This Time is Different

Eight Centuries of Financial Folly

Book by Carmen M. Reinhart & Kenneth S. Rogoff

Article and Review by GlobalMacroForex

This book is a quantitative summary, study, and analysis of financial crises, including sovereign debt default, banking runs, and currency crises. The theme of the book is that every time there is a bubble leading up to a crisis, where market participants and/or governments take on unsustainable debt and bid asset prices well beyond reasonable levels, people tell themselves that “this time is different.”  For some reason, other people had bubbles in the past, but those crashes don’t apply to this situation because of XYZ given reasons.

“From the mid-fourteenth century loans by Florentine financers to England’s Edward III to German merchant banker’s loans to Spain’s Hapsburg Monarchy, to New York banker loans to Latin America in 1970s.”

The purpose of this book is to show that this time is no different.  In fact, all of these different types of crises tend to have similar patterns.  The most recent crisis in 2007 in America does fit the typical scenario of asset price inflation, rising leverage, large sustained current account deficits, and a slowing trajectory of economic growth.  In this summary article, we’ll cover topics including:

·      Sovereign debt default

·      Banking crisis

·      Currency crisis

Let’s dig right in…

Sovereign Debt Default

Reinhart and Rogoff argue that countries’ governments often default on both their domestic and foreign liabilities — typically more often when they are emerging economies.  As a country develops and matures, it can “graduate” from being a serial defaulter to consistently paying its debt.  Today’s developed and advanced economies, with governments that can borrow quite a bit without default, were “serial defaulters” as they developed.

Reinhart and Rogoff give the examples of Spain, which defaulted 7 times in the nineteenth century and 6 times in the 3 centuries before that, and France, which defaulted 8 times from 1500 to 1800.  In fact, the French monarchies often executed major creditors, so the debt default was known as a ‘bloodletting.’  This was so prevalent that French finance minister Abbe Terray (who served from 1768 to 1774) encouraged governments to default at least once every hundred years.

Emerging Markets, on the other hand, are more prone to default in specific patterns.  Usually, they engage in pro-cyclical borrowing — meaning in good times they borrow even more, then have to deal with the negative consequences of that debt in bad times.  Typically these are commodity countries, so when they have more favorable terms of trade, they take on more debt.  Then when commodity prices collapse, the debt becomes un-stainable leaving to default.

Another way of tracking the likelihood of emerging market sovereign default is through net capital flows, also labeled the financial current account with the United States and the United Kingdom.  These financial flows typically peak right before default, meaning they are at the maximum inflow of borrowing. 

Authors Reinhart and Rogoff found that countries default on both internal and external debt.   However, when governments default on their internal debt, inflation tends to spike.  In fact, inflating away the debt is a form of default, even if it’s not outright.  Typically, countries with internal default averaged annual inflation rates of 170%, vs. 33% on external defaulters.

As far as recommendations to policymakers, Reinhart and Rogoff recommend that countries maintain sustainable levels of debt.  They found countries typically “graduate” out of serial default when the debt levels are reasonable enough to accommodate growth.  Governments must factor in sudden stops of capital flows in their debt planning.

Banking Crisis

       Despite a country being able to “graduate” out of being a serial sovereign debt defaulter, Reinhart and Rogoff found that no country can escape from a banking crisis (once started).  They noticed certain patterns in the economic data before and after the banking crisis of both the developed and emerging markets.  Despite stark differences between the emerging and developed markets in income, consumption, government spending, and interest rates, the authors remarkably found the same pattern in the duration of the banking crisis cycle and amplitude of real estate prices. 

Real Estate prices follow a V shape, declines

The real estate price changes typically apply to equities as well.

“Equity prices peak before the year of a banking crisis and decline for two to three years as the crisis approaches and, in the case of emerging markets, in the year following the crisis.  The recovery is complete in the sense that three years after the crisis, real equity prices are on average higher than at the pre-crisis peak.” 

The banking crisis can lead to a sovereign debt crisis because the government debt rises steeply to bail out the bank.  Reinhart and Rogoff found that in 3 years following the crisis, total real government debt usually rose by 86%.  They give the example of $100 billion in government debt turning into $186 billion.

In addition, the authors found these problems are separate from financial Repression, which is when the government artificially forces savers into banks by reducing their other options, which in turn forces those same banks into government debt.  The goal of this is to achieve funding for the government debt at an artificially low-interest rate without the consent of the savers.  The government can exacerbate this already horrible situation with interest rate caps that are significantly lower than the inflation that they create.  The authors give the example of India in 1970, which capped interest at 5% but had inflation of 20%.

Reinhart and Rogoff present a few models from other authors to explain how banking crises affect the real economy.  Under the Bernanke-Gertler model (yes the central banker), banking crisis affects the real economy as firms have less favorable external financing after the crisis while lower internal earnings to raise funds.  In the Kiyosaki and Moore model, collapsing real estate prices affect a firm’s available collateral to borrow more going forward.  Japan in the early 1990s is an example of this.

Currency Crisis

Reinhart and Rogoff noticed a few patterns in countries that have currency crises as well.  They use the examples of Germany, Zimbabwe, and the 1990s Asian currency crises.  One pattern the authors found was in emerging markets with a pegged exchange rate.  For these countries, after interest rates were liberalized, the banks got squeezed and had a crisis.  Then the governments acted as the lender of last resort by having the central bank print money.  This quite often contradicts the emerging market’s exchange rate peg, which was the previous goal of the monetary policy prior to the crisis.  By shifting to a bank bailout goal, the exchange rate depreciates drastically as the market knows the central bank can no longer realistically enforce the peg.

Another cause of currency crises is they are used as a form of a sovereign debt default by paying back currency in worthless money. 

If a country cannot borrow directly in its own currency, it could abuse foreign borrowing, hoping to convert its newly printed money into the foreign currency before the exchange rate collapses in value.  Another strategy is the central bank buys nonfinancial assets directly, instead of buying government bonds.  This leads to faster inflation for consumers as they are directly competing with the central bank purchases.  A combination of these strategies is sometimes applied in places like Germany and Zimbabwe.


Reinhart and Rogoff present a comprehensive quantitative analysis of a variety of types of crises to notice common patterns.  While each crisis has its own unique characteristics, overall they tend to have similar patterns, even among drastically different countries such as the difference between the developing and emerging world.  The book has a complete set of charts of all the different crisis with their differences and stats.  My brief summary article only scratches the surface of the full depth of data in this wonderful text.