This Time Is Different

"Yes. Many of the books I’m going to be talking about today deal with that particular period. I guess that it was a formative period for me. When I was doing my PhD, that’s what I was thinking about, and I hope that the issues remain relevant for younger students. This book was very lucky, in terms of timing, because it came out in 2009, when everybody was talking about debt. It’s a book about financial crises and fiscal crises, and it’s mainly a review of historical data. Its subtitle is Eight Centuries of Financial Folly , so it takes a very long view on the nature of these crises, dating back to the Middle Ages . I think it was the outcome of a very long-standing research project by the co-authors, Carmen Reinhart and Kenneth Rogoff, and it just so happened that the book came out in 2009, when everybody was thinking about the financial crisis that was taking place at the time. It was very timely and it was a great success. It was a New York Times bestseller, which I don’t think is very common for an economics book containing a lot of numbers and data. (I understand that many readers may think those are scary or challenging, but they shouldn’t). Why is the book called This Time Is Different ? Because there is a common theme. The typical pattern, which the authors highlight, is that during good times, when things go well and the economy is healthy—there is low unemployment, high consumption, and economic growth—debt is accumulated either by banks or governments of individual countries. Or by households, as was the case in the United States in the 2000s. As you accumulate more debt, you could become concerned that this is dangerous. With more debt, you become more vulnerable to debt becoming very expensive and not being able to repay it. But the typical response is, ‘Don’t worry, because this time is different…for one reason or another.’ Support Five Books Five Books interviews are expensive to produce. If you're enjoying this interview, please support us by donating a small amount . For instance, in the case of the US global financial crisis, there was greater and greater sophistication of financial markets. More and more sophisticated financial instruments were being traded as mortgage-backed securities. There were all these strange acronyms that we suddenly learned about in 2008 and 2009. ‘This time is different because, thanks to these great financial innovations, we can now deal with the greater and greater amounts of debt that poorer and poorer households have.’ Of course, it’s never different. The patterns are recurrent. Many times, these great accumulations of debt end badly, with crises that are painful and difficult to resolve. The book is very insightful in that it contains an overview of how these crises tend to look. What are the points of similarity across crises? What are the differences? The book talks about different types of crises. It looks at crises that involve banks—and they highlight that bank crises are common both in rich countries and in poor countries; they tend to happen everywhere. They also talk about fiscal crises: external sovereign debt crises, which is when a country—this is typically the case for an emerging market economy—borrows internationally. The government of a country—Argentina is a typical example—borrows a large amount of debt from, say, lenders in the United States. All this debt gets accumulated, and it reaches a point where the government does not find it either possible or desirable to repay it. The debt is defaulted upon. That’s an external sovereign debt crisis, which typically coincides with a recession. The authors discuss in detail the long history of episodes of sovereign default, dating back to English kings defaulting on Florentine bankers in the 14th century. I remember, as a child, going to Siena and being told the story of how the cathedral was not finished because the English king had not paid. That’s a nice anecdote. This book summarises a large body of research by these two authors, their co-authors, and others, but I don’t think it includes that one. But you’re right that among the many papers that Reinhart and Rogoff wrote is this now infamous paper in which they argued that in countries where government debt goes above 90 percent of GDP, growth starts to slow down. That paper was very controversial. There was the story of how a graduate student figured out that the results were incorrect. Some of them were not robust; there was a coding error; and the authors were made fun of because they had used Excel, which is not particularly sophisticated as a piece of statistical software. Some people tried to discredit the authors. It’s unfortunate because, firstly, I don’t think those results are in this book. Secondly, the contribution of this book, in terms of providing super interesting data and a very clear review of the theories concerning these topics, is very neat and insightful. Instead of focusing on that particular detail, anybody interested in the macroeconomics of crisis—and in particular banking crises, fiscal crises, and the relationship between the two, which is very close—should find this book very interesting."

