This Time Is Different: Eight Centuries of Financial Folly, by Carmen M Reinhart & Kenneth S Rogoff, Princeton University Press, 496 pp, £ 19.95, ISBN: 978-0691142166
Never has an Irish tragedy so much resembled a Greek one. Millions of Irish, Greeks and shortly other Europeans too are suffering as a result of mismanagement of public finances, lack of regulation in the banking sector and inadequate monetary policy. The EU has been unable to maintain its coherence, often appears divided and fails to demonstrate belief in a European integration project that transcends the accumulation of capital and rigidly defined economic growth.
This time the crisis could be much worse than previous ones because of its global, and more particularly, its European dimension. The European Union will have to evolve and face the present challenge or change course towards a less democratic and less egalitarian agglomeration of states: nothing like what was imagined, and until recently praised, as the “European miracle”.
After the European Union forced Ireland in November 2010 to borrow €85 billion the message projected around the world six months previously that the Greek debt crisis was due to Mediterranean laziness and a profligate state began to flicker. In the case of Greece, the economic crisis dramatically aggravated chronic inefficiencies and rampant tax evasion. After the Greek aberration however, the crisis entered its “normal” phase, revealing the structural problems in the eurozone: full provision for the mobility of capital and investment but the complete absence of a plan to reduce unevenness within this currency union zone.
Greece is now going through a lull after the storm of last spring. The bailout package of €110 billion ensures that the country need not borrow again from financial markets until 2013. Financial markets, it seems, rapidly lost confidence in the ability of countries in the European periphery to repay their debts. Media within and without the country reprimand Greece for having lost competitiveness but downplay the role of bubbles in the stock market, the housing markets and domestic consumption. The bubbles, today, as in the past, would not have been possible without an unregulated banking sector and lending by primarily private banks. This is why countries in the periphery of the eurozone (except Finland) are crumbling while the German economy is growing at extraordinarily high ‑ for times of crisis ‑ levels.
It is in this context and “economic climate” that interest in books describing the course of economic crises is set to intensify. Where Charles Kindleberger paved the way with his Manias, Panics and Crashes: A History of Financial Crises, others have followed, many treating the current financial crisis. Historical studies of the 1929 crash continue to proliferate and historical research has no less significant implications at the level of policy; Ben Bernanke, director of the US Federal Reserve, has written on the 1929 crisis. The US government’s and Bernanke’s handling of the current crisis through the injection of more dollars into a struggling economy has yet to bear fruit. The Federal Reserve waited for far too long to raise interest rates to deflate the overblown housing bubble; it is probably because they thought “this time is different”.
Reinhart and Rogoff’s book belongs to the tradition of studies that appear in the middle of a crisis but it manages to keep its spine above water because of its historical depth and systematic rigour. The authors are economists at the University of Maryland and Harvard University respectively and the National Bureau of Economic Research. Their new book puts the current crisis, but also past ones, into perspective. At times of rapid economic growth people develop the illusion that sound and adequate institutions and policies are in place to prevent an economic catastrophe; this is folly. We have been there before and we will be again, Reinhart and Rogoff argue. Their book is not just about the underlying reasons and symptoms of past, current and possibly future crises; a unique historical database provides a comprehensive view of international debt and banking crises, inflation, numismatic crises and currency debasements. Their aim is “to be expansive, systematic and quantitative”.
Using a mountain of data sampled from sixty-six countries and over eight centuries, though primarily from the modern period and after 1850s when national accounts become more reliable, the authors take an evolutionary approach to history. They see countries “graduate” from debt crises, although no country remains immune to them. Emerging economies today will mature (at some indeterminate point in the future) and like today’s strong economies will be more stable and able to avoid defaulting on their financial obligations to creditors. The authors provide the “missing link” in explanations of the crisis, the domestic debt that governments historically and even today arduously avoid publicising. But still, even in their unconventional evolutionary model of “graduation” from defaulting, no country has graduated from banking crises, as the collapse of Northern Rock and Lehman Brothers demonstrated. What is not questioned is whether banking and financial crises are inherent in the advanced financial capitalism of the modern world. In other words, does the increasing interconnectedness of the global financial system create more crises, especially after the de-regulation of the financial markets? In this sense, the model proposed by Reinhart and Rogoff is not just evolutionary; it is financial Darwinism. Only the fittest will survive.
