Tuesday, August 21, 2018

"This Time Is Different" - But Is It Really?

Efforts to justify the lofty levels of today's markets and especially the FANG stocks are sometimes difficult to comprehend. The general consensus prior to the election of Donald Trump as President was that his election 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 Trump's proposed solutions to America's problems. Wall Street made it clear their choice was not to venture down the risky path he proposed. Surprisingly not only have stock prices continued to rise but many investors have taken the stance that more good times are ahead.

Now to the crux of this article. A read of the pdf file rather than the 2009 bestselling book titled, "This Time Is Different" has done little to convince me that this time is different unless you are talking about a few degrees or details. Sadly, periods of rapid credit expansion always end 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.

Global Debt Has Surged Since 2008
Global debt has surged since 2008, to levels that should frighten any sane investor because debt has always had consequences. One thing that came across as you read the file is a strong pattern and similarity exists between many of the defaults that have occurred throughout history. In many ways, they mirror the situation developing today as debt continues to grow at an incredible rate across the globe. 

Today much of this is related to a wide acceptance of the economic theory of MMT which details in a different way 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 at the vast amounts of historical data on the past financial failures that have taken place we naysayers voice reason for concern.

Post-2012 Debt Of Emerging Markets Has Exploded!
The failures and meltdowns that are chronicled in the 2008 bestseller 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 evidence over a broad sweep of history suggests that surges in capital inflows often precede 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 and more recently Turkey's rapid fall and crisis.

That Deleveraging Took Place Is A Myth
It seems public debt is handled or should we say, mishandled, in several ways. The massive debt load hanging above our heads in 2008 has not receded or gone away it has merely been transferred to the public sector where those in charge of such things feel it is more benign. A series of off-book and backdoor transactions by those in charge has transferred the burden of loss from the banks onto the shoulders of the people, however, shifting the liability from one sector to another does not alleviate the problem.

It was also pointed out that countries involved in rapidly increasing trade often drive up prices for primary commodities leading to investment and borrowing in that commodity which results in defaults when prices drop. Commodity price cycles have a way of destabilizing economies which can translate 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.

Much can be garnered from the book that elevated Reinhart and Rogoff as close to celebrity status as a couple of economists can ever come. A key lesson is that 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.

Mature Market And Emerging Market Debt (click to enlarge)
Defaulting on debt and financial promises have become the norm or almost become a rite of passage as countries pass through the emerging market state of development. This is then followed by periods of high inflation. 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 but 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. Sadly, even as this is being written Venezuela and several other countries are rushing to prove that this time is never different.

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