"Well, Kindleberger tells a very rich narrative of crashes, but the great thing that Rogoff and Reinhart have done is they’ve assembled this huge database. They’ve gone back 800 years and you can see roughly what’s been going on with government borrowing and lending over that time. Eight hundred years. We’ve been having banking crises for a long time. I did not put a book of mine on this list – Money, Greed and Risk – but it says the same kind of thing. It sort of shows the cycles and shows that all these things are essentially the same. A point to make is that nothing gets really crazy unless at first it’s a good thing. So there’s some innovation that makes the market work better and the guys who think of that get very rich because finance is always done with other folks’ money. So when you make an innovation, the first, second and third movers make a lot of money. Then everybody else rushes in to try to do it too, and the reason banking and finance is so risky is that it’s highly leveraged. It’s playing with borrowed money. You’re not putting up your own cash, or you’re putting up a little bit and getting the bank to provide the rest. So if you can invest in an innovative way then you’re making buckets. If you’re making something real, like steel, you might overproduce it, but you can’t have such a wild kind of production that you do in banking. It was something in China. But a good example is from the 14th and 15th centuries when a merchant trader would load a ship up with goods and he would sail around the world, sometimes for years, trading the goods he had for the goods he wanted. It was goods for goods and it was a slow process. Get the weekly Five Books newsletter Then the Italians invented the paper bill of exchange – basically a cheque, drawn on a banking house back in Venice or Genoa. And for the first time the trader could give a piece of paper in return for goods. Trade boomed. This was a brilliant invention. So other banks came in and started issuing these pieces of paper and in 60 years there was a huge crash that brought down the Italian and Dutch banking houses."

"If you travel around the US, the UK and Europe, people say “China this, China that…” and I find myself constantly having to remind people: China is still a very poor country! On a per capita income basis, they’re still number 99 in the world. Their financial markets are not developed at all. At the moment, there are all sorts of risks that we are seeing – the property markets in China are just one example. The property bubble we saw in Japan was a killer, as we all know. It’s affected the country economically for the last few decades. All of that is still a possibility in China, because they’re not functioning at a developed market level and are working super-hard to avert structural decline or stalling that we have seen in Japan. I think the more interesting story in This Time Is Different is what happens in the aftermath of bubbles, which links to what we were talking about before. In the case of the US, it’s still very reliant on tried and tested formulas to try to sort out economic busts – ie let’s just reflate this bubble by using relatively loose monetary policy and fiscal policy (think low interest rates, tax breaks, government spending increases, quantitative easing). In a similar vein, the Chinese moved very quickly, with strong political will, to finance and build massive infrastructure projects and construct massive cities. They have a lot of flexibility in what they can do in the aftermath of a financial crisis and how they can execute it, because they’ve got the political will and the political ability. Yes, but it also details what happens in their aftermath. It talks about the fact that countries almost always have these bailouts and end up with massive debts. And it points out that if you have 90% debt-to-GDP ratios, you invariably end up in a marked slow-growth period for several years. So, according to Reinhart and Rogoff’s book, we can expect that the US and western Europe are now in a long-term type of decline. I think the key point I would argue is that the US in particular – and many countries in Europe as well – have not yet understood the fact that they now have structural unemployment. They are no longer dealing with cyclical unemployment. In the past, when the US had a recession, or Britain had a recession, they would do exactly what the US is doing now. They would reflate the economy and things would ostensibly be fine. Why this is not working this time, and why I don’t think it will work longer-term, is because you’ve got competition. In the past you had no competition. America made all the computers, it made all the T-shirts. This time is different because there’s global competition. The fact that America is not producing computers does not mean the world can’t buy computers, because the Chinese are producing them. Get the weekly Five Books newsletter The way you deal with structural unemployment is quite different from the way you deal with cyclical unemployment. Dealing with structural unemployment means the US has to be much more aggressive than I would argue policymakers have been. You have to have the wiggle room, the flexibility, to be able to implement long-term structural policies. You have to have everyone on board. Which China has but the US doesn’t, because of the demands of democracy. If we were in China, I think they would know how to deal with structural unemployment much more aggressively than policymakers do in the West, who are hamstrung by short-term politics as discussed earlier. It’s the only book I have seen that provides, with great detail and over 800 years, clearly defined, analytical, data-driven evidence of what the impact of a post-financial crisis period is and hence what we can anticipate. In all my reading during my PhD, in all my reading in general, I’ve never seen anything that comes close in terms of being comprehensive. It’s a tour de force. One thing they point out is that a lot of countries have defaulted. They talk about Germany, for example, and about a lot of other countries. I think that’s quite interesting, because I’ve talked about how a US default is not off the table. A lot of people get their hackles up when I say that, but reading this book you realise many countries have got out of post-financial crisis aftermath periods by defaulting. Reinhart and Rogoff are not saying America should default, but there are many countries that have defaulted."

