Every generation likes to think it is different. It also likes to think that its various crises are different. So it comes as no surprise that, with the American sub-prime crisis taking the US economy down the tube, there should be many who think this crisis is somehow unique.
But is it, really? No, say Carmen M Reinhart and Kenneth S Rogoff. "Our examination of the longer historical record," they say in a recent paper*, finds stunning qualitative and quantitative parallels to 18 earlier post-war banking crises in industrialised countries." Be it the steady increase in equity prices or housing prices, it has all happened before.
Reinhart and Rogoff don't say the various crises are identical. But they find enough similarities. "The quantitative and qualitative parallels in run-ups to earlier postwar industrialised-country financial crises are worthy of note." They cite ten international instances.
In what should serve as a warning to our gung-ho liberalisers, they also write that "the majority of historical crises are preceded by financial liberalisation." This has been documented by Reinhart in another paper.
What happens is that new players, who are either completely unregulated or very lightly regulated, enter the financial markets scrum. This seems to happen each time. But -- and this is the key point -- while their entry and presence serves in some ways to increase the stability of the financial system, which is what the frenetic liberalisers see, they also have the opposite effect which gets obscured in the general euphoria until it is too late.
The problem, it would thus seem, is that there is no way of telling what exactly is going on. You get this queasy feeling in the tummy but until you bring it all out on your neighbour's lap, you keep mum. No wonder central banks and governments like to play it safe as they grope about.
Not everything is the same, naturally. Reinhart and Rogoff acknowledge that inflation is better under control now than it used to be in the past I think that is too heroic a statement but let it pass.
Nor is the US under a fixed exchange rate system and that tends to relieve its pain somewhat by distributing it across the world. But then, that is the macro side which often matters very little when the ill-winds begin to blow. Thus, " the apparent decline in US productivity growth and in housing prices does not provide a particularly favorable backdrop for withstanding a credit contraction."
The authors make another striking point. Noting that, in the latter half of the 20th century, the US banks have always been the most important intermediaries for global capital flow, they say that in the 1970s, they took in the petro-dollars and re-directed to the developing economies. Very good and beneficial, too, for the world. They say that the same thing is happening this time as well, with one crucial difference.
" a large chunk of money has effectively been recycled to a developing economy that exists within the United States' own borders. Over a trillion dollars was channeled into the sub-prime mortgage market, which comprises the poorest and least creditworthy borrowers within the United States."
The point, say Reinhart and Rogoff, is that the mechanism is the same. That, I suspect, includes greed and poor judgment as well which leaves open the question about regulating the one and guarding against the other. Or, if capitalism is to be saved as capitalists (as Raghuram Rajan's book says) who is to do it? Governments, central banks, markets?
*Is the 2007 US Sub-Prime Financial Crisis So Different? An International Historical Comparison, NBER Working Paper No. 13761 January 2008
