Analyzing Eight Centuries of Financial Crises

Analyzing Eight Centuries of Financial Crises

downThere may be new things under the sun, but financial crises that
push countries to renege on their debt aren't among them.

England, in the first throes of the Hundred Years War, defaulted on
its debt to Italian lenders in 1340. France defaulted on its debt
eight times between 1558 and 1778. Spain defaulted seven times in the
19th century alone. And so it has gone on up until present times.

Economists Carmen Reinhart at the University of Maryland and Ken
Rogoff at Harvard have put together a database of "international debt
and banking crises, inflation, currency crashes and debasement" that
covers eight centuries of financial history and includes 66 countries.

"It's sort of a history of every bad thing you can imagine in terms of
policy-making," says Ms. Reinhart. She and Mr. Rogoff took a first
stab at analyzing the data in a new paper.

One finding that stands out: Countries default on their external debt
in waves, with long lulls between major episodes. Indeed, the last big
raft of countries to see their debt go sour came during the late 1990s
Asian financial and Russian debt crises. Since 2002 no emerging market
country has come close to defaulting on its external debt - even with
the onset of the subprime crisis in the U.S. Seeing this most recent
period of quiescence as a sign that countries have figured things out,
rather than a typical post-crisis lull, could be perilous, the
economists caution.

"[T]he ability of governments and investors to delude themselves,
giving rise to periodic bouts of euphoria that usually end in tears,
seems to have remained constant," they write. -Justin Lahart
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If (competitive) devaluation of currencies isn't considered reneging
on debt, I don't know what is.

Consider my making a loan of $100 to you for one year at 5% simple
interest with inflation at 4% (really like 10%). In one year I get
$105. At 4% inflation the purchasing power of $105 is $100.80. I pay
tax on $5 at 30%, or $1.5 and I'm left with $99.3. Do the math at 10%
inflation and woe are we. Savers, send money overseas in tax sheltered
accounts (use, e.g. FXE, FXA)!
Comment by Piqued - March 19, 2008 at 11:12 am

Seen the price of gold today. Central banks trying to hold up the $ in
light of yesterday's rate cuts?
Comment by J&J - March 19, 2008 at 11:38 am

Amen to Piqued...

SPOT-ON...
Comment by Jim - March 19, 2008 at 12:06 pm

Finacial crises aren't the result of "[T]he ability of governments and
investors to delude themselves."

Financial crises through history ARE without exception the result of
fraud in the beginning.

All the shock and awe surrounding current events, "how could this
happen?", "what were they thinking?", "he was playing bridge?", "he
was entertaining (lying straight faced) media elites?" are part of the
con, the misdirection that allows for the clean getaway.

Does any thinking person believe the derivatives that have gotten us
to where we are today and will continue to set our course for the
foreseeable future just happened?

That these derivatives sprang from a well intended new approach to
investing in a transparent, level playing field and law abiding market
place?

Does anyone think these derivatives were just the outcome of a the
latest class of best and brightest coming out of top business schools
MBA program?

This is the most naked display of gaming the system combined with will
a full connivance by those charged with ferreting out such malevolence
(and those who saw and knew better, Alan were talking about you babe)
in league with the need for a political economic reality--a guns and
butter war--on the home front.

Guess what, unfortunately here in the great United States of American
we get the government (economic policy, foreign policy) we deserve and
all the flows from that.
Comment by teoc - March 19, 2008 at 12:16 pm

Currency valuations work both ways - and a stronger dollar at this
point may not be in US interests. Most currencies trade freely and so
the "competitive devaluations" are more often a result of market
forces than a conspiracy of foolish governments churning out worthless
paper from their tresuries (a la Zimbabwe). The weaker dollar may in
fact be the ONLY way to lower the US deficit in its trade account and
to make US manufacturing compeitive again.
Comment by Donald - March 19, 2008 at 12:16 pm

