'This time it's different' -- THE BOOK

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machinehead's picture
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'This time it's different' -- THE BOOK

Today Catherine Rampell has a fine article in the New York Times about the book titled This Time It's Different, by Kenneth Rogoff and Carmen Reinhart. It contains some witty, revealing comments about economics, rarely to be found in the mainstream press. For example:

This Time Is Different” ... is a panoramic opus, both geographically and temporally, covering crises from 66 countries over the last 800 years. The book, and Ms. Reinhart’s and Mr. Rogoff’s own professional journeys as economists, zero in on some of the broader shortcomings of their trade — thrown into harsh relief by economists’ widespread failure to anticipate or address the financial crisis that began in 2007.

“The mainstream of academic research in macroeconomics puts theoretical coherence and elegance first, and investigating the data second,” says Mr. Rogoff. For that reason, he says, much of the profession’s celebrated work “was not terribly useful in either predicting the financial crisis, or in assessing how it would it play out once it happened.”

“People almost pride themselves on not paying attention to current events,” he says.

In the past, other economists often took the same empirical approach as the Reinhart-Rogoff team. But this approach fell into disfavor over the last few decades as economists glorified financial papers that were theory-rich and data-poor.

Much of that theory-driven work, critics say, is built on the same disassembled and reassembled sets of data points — generally from just the last 25 years or so and from the same handful of rich countries — that quants have whisked into ever more dazzling and complicated mathematical formations.

“There is so much inbredness in this profession,” says Ms. Reinhart. “They all read the same sources. They all use the same data sets. They all talk to the same people. There is endless extrapolation on extrapolation on extrapolation, and for years that is what has been rewarded.”

“I have a talent for rounding up data like cattle, all over the plain,” Carmen Reinhart says.

http://www.nytimes.com/2010/07/04/business/economy/04econ.html?pagewanted=1&_r=1&ref=homepage&src=me

A general guideline is that one needs at least 30 sample observations to draw statistically valid conclusions. If you assume that there are repeating patterns in the business cycle, then a mininum data set spanning 30 business cycles of a nominal 5-year length would need to look back at least 150 years. That's a tall order, because of secular changes in markets, discontinuities in data, and the fact that stock indeces only began to be adopted in the late 1800s.

Catherine Rampell goes on to pinpoint a fatal delusion of economists:

The economics profession generally began turning away from empirical work in the early 1970s. Around that time, economists fell in love with theoretical constructs, a shift that has no single explanation. Some analysts say it may reflect economists’ desire to be seen as scientists who describe and discover universal laws of nature.

Economists have physics envy,” says Richard Sylla, a financial historian at the Stern School of Business at New York University. He argues that Paul Samuelson, the Nobel laureate whom many credit with endowing economists with a mathematical tool kit, “showed that a lot of physical theories and concepts had economic analogs.”

Since that time, he says, “economists like to think that there is some physical, stable state of the world if they get the model right.” But, he adds, “there is really no such thing as a stable state for the economy.”

So, so true! Anyone who's seen Dr. Martenson's Crash Course can identify the problem with the 'physical laws' analogy: how could you do physics if the units of mass, length and time were circularly defined, and constantly drifting in value due to 'inflation'? Fiat currency, imposed by imperial edict, leaves economics mired in a pre-Copernican era of empirical observation. Thus the contempt of the economics elite for mere 'economic history' of the Rogoff/Reinhart stripe, which is probably all that the discipline can aspire to under the realm of ignorance and superstition that prevail in a 'flat-earth' financial system plagued with comical, multi-colored confetti currencies.

Ms. Rampell's article might leave one with the impression that economists were the first ones to track down old market data. My recollection is different. Actually it was grizzled old TA'ers -- technical analysts, as in Dow Theorists, cycle enthusiasts, K-wavers -- who went trolling through old archives hoping to find the holy grail of 'can't lose' trading strategies. If you're looking for, say, a 72-year supercycle, then you need centuries of data to establish it with any validity. Edward R. Dewey's Foundation for the Study of Cycles has been at it since the early 1940s.

http://foundationforthestudyofcycles.org/

Although Ms. Rampell didn't mention one of my favorite works of economic history -- the late Sidney Homer's A History of Interest Rates, a masterful work which begins in ancient Mesopotamia, classical Greece and Rome -- she cites several other economic histories which may interest those who crave a longer-term perspective:

Perhaps because “This Time Is Different” is empirical rather than proscriptive, it has defied categorization.

The New York Times Op-Ed columnist David Brooks, for example, praised the book as “the best explanation of the crisis” but referred to it as a history book, rather than a work of economic analysis, since it is “almost entirely devoid of theory.” (The implication being, of course, that genuine “economic analysis” must be hypertheoretical.)

Of course, it’s not as if history is an entirely new ingredient in economic study. There have been other vibrant historical recountings of financial crises, including “Manias, Panics and Crashes,” the 1978 book by Charles Kindleberger. Such books have typically been narrative, though, unlike the data-intensive “This Time Is Different.”

