicated countries experiencing sudden large capital inflows are at a high risk of having a debt crisis.  The preliminary evidence over a much broader sweep of history suggests this is often the case and surges in capital inflows often preceding external debt crises at the country, regional, and global level since 1800 if not before. Also, periods of high international capital mobility have repeatedly produced international banking crises, this is not only true during the last one hundred years but historically. For me, all this brought to mind China's current problems.

It seems public debt is handled or should we say, mishandled, in several ways. One example from the past was how Henry VIII, in addition to engaging in an epic debasement of the currency, seized all the catholic church's vast land holdings. While not strictly a bond default, such actions often accompanied by executions can still be considered as reneging on financial obligations. Call it what you wish but it is difficult to argue this doesn't constitute some kind of default. The varieties of economic crisis can even extend to Ponzi-type schemes that finally collapse in upon themselves creating contagion and resulting in a destructive domino effect. The massive derivatives market that is touted as one of our modern financial tools is often sighted as having the potential to wreck havoc in this way. 

It was also pointed out that countries involved in rapidly increasing trade often drove up prices for primary commodities. This tends to cause more investment and borrowing in that commodity which results in defaults when prices drop. Commodity price cycles have a way of destabilizing economies, this again creates a situation that translates into sovereign defaults when prices return to sustainable ranges. History shows some countries are simply crisis-prone and because of this they becoming "serial defaulters" who over-borrow when times are good which leaves them behind the eight-ball when a downturn occurs. Even the distinction of whether the debt was held internally by its citizens on externally by others did not alter the outcome and things still ended by default. The view that things are different this time is the reason they never are and seems to be the key as to why mankind continues to fall into the same kind of trap time and time again.

Defaulting on debt and financial promises have become the norm as countries pass through the emerging market state of development followed by periods of high and extremely high inflation. This has almost become a rite of passage, even the United States endured an inflation rate in excess of 20 percent during the civil war in the 1860s. Some people think Asian countries have been able to avoid the kind of high inflation that has plagued the countries of South America and that they were able to avoid defaults until the late 1990s when the Asian financial crisis rattled the world. The fact is China experienced over 1500 percent inflation in 1947 and Indonesia over 900 percent in 1966.  The Asian tigers of Singapore and Taiwan were hit by inflation well over 20 percent in the early 70s and Africa has even had worse luck avoiding this curse. Angola suffered inflation over 4,000 percent in 1996 and Zimbabwe's 66,000 percent inflation for 2007 put that country on track to surpass the Republic of the Congo.

Some important lessons can be garnered from the book that elevated Reinhart and Rogoff as close to celebrity status as a couple of economists can ever come. By looking back at 800 years of financial history we see time and time again how high government debt ratios lead to slow economic growth. Overdone are the claims that governments all over the world have taken heed and downsized by adopting austerity measures costing millions upon millions of workers their jobs. Instead, we have seen deficit spending and borrowing surge as never before. It is safe to say everyone involved in shaping economic policy should own a copy of  "This Time Is Different" and open it when things seem to be going well because the read brings with it a blast of badly needed seriousness and reality.

 Footnote; This is part one of a two-part series. The second part titled, "Don't Get Caught On The Wrong Side Of A Debt Default" will appear next week. Your comments are welcome and encouraged. If you have time please check out the archives for other posts that may be of interest to you.


  1. The most recent thing I heard from a MMTer was that the portion of the debt that the US borrows from residents was not really debt because you can't borrow from yourself.

    1. My favorite is that a country with its own fiat money can never go bankrupt because it can always print more.