So what is the difference between raising taxes and debt-induced
devaluing of currency? It seems only public perception, and Bernay's
"masses" are too stupid to figure out that the modest tax rates are
perhaps more responsible and lead to more spending accountability than
war charges paid on credit. Voters seem to flock to tax freedom and
high debt like addicts to cocaine. We want the immediate high even
though 2,3,4 years down the line the negative effects will come back
to haunt us... and so they have. In 2001, a euro was worth 70 cents, now
it is worth $1.56. Printing money, buying debt, to pay for war and
printing more money and buying more money to bail out banks will only
send our dollar lower, domestic inflation higher, but thank goodness
we didn't have to pay more taxes. Just lost my house, but thank
goodness I didn't have to pay more taxes.
Comment by Clearly Confused - March 19, 2008 at 12:20 pm

The US won't default though. we'll just outsmart everyone else using
the technique Piqued described in his post. It's all psychology. Who
really is deluded...it's those foreign investors holding our worthless
paper. I think China's economists must be feeling pretty confused
right now.
Comment by financial engineering - March 19, 2008 at 12:23 pm

I agree with Clearly Confused. to the tax curve of reaganomics, you
can see higher taxes lead to more society ownership and therefore more
complaints about spending and tax evasion if we disagree with the
spending policies, on the other end however too low a tax and high
debt seems to lull the public into disassociation with spending
policies. They see benefits but when its time to face the costs years
later its a shock.
I'm wondering as Piqued pointed out if the US really can dupe its
neighbors with competitive devaluation, perhaps buying American
exports is more attractive, but so also is buying up American land and
companies that in the end will lead to intervention into American
policies.
Comment by casualinvestor - March 19, 2008 at 12:36 pm

What would happen, if there would be no melt downs?

Tuthankhamon deposited $1 (one dollar) to Chase Thebhattan Bank 4000
years ago. Chase Thebhattan paid interest on the deposit which was the
same as the long run global GDP growth (2.3%/ annum). Tuthankhamon
wanted only that the "real value" of his deposited funds would be
maintained. This year the value of the account would thus be
$4,702,606,757,684,430,000,000,000,000,000,000,000,000.

Tuthankhamons's heirs went to the bank to withdraw the deposit.
Surprise: This kind of dollar amount can not exist! Only the paper and
ink for the bank notes would deplenish the world's natural resources
to zero, and the pile of notes would weigh more than the Globe. And
worst: Chase Thebhattan's computers can handle only 15 meaningful
digits - the teller would make inevitably an error of a couple of
octillions when counting the money! No small change!
Comment by grandpa - March 19, 2008 at 12:38 pm

"The US won't default..."

What do you think a 50 cent (apologies to the rap artist) dollar is/

What do you think $4 a gallon gas is?

What do you think an inflation rate that has been double digit for at
least a decade (good time for a WSJ story on the outcome of the
Clinton administrations decision to turn inflation reporting into an
ongoing distortion)is?

What do you think the meaning of "is" is?

"deluded...it's those foreign investors holding our worthless paper..."
breathtaking.

Open your wallet, take out your dollars and become one with those
deluded foreign investors holding worthless paper.

Just hope the Chinese aren't so outraged that they show up to seize
some real assets.
Comment by teoc - March 19, 2008 at 12:45 pm

People buy American because its American... not because its cheap,
besides, our unions, workers comp, safety and environmental
regulations will never allow us to compete with Capitalist goldmines
like China whom we chide for human rights violations as we hurriedly
stock our shelves with cheap products. Why do so many buy Coke when it
is basically sugar and water? because its America. not because its
cheap. Does anyone else see the benefit in devalued currency? I don't.
Comment by Manufacturing - March 19, 2008 at 12:47 pm

"The first panacea for a mismanaged nation is inflation of the
currency; the second is war. Both bring a temporary prosperity; both
bring a permanent ruin. But both are the refuge of political and
economic opportunists" Hemingway

I think that the reason so many people are into debt up to their
eyeballs is because collectively the American people are not stupid;
most can't name it, but if they can inflate their way out of debt,
they do it (and because mortgage interest is deductible). But the
approach, as pointed out by above posters, does beggar thy neighbor.