However, their study argues against myopic neo-liberal approaches to the workings of financial markets that pledge self-regulation as a panacea for national economies. Reinhart and Rogoff acknowledge that high international mobility of capital has led to major international banking crises, not only in the 1990s but, most importantly for the book’s argument and for the knowledge of us all, historically. The authors, arguing against those who think that this time is different, show that there is a clear pattern, with house and property price booms preceding banking crises. Rich countries are not special and no exception to the rule.
The past is not a foreign country but a familiar territory for Reinhart and Rogoff. Their link between inflation and modern currency crashes is based upon their study of countries and inflation data over five centuries. This history of inflation and exchange rate crashes in chapter twelve leads the authors to take a more fatalistic turn on the graduation argument: “it is profoundly difficult for countries to permanently graduate from a history of macroeconomic mismanagement without having occasional but very painful relapses”. This is exactly where we are at the moment on a global economy scale. In small countries on the “periphery”, such as Ireland and Greece, which experienced in recent years a very short period of affluence for the first time in their history; macroeconomic mismanagement is only partly to blame and in the case of Ireland it is not to blame at all. This is in fact the other omission of the book. An economic history book with little or no history has diminishing returns. This is the tyranny of the database that strips of historical context what precision it can deliver. Still, historical comparisons are there to be made by those who want to use the book for their own purposes.
The authors clarify the argument on graduation further towards the end of the book but this is where its other shortcomings become clearer too; the authors construct an “institutional investor” ratings table for sixty-four of their sample of sixty-six countries. Candidates for graduation, the terms on which countries can access international capital markets, meet the criteria for the “Club A” countries at a rating of 66 or higher (out of one hundred). Even if the exercise is “meant to be illustrative rather than definitive”, the same indexes, constructed and published by credit rating agencies, have implications for millions of people and amount to a matter of millions of euro when it comes to upgrading or downgrading a national economy and its banks. Ireland is not in the index or in the database at all (an unfortunate omission). Ironically Greece, at the time of the book’s publication, was categorised as having “potential for graduation”, with a rating of eighty-one; at this moment Greek bonds are rated “junk” and are not on the market, so Greece would figure at the bottom of the list. The point is illustrative rather than absolute and it does not negate the validity of the overwhelming work that the authors have put in amassing and calibrating data on national economies; it simply highlights the turns of history in the unfolding crisis as it enters its second phase.
In Europe, it all started with Ireland and the nationalisation of Anglo-Irish bank; then in Iceland, Hungary and Greece, from late 2009 a debt, banking, currency, political and social crisis began and are all continuing in various combinations. The “bailout” of the Irish economy in November 2010 signifies the spiralling character of the crisis as it enters its second phase. While Ireland is forced to accept the loan of €85 billion, Greece became a test case for the unravelling of the foundations of the welfare state. By 2009 there were clear warning signs about the state of the Greek economy. The “strong” Greece that organised “surprisingly” an immaculate 2004 Olympics became at the end of 2009 the weakest link of the eurozone and, for a short while, of the world financial system. Greek governments had failed for years to provide reliable statistics, beginning with the rush to join the eurozone in 2001. The same governments continued to spend rampantly and mismanage public resources, especially in the period 2007-09. However, the international causes of the sovereign debt crisis in Greece, Ireland and probably in Spain and Portugal are twofold; first, the deficient character of the monetary union in Europe and secondly the economic crisis that broke out in 2007-2009 and which continues to challenge governments today. National characteristics define the course of the crisis in each country but the causes are in fact global, and especially European. The European Union is facing a multi-faceted crisis at several levels.
In Greece, soon after the new government of the Socialist Party took over in October 2009, it revealed that the Greek budget deficit for 2009 had skyrocketed to nearly thirteen per cent of GDP (it has now been stopped at fifteen per cent), four times the size agreed under the European Union Stability Pact and the Maastricht Treaty, which does not allow countries to exceed three per cent. However, Portugal, Spain, France, Italy and Britain have gone above that limit for some time now. In December 2009 the Greek prime minister warned that national sovereignty was under threat from financial speculators, but also from the huge public debt and budget deficit. When it comes to monetary policy, sovereignty was ceded to the European Central Bank when the country joined the eurozone in 2002.
