Reinhart Carmen M. - This Time Is Different: Eight Centuries of Financial Folly

THIS
TIME
IS
DIFFERENT

Eight Centuries
of Financial Folly

CARMEN M. REINHART
KENNETH S. ROGOFF

Copyright 2009 by Princeton University Press
Published by Princeton University Press, 41 William Street,
Princeton, New Jersey 08540
In the United Kingdom: Princeton University Press, 6 Oxford Street,
Woodstock, Oxfordshire OX20 1TW
press.princeton.edu

All Rights Reserved

Thirteenth printing, and first paperback printing, 2011
Paperback ISBN 978-0-691-15264-6

The Library of Congress has cataloged the cloth edition of this book as follows

Reinhart, Carmen M.
This time is different : eight centuries of financial folly/
Carmen M. Reinhart, Kenneth S. Rogoff.
p. cm.
Includes bibliographical references and index.
ISBN 978-0-691-14216-6 (hardcover : alk. paper)
1. Financial crisesCase studies. 2. Fiscal policy
Case studies. 3. Business cyclesCase studies.
I. Rogoff, Kenneth S. II. Title.
HB3722.R45 2009
338.542dc22
2009022616

British Library Cataloging-in-Publication Data is available

This book has been composed in Goudy text
with Trade Gothic and Century italic by
Princeton Editorial Associates, Inc., Scottsdale, Arizona

Printed on acid-free paper.

Printed in the United States of America

13 15 17 19 20 18 16 14

To William Reinhart,
Juliana Rogoff,
and Gabriel Rogoff

PREAMBLE: SOME INITIAL INTUITIONS
ON FINANCIAL FRAGILITY AND THE FICKLE
NATURE OF CONFIDENCE

Crises Defined by Quantitative Thresholds:
Inflation, Currency Crashes, and Debasement

Crises Defined by Events: Banking Crises
and External and Domestic Default

A Global Database on Financial Crises
with a Long-Term View

Prices, Exchange Rates, Currency Debasement,
and Real GDP

A Digression on the Theoretical
Underpinnings of Debt Crises

The Early History of Serial Default:
Emerging Europe, 13001799

Domestic Debt: The Missing Link Explaining
External Default and High Inflation

Domestic Debt on the Eve and in the
Aftermath of External Default

Domestic and External Default:
Which Is Worse? Who Is Senior?

The Incidence of Default on Debts Owed to
External and Domestic Creditors

Default through Debasement:
An Old World Favorite

The U.S. Subprime Meltdown and the
Second Great Contraction

The U.S. Subprime Crisis: An International
and Historical Comparison

A Global Historical View of the Subprime
Crisis and Its Aftermath

The This-Time-Is-Different Syndrome and the
Run-up to the Subprime Crisis

Risks Posed by Sustained U.S. Borrowing from the
Rest of the World: The Debate before the Crisis

A Comparison of the Subprime Crisis with
Past Crises in Advanced Economies

Comparisons with Experiences from the
First Great Contraction in the 1930s

The International Dimensions of the Subprime Crisis:
The Results of Contagion or Common Fundamentals?

Reflections on Early Warnings, Graduation,
Policy Responses, and the Foibles of Human Nature

This book provides a quantitative history of financial crises in their various guises. Our basic message is simple: We have been here before. No matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities with past experience from other countries and from history. Recognizing these analogies and precedents is an essential step toward improving our global financial system, both to reduce the risk of future crisis and to better handle catastrophes when they happen.

If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a governments policies, a financial institutions ability to make outsized profits, or a countrys standard of living. Most of these booms end badly. Of course, debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge policy makers, investors, and ordinary citizens must never forget.

In this book we study a number of different types of financial crises. They include sovereign defaults, which occur when a government fails to meet payments on its external or domestic debt obligations or both. Then there are banking crises such as those the world has experienced in spades in the late 2000s. In a typical major banking crisis, a nation finds that a significant part of its banking sector has become insolvent after heavy investment losses, banking panics, or both. Another important class of crises consists of exchange rate crises such as those that plagued Asia, Europe, and Latin America in the 1990s. In the quintessential exchange rate crisis, the value of a countrys currency falls precipitously, often despite a government guarantee that it will not allow this to happen under any circumstances. We also consider crises marked by bouts of very high inflation. Needless to say, unexpected increases in inflation are the de facto equivalent of outright default, for inflation allows all debtors (including the government) to repay their debts in currency that has much less purchasing power than it did when the loans were made. In much of the book we will explore these crises separately. But crises often occur in clusters. In the penultimate text chapter of the book we will look at situationssuch as the Great Depression of the 1930s and the latest worldwide financial crisisin which crises occur in bunches and on a global scale.

Of course, financial crises are nothing new. They have been around since the development of money and financial markets. Many of the earliest crises were driven by currency debasements that occurred when the monarch of a country reduced the gold or silver content of the coin of the realm to finance budget shortfalls often prompted by wars. Technological advances have long since eliminated a governments need to clip coins to fill a budget deficit. But financial crises have continued to thrive through the ages, and they plague countries to this day.

Most of our focus in this book is on two particular forms of crises that are particularly relevant today: sovereign debt crises and banking crises. Both have histories that span centuries and cut across regions. Sovereign debt crises were once commonplace among the now advanced economies that appear to have graduated from periodic bouts of government insolvency. In emerging markets, however, recurring (or serial) default remains a chronic and serious disease. Banking crises, in contrast, remain a recurring problem everywhere. They are an equal-opportunity menace, affecting rich and poor countries alike. Our banking crisis investigation takes us on a tour from bank runs and bank failures in Europe during the Napoleonic Wars to the recent global financial crises that began with the U.S. subprime crisis of 2007.