But even in its quantitative perspective and breadth, the book still stands on the shoulders of an economic classic, “A Monetary History of the United States: 1867-1960,” written by another great male-and-female pair of economists, Milton Friedman and Anna Jacobson Schwartz.

“What Friedman and Schwartz did for the U.S. was heroic,” says Ms. Reinhart. “Ken and I have benefited from the use of the Internet to track down books, sources and experts to help us with our work. Friedman and Schwartz did not.”

In any case, through a stroke of luck in timing, This Time It's Different has acquired some of the same cachet that Robert Shiller's Irrational Exuberance did, when it was published in January 2000 within days of the Dow's Bubble I peak. The title of the former book, of course, is ironic. Not only is it not different this time, it's happened dozens of times before. As another old saying goes, 'the coming default will not be official until it's officially denied.'

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Re: 'This time it's different' -- THE BOOK
machinehead wrote:

 The title of the former book, of course, is ironic. Not only is it not different this time, it's happened dozens of times before. As another old saying goes, 'the coming default will not be official until it's officially denied.'

+1. MachineHead, I got it set to get email notification when you post. I did this because not only do you know everything about economics and how the political system works, you have the ability to boil away the massive [email protected] and expose the essence of the matter.

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Re: 'This time it's different' -- THE BOOK
Davos wrote:
machinehead wrote:

 The title of the former book, of course, is ironic. Not only is it not different this time, it's happened dozens of times before. As another old saying goes, 'the coming default will not be official until it's officially denied.'

+1. MachineHead, I got it set to get email notification when you post. I did this because not only do you know everything about economics and how the political system works, you have the ability to boil away the massive [email protected] and expose the essence of the matter.

+1 what Davos said.

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Re: 'This time it's different' -- THE BOOK

MH,

You might want to read this book before you draw any conclusions about it.

You can read most of it on google books: This Time Is Different

John Mauldin also discusses this book quite frequently, so check out some of his weekly letters over the past 3-4 months if you like.

Jeff

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This time is different ~ By Carmen Reinhart, Kenneth Rogoff

This Time is Different: Eight Centuries of Financial Folly ~ by Carmen M Reinhart, Keneth S. Rogoff

[quote=]

Wikipedia Review

A noted survey of financial crises is This Time is Different: Eight Centuries of Financial Folly (Reinhart & Rogoff 2009), by economists Carmen Reinhart and Kenneth Rogoff, who are regarded as among the foremost historians of financial crises. In this survey, they trace the history of financial crisis back to sovereign defaults – default on public debt, – which were the form of crisis prior to the 18th century and continue, then and now causing private bank failures; crises since the 18th century feature both public debt default and private debt default. Reinhart and Rogoff also class debasement of currency and hyperinflation as being forms of financial crisis, broadly speaking, because they lead to unilateral reduction (repudiation) of debt.

~ VF ~

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Vanityfox451
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Re: 'This time it's different' -- THE BOOK

You Beat Me To It Jeff ... Laughing... !!!

I hadn't refreshed the page ...

Best,

Paul

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Re: 'This time it's different' -- THE BOOK

I know it was reproduced in part in another thread, but Dr. Hussman's recent review and extrapolations from This Time Is Different deserve to be again placed here in this thread.

Here are a few relevant snippets:

Unthinkability is Not Evidence

One of the greatest risks to investors here is the temptation to form investment expectations based on the behavior of the U.S. stock market and economy over the past three or four decades. The credit strains and deleveraging risks we currently observe are, from that context, wildly "out of sample." To form valid expectations of how the economic and financial situation is likely to resolve, it's necessary to consider data sets that share similar characteristics. Fortunately, the U.S. has not observed a systemic banking crisis of the recent magnitude since the Great Depression. Unfortunately, that also means that we have to broaden our data set in ways that investors currently don't seem to be contemplating.

On this front, perhaps the best single reference is a somewhat academic book on economic history with the intentionally sardonic title, This Time Is Different, by economists Kenneth Rogoff (Harvard) and Carmen Reinhart (University of Maryland). The book presents lessons from a massive analysis of world economic history, including recent data from industrialized nations, as well as evidence dating to twelfth-century China and medieval Europe. Reinhart and Rogoff observe that the outcomes of systemic credit crises have shown an astonishing similarity both across different countries and across different centuries. These lessons are not available to investors who restrict their attention to the past three or four decades of U.S. data.

Reinhart and Rogoff observe that following systemic banking crises, the duration of housing price declines has averaged roughly six years, while the downturn in equity prices has averaged about 3.4 years. On average, unemployment rises for almost 5 years. If we mark the beginning of this crisis in early 2008 with the collapse of Bear Stearns, it seems rather hopeful to view the March 2009 market low as a durable "V" bottom for the stock market, and to expect a sustained economic expansion to happily pick up where last year's massive dose of "stimulus" spending now trails off. The average adjustment periods following major credit strains would place a stock market low closer to mid-2011, a peak in unemployment near the end of 2012 and a trough in housing perhaps by 2014. Given currently elevated equity valuations, widening credit spreads, deteriorating market internals, and the rapidly increasing risk of fresh economic weakness, there is little in the current data to rule out these extended time frames.

