Among the many things that history teaches us is the fact, possibly the most important one, that in human affairs, very few things are completely new. It seems this is true of financial crises as well. They seem to happen with metronomic regularity, and they happen everywhere.
In a recent paper*, Carmen M Reinhart and Kenneth S Rogoff have traced 800 years of financial crises. They have used a new data set which includes defaults in India and China.
And what have they found? Just that "serial default is a nearly universal phenomenon as countries struggle to transform themselves from emerging markets to advanced economies." Also because these things happen only once in a few decades, everyone thinks that this time it is different.
"A recent example of the 'this time is different' syndrome," they say, "is the false belief that domestic debt is a novel feature of the modern financial landscape." They also confirm that things go belly-up because of interest rate shocks and commodity price collapses. "Thus, the recent US sub-prime financial crisis is hardly unique." The problem each time finds its root in lax lending.
The key message in the paper is that, far from learning from past mistakes, people and governments go on repeating them. "Thanks to better-informed macroeconomic policies and more discriminating lending practices, it is argued that the world is not likely to again see a major wave of defaults.Such celebration may be premature."
Most devastatingly, they say that while practically everything else, ranging from the height of humans to WMDs, has changed, "the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained a constant." So much for the cornerstone assumption of economics that because humans are rational, they don't commit the same mistake twice. Nothing seems more farfetched than the economics myth of rationality.
Reinhart and Rogoff note that Britain has done better than others in the matter of serial default. The received wisdom is that it managed to develop better institutions. But, say the authors, it is not clear what would have happened if Britain had lost more wars than it did since the 17th century. "For example, had Napoleon not invaded Russia and France prevailed in the Napoleonic War, would Britain really have honoured its debts?"
I have a refinement on this question: Had Napoleon not been down with diarrhea and delayed the start of the battle of Waterloo (such irony in that name) till noon, thus giving time for Blucher to arrive and rescue the Brits, what would have happened to Britain's debt?
Reinhart and Rogoff don't assign any value to luck but a really detailed study of causality usually shows that pure chance and dumb luck often have more to do with determining outcomes than design. Certainly, in the days when monetary and fiscal stability depended on shipping because of bullion imports and commodity exports, finely balanced expectations could go dreadfully wrong.
Arguably, recent financial crises have all been accompanied by at least one large institution going bust. In hindsight this tends to mark the low of the crisis. This time around, the US Federal Reserve has thus far prevented this by bailing out troubled institutions. Has it learnt from the Japanese mistakes of the 1990s? It remains to be seen whether this is stabilising, whether it delays a resolution by preventing re-pricing of risky assets, or whether it merely sows the seed for another crisis somewhere down the line.
*This Time is Different: A Panoramic View of Eight Centuries of Financial Crises, NBER Working Paper No. 13882, March 2008