“Financial markets”, basically bank consortiums and investment funds primarily in Europe and the US, exploit the instability and turmoil that looms over the eurozone to reap significant gains and maximise profits. Their ultimate goal is to secure their investment and they will probably not desist until the eurozone has become even more integrated and the European Central Bank prints money to guarantee the national bonds of member states. Back in spring 2010 more and more negative publicity in world media about the Greek economy (the pattern has been repeated since then) led to heightened nervousness among investors, who refused to lower interest rates. In April 2010 the Greek economy left international markets as it could no longer borrow and was facing bankruptcy ‑ speculation of funds fed on a speculation of rumours. Now Ireland is forced to accept another massive loan at burdensome interest rates, once again in a Sunday rush to pre-empt the opening of stock markets worldwide. The people who protest in anger and frustration can wait; financial markets should not.
There is no doubt that Greece must at last, after decades, deal with its own financial woes. Being in the eurozone however complicates things as there is no option to devalue the national currency as the country did in the 1980s and 1990s, unless the radical solution of exit from the eurozone (at least for a while) is chosen. This would involve public control of banks and the freedom to devalue the currency. Such a strategy would be high risk and in any case there is no political party or coalition of parties that would be prepared to follow this course. At a European level ‑ the only level at which this crisis can be tackled ‑ the long-drawn-out and tentative agreement of EU leaders to create a mechanism for mitigating and even more ambitiously preventing crisis is still uncertain. More realistically, a political response that would disengage from the demands of financial markets that are by definition volatile and oriented towards short-term profit, is urgently needed from EU leaders. Their historical failure to react decisively, with clarity as well as vision renders them a caricature of the founders of the European integration project, which was, after all, inherently political, even if it originated in the coal and steel sectors.
The unfolding of the crisis, first in Greece and now in Ireland, reveals the gross procrastination and hypocrisy of some eurozone countries. The German government has failed to demonstrate a policy that goes beyond strictly defined national interests. In January 2010, Greece faced the scenario of borrowing from the International Monetary Fund; back then it was considered that such a move would undermine the whole eurozone and strike a severe blow to the common currency. The Greek government, amid pressures in the eurozone and within its own ranks, oscillated between seeking a rescue package in Europe and resorting to the IMF. For a long time, statements speculating as to whether “Europe” would “rescue Greece” or not, hardly clarified the issue; weeks went by in a stagnation that exposed the absence of any EU plan to face such a crisis. Governments and public opinion refused to see that this was not an exclusively Greek crisis. The deficiencies (and they are many) of the Greek economy revealed the basic asymmetry that exists in the eurozone, where a full-scale monetary integration was established but a similar economic integration did not follow; never mind further political integration and social cohesion – “people’s Europe” ‑ which is seriously lagging behind.
The crisis has revealed that neither eurozone countries nor the European Central Bank (ECB) were prepared for such problems as there was no mechanism to prevent the crisis from escalating. The ECB is not really behaving as a central bank because it cannot guarantee the debt of the eurozone countries, as the United States government and the Federal Reserve can guarantee the debt of the state of California. In a wider sense this is a crisis and a test for European solidarity. What does European Union stand for anyway? Policies and strict attitudes that include punitive measures and financial overseeing for anyone who goes beyond the three per cent budget deficit can become a straitjacket in periods of crisis like the current one. Such policies point to an orthodoxy that makes little sense in times of crisis, which always have unpredictable results; if debt and deficit were not reduced during more affluent times it is significantly more painful to do so during times of recession.
This is hardly what the vast majority of Europeans hoped for or expected from the European integration experiment. Euroscepticism is on the rise everywhere. A demonstration of social solidarity among European countries, not just strict fiscal discipline, is what is needed at the moment. A downward spiral and a long recession in Greece, Ireland, probably Portugal and even more alarmingly Spain will harm the whole European Union, not just the eurozone; Greece will probably have to renegotiate and restructure its debt anyway, even with the recent agreement to repay by 2024. In a different scenario, a Greek exit from the eurozone could force other countries to rethink and restructure the European financial system, which is already interdependent, since German and French banks hold a large percentage of Greek and Spanish debt. The balance is a very tight one. Austerity measures in Greece, Ireland, Portugal and Spain, adopted at extraordinary speed, hurt those least responsible for the current crisis. Even if the aim to reduce deficits is achieved it will be coupled with record unemployment and few prospects of recovery. A decade of recession is not unthinkable. The numbers may recover but will people benefit from “growth”? An accumulation of capital through mergers and acquisitions, already under way, where competitiveness will translate into loss of income and a deterioration in living standards for many Europeans is possible.