The Chinese are NOT stupid. They used us to build their manufacturing
base, and they are moving up in the world of manufacturing, from basic
supplies to higher-end materials. All our non-saving, SPENDING did
stimulate an economy-theirs, and for a brief deluded moment, ours. But
first principal question: where does the spent money now reside? They
also, culturally have a much longer term perspective than we do.
(Read, for example, "The Art of War.") When and if they want they
could dramatically raise the interest rates in this country by dumping
dollars, which they currently hold in the form of bonds. Think through
that result. Precious few US savers would delight, money would flow
back to this country chasing higher-yields, the $ would strengthen,
and they could use the cash to buy up many, many of our remaining
assets (real assets/land and businesses).

The Fed is not ignorant of this fact. And their actions to date are in
fact, non-inflationary since they sterilize much of their current
action. But previously they have been inflationary since collectively,
we ask for too much: social security, medicare, medicaid etc. Nice
ideas, beautiful if you can lay off the costs on a neighbor and
inflate your way out of that debt. The world is NOT stupid. We cannot
get away with this forever.

Materialism is to blame for some of this mess we've self-imposed, but
who doesn't want for a better life. So are ALL of our politicians:
when you hear ANY politician telling you that he/she will give you
something, it comes out of our collective pockets. Worse, we foist our
current social obligations onto our young.

I don't want anything from anyone save for a chance to compete
honestly in a stable land of educated people with good infrastructure
with a defense dept we are loathe to employ. For this I am willing pay
my share. I should not have the right, via a politician, to dip into
your pocket. I should not have the right, via an economist and
politician, to inflate my way out of debt. But this is what we, err,
many vote for.

Peace and true prosperity can only be done with stable money in the
long run. Anything else breaks both financial and social contracts (no
true interest is paid, and money returned is devalued, trust breaks
down, and with it respect for people and rule of law). And it can be
done with low taxes, see the first 150 years of this country. But you
can't ask for anything from someone without being willing to pay for
it.

For now, I am sending my saving out of this country, I will not lend
here until I receive a promise to pay a proper rent for it, and return
it, un-altered (not devalued, which is all that inflation is.)

"Inflation is everywhere and always a monetary phenomenon" Friedman
Comment by Anonymous - March 19, 2008 at 2:18 pm

Instead of spending billions on bailouts, US should consider opening
the gates to some 500,000 migrant professionals (MDs, Nurses, IT
specialists, engineers and scientists).
These professionals are required to keep the US high-tech and
healthcare industries competitive. As a fringe benefit additional
demand for 500,000 houses would solve the real estate crisis very
rapidly.
It costs a foreign nation hundreds of thousands of dollars to
"produce" an MD or an IT professional - the US still has the ability
to attract these individuals and import such "human capital" at a very
low cost.
Clearly, such a proposal would be very unpopular as it is counter
intuitive to the classic local protectionism that arises with every
economic crisis, so we need some leadership to see beyond that.
Good luck.
Comment by CF - March 19, 2008 at 5:56 pm

Based on my research of tracking, simulate the causes, onset, spread,
recovery early warning of lasst 30 years global financial, currency,
assset price bubbles burst crisis,
They all caused by excessive rate, tax cuts led to excessive consumer,
business
demand resulted asset price bubbles due to poor probabilic
econometrics based
financial modeling and reactive monetary policy, financial decisions
on unrelible credit rating methods, underestimated inflation, ignoring
asset price bubbles impact, betting (hedging) on the wrong side of
investments
What we needed is proactive, structural dynamic simulation
of macroeconomy, market fundamental price mechansim
based decsions analysis.
details on
www.osawh.com/marco.html
and
www.osawh.com/mortdefa.htm
and
www.osawh.com/Fedcrisab.htm
Comment by Warren Huang - March 19, 2008 at 11:01 pm

Go back into your old text books and you will find the answer. It is
the Russian economist by the name of Kondratieff that discovered long
ago what you young guys are still trying to figure out.
Comment by Old Guy - March 20, 2008 at 2:35 pm

This is dedicated to Old Guy. Here is a link that explains the
Kondratieff waves. Guess what season we are entering.

http://www.kwaves.com/kond_overview.htm
Comment by Pausebreak - March 20, 2008 at 3:10 pm
.