Though Reinhart and Rogoff published This Time is Different in early 2009, extending the analysis they provided in a January 2008 NBER working paper (13761), the book accurately foreshadowed the recent debt crisis in European countries, noting "As of this writing, it remains to be seen whether the global surge in financial sector turbulence will lead to a similar outcome in the sovereign default cycle. The precedent, however, appears discouraging on that score. A sharp rise in sovereign defaults in the current global financial environment would hardly be surprising."

Just on the basis of historical parallel, Reinhart and Rogoff's findings would indicate that the most likely outcome of all this mess is a wave of sovereign defaults that trigger printing and subsequent inflation and possibly hyperinflation.   Of course, a careful study in human psychology or even biological determinism would reveal the same.

It's just how humans are wired up.

He continues:

Deflation, Inflation

Reinhart and Rogoff observe that "the aftermath of systemic banking crises involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources. Banking crises almost invariably lead to sharp declines in tax revenues as well as significant increases in government spending. On average, government debt rises by 86 percent during the three years following a banking crisis.

"Banking crises in advanced economies significantly drag down world growth. The slowing, or outright contraction, of economic activity tends to hit exports especially hard. Weakening global growth has historically been associated with declining world commodity prices. These reduce the export earnings of primary commodity producers and, accordingly, their ability to service debt."

From an inflation standpoint, is important to recognize the distinction between what occurs during a credit crisis and what occurs afterward. Credit strains typically create a nearly frantic demand for government liabilities that are considered default-free (even if they are subject to inflation risk). This raises the marginal utility of government liabilities relative to the marginal utility of goods and services. That's an economist's way of saying that interest rates drop and deflation pressures take hold. Commodity price declines are also common, which is a word of caution to investors accumulating gold here, who may experience a roller-coaster shortly. Over the short-term, very large quantities of money and government debt can be created with seemingly no ill effects. It's typically several years after the crisis that those liabilities lose value, ultimately at a very rapid pace.

Emphasis mine.  I think this is the key point as we wonder about inflation vs. deflation.  It's not an "either-or" situation but a matter of "yes" with only an element of timing to work out.  At first rates drop during the credit crisis as everybody piles into "safe" government securities, but then, later, post-crisis it's revealed to markets that government liabilities behave the same as cash, essentially, and that there's entirely too many of them in circulation given the subdued workings of the damaged economy to which they are attached.  Boom!  The obligations get sold off, interest rates spike, and piles of money moves at lightening speed into anything and everything that's not paper.

One component of inflation is strictly a mathematical relationship between the available quantities of money (and money-like things) and goods & services.  The other component is the aggregate preference for holding money (and money like things) vs holding "stuff."

On this matter they draw blood:

Reinhart and Rogoff continue, "Episodes of treacherously high inflation are another recurrent theme. Indeed, there is a very strong parallel between our proposition that few countries have avoided serial default on external debt and the proposition that few countries have avoided serial bouts of high inflation. Even the United States has a checkered history. Governments can default on domestic debt through high and unanticipated inflation, as the United States and many European countries famously did in the 1970's.

"Early on across the world, the main device for defaulting on government obligations was that of debasing the content of the coinage. Modern currency presses are just a technologically advanced and more efficient approach to achieving the same end. In many important episodes, domestic debt has been a major factor in a government's incentive to allow inflation, if not indeed the dominant one. If a global surge in banking crises indicates a likely rise in sovereign defaults, it may also signal a potential rise in the share of countries experiencing high inflation. Inflation has long been the weapon of choice in sovereign defaults on domestic debt and, where possible, on international debt."

Ouch.

This view is exactly in line with what I have been trying to raise awareness about these past few years. The pattern is not only completely understandable from a scientific-reductionist standpoint, it has been repeated many, many times.

It's amazing to me how much history and the lessons it offers  have been scrubbed from the books and minds of a populace seemingly unable to think of anything other than a simple extrapolation of the present.

As we all know here, it's entirely possible that the next twenty years are going to be completely different from the past twenty years.

Try getting that published in a economic journal.  Unpossible.

machinehead's picture
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Re: 'This time it's different' -- THE BOOK
JAG wrote:

MH,

You might want to read this book before you draw any conclusions about it.

You can read most of it on google books: This Time Is Different

John Mauldin also discusses this book quite frequently, so check out some of his weekly letters over the past 3-4 months if you like.

Jeff

Thanks, Jeff. For those so inclined, the entire book is posted as a .pdf file at the usual Torrent indexing sites. 

As proto-cyberpunk Stewart Brand quipped in 1984, 'Information wants to be free.' Laughing

http://en.wikipedia.org/wiki/Information_wants_to_be_free

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Re: 'This time it's different' -- THE BOOK

Deflation is the lever for inflation.  Makes perfect sense to me.

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