Governments in both Ireland and Greece have lost legitimacy, in Ireland even more so that in Greece. Elected on the back of promises of income redistribution and retribution for the corrupt, the Papandreou government has been forced to succumb to an unprecedented rescue package that comes with extremely tight strings attached. Amid the crisis, confusion has reigned: there seems no reason why battling corruption and bureaucracy and improving efficiency should be associated with the reduction of wages and pensions that were already at about only fifteen per cent of the EU (fifteen countries) average. Still, for the Greek government, they all are all linked. As long as there is no restructuring of the debt of all high deficit countries (Greece, Ireland, Spain, Portugal and perhaps Italy), in concert with the European Central Bank and the major banks that hold national debt, there can be no light at the end of the tunnel. At the moment there is no provision for boosting production, only a hope that the Greek economy will somehow become more “competitive” and manage to service its enormous debt, which will reach one hundred and fifty per cent of GDP by 2015. Even more worrying is spiralling unemployment, which has already jumped above 12 per cent and will rise to Spanish levels of about 20 per cent.
The conservative party in Greece, now in opposition, ruled for the six years during which debt skyrocketed. The same two parties, however, have held power over the last thirty-six years, since the restoration of democracy in 1974. Without any imagination, let alone social justice, civil servants and pensioners are once again called in to foot the bill, only this time in unprecedented ways. This crisis will be long-lasting and it could create the conditions for a growth of radical politics. Just as there is a need for a change of direction from above, with collective agreement on the restructuring of debt, so also radical politics are needed from below: politics that will generate political passions and get people involved in creative ways. Apathy and the rise of right-wing extremist politics is the alternative outcome, as the recent local elections results in Greece show. Radical politics can surpass established political parties as well as technocrats, Berlusconi-style entrepreneurs and prominent journalists who may want to form a government of “national unity”. The form of politics that can show the way out from the political crisis can only be grass roots, community-based and civil society-inspired. Then, perhaps, new parties could emerge and economic stability be achieved.
Although the political dimension is entirely absent from This Time Is Different, the people of Ireland and Greece are now finding out that economic decisions are primarily political decisions. There are a few pages at the end of the book modestly called “observations for policy responses” where the authors call for a complete overhaul and a radical change in the reporting of data and challenge the lack of transparency. The reporting of financial data on domestic debt has become even more opaque in the current crisis (post-2007) and this bodes ill for the future. The authors warn that governments should expect sudden stops in capital flows as these recur after severe crises and defaults; for this reason governments should resist the temptation to inflate domestic debt away. This advice looks sound in conditions of independent monetary policy. The authors, however, surprisingly do not consider conditions in the eurozone at all. The crisis of monetary union is simply not examined and this makes it less relevant for the eurozone crisis, even if extremely informative and a valuable reference tool owing to the mountain of data distilled in its pages.
The book is written primarily with a US audience in mind, even if it is global in scope, and one of the best sections reviews the subprime mortgage crisis in the American housing market. Despite their failure to address the causes of the current economic crisis in Europe the authors do highlight the absence of regulations and rules that would lead (hopefully) to disciplined international accounting and would spare future generations the folly of believing that their times of growth are really different. The “lesson of history” for the authors is that no matter how advanced and improved institutions and policies are, they can still fail. The blame is put on governments as well as investors who “delude themselves” and interestingly the authors towards at the end quote Milton Friedman, who alerted his readers to the “ability of governments to mismanage financial markets”. Unfortunately nothing is said about the ability of financial markets to mismanage public funds and the discovery by governments which bailed out banks that they are left with huge debts that they are forced to pass on to their citizens. The docility of the latter cannot be taken for granted, as the human spark and creativity that leads to uprisings and changes in the social and economic order is not predictable. The next phase of the crisis could unfold in the streets as well in boardrooms. This time could be different indeed.
Sakis Gekas is Assistant Professor in Modern Greek History at York University, Toronto. He has published on Mediterranean economic and social history, and is currently completing a history of the Ionian Islands State under British rule.