Saturday, September 10, 2011

Eight centuries of feast or famine, boom or bust

Crises always a new story; old patterns persist

A government suddenly decides to deregulate its financial rules, to relax the oversight on banking or securities trading.

A ruler needs to cover war debt, so he and his cabinet make a quick decision to debase the currency, borrow from foreign creditors, and continue as if everything is fine.

There is a new financial market, something unprecedented and so lucrative investors can hardly believe the results of their profit-taking. Suddenly, debt to earnings ratios don't matter. The party will last forever, and besides, large current account deficits fueled by borrowing from abroad is only a temporary phenomenon of the emerging market.

A best-selling study of 8 centuries of such market corrections, recessions, depressions, panics and massive financial failures puts to the lie to all those phony ideas.

It's always a brand new story, no doubt. But the truth is, the pattern is always an old, old stain indelibly rooted in the warp and weave of the tapestry, according to the authors of “This Time Is Different,” Princeton Press.

A former economist for Bear Stearns and a Harvard economics professor, Carmen M. Reinhart and Kenneth S. Rogoff set out to write an analysis of the lead-up to the 2008 financial crisis. Their initial work turned out to be Chapters 13 and 14 of this phenomenal best seller.

Ms. Reinhart says in an interview with the “Financial Times” that in each case, this time is different due to the ignorance of the people who have little information for what has gone before their experience. The resulting arrogance of their inexperience leads them into the same traps and precipitous folly of the centuries.

The resulting financial failures occur in clusters and happen with consistency – the currency crashes, hyperinflation, government defaults and the resulting cycles in housing and equity prices, capital flows, unemployment, and government revenues.

Though the nations survive their foibles, short memories make the crises appear and reappear on schedule – with incredible predictablity and all attendant suffering.

Carmen M. Reinhart is the Dennis Weatherstone Senior Fellow at the Peterson Institute for International Economics. She was previously professor of economics at the University of Maryland. Kenneth S. Rogoff is the Thomas D. Cabot Professor of Public Policy and professor of economics at Harvard University. He is a frequent commentator for NPR, the Wall Street Journal, and the Financial Times.

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