Vital textbook for policymakers warns of folly in ignoring the past


PASCHAL DONOHOEreviews ‘This Time is Different, Eight Centuries of Financial Folly’By Carmen M Reinhart and Kenneth S Rogoff, Princeton University Press

WHEN THE governor of the Central Bank renewed calls for an investigation into the banking crisis, he compared such an inquiry to the commission that investigated the attack on the Twin Towers in New York. Perhaps this comparison was prompted by an assumption that our banking failure was unique – a distinct event with catastrophic consequences.

In this new book analysing 800 years of financial crises, Carmen M Reinhart and Kenneth S Rogoff clearly illustrate that these crises are frequent, predictable and have many features in common.

The key feature they share is clearly stated in the title. Governments, homeowners and bankers will look at the development of a bubble in asset prices and argue that this boom is sustainable and that the mistakes of the past are not being repeated.

The authors argue early in the book that “the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis, stems from the perception that ‘this time is different’ . . .

Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation and good policy.”

The cornerstone of this book is an extensive database reviewing the details of 800 years of financial crises across 66 countries.

This wealth of detail stretches from the defaults on mid-14th century loans made by Florentine financiers, to Latin American defaults of the 1970s and right up to the subprime crisis.

Ireland makes the briefest of appearances in this database, with a reference to the run on Irish banks that occurred between 1836 and 1837. The other instance is the failure of the Tipperary Joint Stock Bank in 1856, upon the discovery that one director had robbed the bank and falsified accounts.

We can be assured of more frequent mention in future editions.

This sweep through financial history allows the authors to step outside the trauma of current crises to discern an ominous rhythm.

In relation to banking crises, they argue that “in effect, for the advanced economies during 1800–2008, the picture that emerges is one of serial banking crises”.

Similarly, it reminds us that sovereign defaults on debt are “the norm through every region in the world, including Asia and Europe”.

The reader is left with a deep appreciation of the fragility of sustainable economic prosperity.

The task of delivering economic security and an economy capable of maintaining decent living standards looks so difficult when the cycles of economic history become apparent.

Yet, this is the very point of writing and reading history. Countries that have learnt from their own economic history have become more successful in dealing with new crises.

The lessons are simple but profound, and the book concludes the journey through financial folly with a summary of them.

It comments on the need for more extensive data to develop an “early warning system” for crises. The need for international institutions to co-ordinate financial regulation and provide better standards for debt accounting is also stressed.

The need to avoid premature self-congratulation is emphasised. The authors point out that several debt crises occurred after countries received economic plaudits – for example Argentina in the late 1990s, prior to their financial crisis in late 2001.

However, the persistent presence of high levels of borrowing before a crisis appears to be the most relevant insight from history for our future. The book repeatedly stresses that domestic debt must be included in assessing national financial health.

High levels of borrowing can be sustained inside an economic bubble, but such can seldom survive forever.

The book optimistically concludes that “History does point to warning signs that policymakers can look to assess risk, if only they do not become too drunk with their credit-bubble-fuelled success and say, as their predecessors have for centuries, ‘This time is different’.”

If an inquiry is ever instigated into the causes of our financial crisis, all involved in the work should get a copy of this exceptional book.

It is not always an easy read, with the wealth of detail and the theory behind debt crises occasionally making it tough going.

However, this is the kind of economics we desperately need, as it is relevant, fact-based and replete with wisdom from the past – and lessons for the future.

Paschal Donohoe is a member of Seanad Éireann. He was formerly the commercial director of Procter Gamble Ireland