"Choosing this last book was really a struggle; there are so many I wanted to include. For the fifth book, I felt it was important that it be about the financial crisis because the first four books illustrate the origins, beauty, power, and relevance of finance, so this one should provide some balance by illustrating the potential dangers and devastation of finance. It turns out that there are lots of books out there with this perspective, I guess because there are so many ways we can get ourselves into financial troubles. But you only allowed me five books, so I chose one that I felt would best represent the issues that lie at the heart of financial crisis. It’s This Time Is Different by Carmen Reinhart and Ken Rogoff, a book that covers about 800 years of financial crises. I chose it not only because the two authors are highly accomplished economists, but also because they also took an enormous amount of time to put together datasets that allow us to look back eight centuries and ask, quantitatively, whether there are any common denominators to financial crises? And the not-surprising answer is, ‘Yes, absolutely.’ We know that Homo sapiens is at the core of all of these crises and human behavior really hasn’t changed that much in 800 years, even though many other things about our world have changed. And that’s part of the problem. Technologies have advanced very rapidly, but our ability to manage those technologies has not kept pace. Nowhere is this more clearly illustrated than in Reinhart and Rogoff’s book. They show that financial crisis is almost unavoidable. They provide a sobering look at how economies systematically expand unsustainably, and then we all pay the price in the aftermath of the inevitable collapses. This boom-bust pendulum swings back and forth—in some countries, on multiple occasions within a given lifetime. The hope is that once we understand this kind of a cycle—and Reinhart and Rogoff do a great job of documenting it and helping us understand its origins—we can then begin to develop the policies and practices that will allow us either to avoid them in the future or at least better prepare for them and their most severe aftershocks. I am. In fact, that was one of the books on my short list and had you allowed me six or seven books, that would have been among them. But if I had to pick only one book on financial crises, it would be Reinhart and Rogoff, for the simple reason that Kindleberger’s wonderful book is mainly a series of cautionary tales. And those tales are important. But, at the end of the day, they’re still just stories. Reinhart and Rogoff give us much more: a systematic study of crises, with real data that can tell us where we are in that cycle of fear and greed, where are we in terms of, say, the debt-to-GDP ratio, and how likely is it that a ratio of five is going to get us into trouble versus 12 or 15 or 50? The importance of data is not nearly as strongly emphasized in Kindleberger’s book, or in Charles Mackay’s book, or in any other book on financial panics, crashes, manias, bubbles and bursts. Reinhart and Rogoff raise the level of discourse about financial crises to an entirely new level, where we can start to study these kinds of phenomena systematically. Only through this kind of forensic analysis will we eventually be able to develop tools and policies to break out of these cycles. No, I’m not confident of that at all. In fact, I feel like we may be going backwards, now that the pendulum has swung back toward deregulation. As you probably know, there have been a series of attempts to dismantle parts of the Dodd-Frank Act, including the Volcker Rule and the Consumer Finance Protection Bureau. Many of the things that we started to put in place in 2008 are systematically being undermined or rolled back. And I’m not going to blame any one administration. I think it’s human nature, regardless of who’s president or who’s in Congress. Immediately following a crisis, everyone’s very concerned about it, we focus on it, and try to deal with it in many different ways. But over time, we tend to forget. It’s now been a decade since the financial crisis; the stock market is up, unemployment is down, GDP growth is strong. We seem to be doing great, so why worry about imposing tougher regulations a perfectly well-functioning financial system? In this kind of a salutary environment, it’s just too easy for us to sit back and enjoy it, and not worry about crises. That’s a mistake, but it’s human nature. And until and unless we have another crisis, I think it’s going to be very difficult for us to make genuine progress. There are those of us in academia, in government, and even in parts of the financial industry who might be continuing to focus on this as an issue, but we’re in the minority at this point. It’s much easier to be a cheerleader for a growing economy than to be a naysayer. So I think it’ll take another cycle of boom-and-bust before we start to develop systematic ways of dealing with crises on a more permanent basis. My most recent research involves applying financial engineering tools to deal with some of the biggest challenges facing society, like cancer. A few years ago, a number of friends and family of mine were dealing with cancer of one sort or another and in trying to be helpful to them, I began learning more about the disease. That process brought me to some literature on the business aspects of cancer drug development. It became clear to me that one of the bottlenecks in this industry is lack of funding at the early stages of drug development, and that’s an area where finance can make a difference. By way of background, drug development is a long process that starts in the laboratories of scientists and clinicians at universities and academic medical centers. To go from an idea for a new drug to FDA approval requires a lengthy process of preclinical work and then testing in humans, which is spread out over phases 1, 2, and 3, each phase involving progressively more patients, and where testing progresses from one phase to the next only if the previous phase shows that the drug candidate is safe and effective. In many cases, this whole process can take 10 to 15 years, thousands of volunteer patients, and cost hundreds of millions to billions of dollars to develop a single FDA-approved drug. There’s plenty of money in the pharmaceutical industry to pay for phase 3 clinical trials because by the time you reach phase 3, you’ve got a pretty good sense that your drug candidate is safe and effective, so a lot of the risk has been reduced. But money at the very earliest stages of university R&D and phase 1 trials is much harder to come by because the risk of an ineffective drug with toxic side effects is greatest at this stage. Money is so hard to come by that the industry calls this stage the ‘Valley of Death.’ So how do you cross this Valley of Death? From a financial economist’s point of view, the answer is actually pretty simple: reduce the risk of early-stage drug discovery. And one tried and true way of reducing risk is by combining “multiple shots on goal,” to use a hockey or soccer term. You combine a number of these projects into a single financial vehicle, allowing investors to invest in not just one or two projects but in a much larger pool of projects at the same time. Although the chances of any single drug candidate succeeding is quite low—in cancer, it’s about 5%—with a large enough portfolio of candidates, you’ve got a very high chance of getting at least one or two winners. And all you need is one or two winners to pay for all the trials in the entire portfolio, with a lot of profit left over. I believe they are practical, but that remains to be seen. Over the last few years, I’ve started developing these ideas in a more concrete way. I’ve published a number of papers showing what kind of returns are possible if you combine these multiple shots on goal, and the results look quite promising in areas like cancer and rare diseases. Some of these ideas have started getting traction in the last couple of years, and through these new business models and financing structures, more funding is now coming into the system to help scientists and clinicians cross the Valley of Death. On the other hand, for certain other diseases like Alzheimer’s or infectious diseases, the numbers don’t look nearly as attractive so some type of government support will be needed to deal with those challenges. This is the area I’m most passionate about right now, but the same tools can be applied to a number of other big challenges like climate change, energy, poverty—any problem that requires large amounts of funding at the outset, takes a long time to pay off, is very risky in the sense that the probability of success is very low, but where the payoff is extremely high in the event of a single success. Financial tools like portfolio theory, securitization, credit default swaps, and other derivative securities are ideally suited to deal with these long shots, and we need to be taking more long shots, not less. Contrary to popular impressions, finance doesn’t have to be a zero-sum game if we don’t let it. With the right financial structures, it’s possible to do well by doing good, and we can do it now."

"Reinhart and Rogoff are two macroeconomists who have done a marvellous job in bringing together a lot of historical and international data about how unstable financial systems are. The title of their book, This Time is Different , tells you the whole theme. In many respects, the Wall Street crisis was not at all different from Argentina or Britain in the early 1990s or any number of other crises that have been fuelled by credit bubbles and mismanaged macroeconomic policy. The reason that it was so surprising is that a lot of Americans in the 2000s believed that the US financial system was so deep and well developed that it would never be subject to the kind of instability that happened in Latin America during the 1980s. In a way they were victims of complacency. The other thing that is disturbing about the book is that it really shows how long it takes for a country to recover from this kind of a crisis. This suggests that the US and Europe, which is involved in a separate financial crisis of its own, are in for a prolonged period of low growth and stagnation. That’s one of its advantages. It’s written by two academic economists, it’s got a lot of data and you’ve got to plough through that. It’s a good reference, but it’s not the easiest book to read and it presupposes a certain amount of knowledge of macroeconomics. One of the great ironies that the book points to is the fact that a lot of the Asian governments were a lot wiser than the US. The US – through the US Treasury and its proxies, like the International Monetary Fund – put very heavy pressure on a lot of the emerging economies in Asia in the 1990s to liberalise. That had the effect of leading to a big influx of liquidity into Asia as a result of the Asian miracle, which then flowed out again in the mid-1990s and led directly to the Asian crisis in 1997. “ Just like these Asian governments, we didn’t have an adequate regulatory system in place, and we got into even bigger trouble than they did as a result.” The American reaction to that was to say, “Oh, this shows that the Asian governments are involved in crony capitalism! There’s not enough regulation, they don’t have mature institutions.” They patted themselves on the back that our system was much better than that. But in fact, in many respects, the financial crisis was simply a repeat of the Asian crisis. Instead of the money coming from the outside world into Asia, it flowed from Asia into the US, particularly from surplus countries like China. So there has been a certain amount of poetic justice. Just like these Asian governments, we didn’t have an adequate regulatory system in place, and we got into even bigger trouble than they did as a result. I don’t think there’s ever been a full acknowledgement of that on the part of Western policymakers. What’s happened in Asia is that all of those countries have gotten much more cautious about allowing free financial flows into their economies since 1997. That history – which we’ve managed to forget – is one that is pretty well covered in the Reinhart-Rogoff book. Yes, it was coming from the IMF, but the real pressure behind that was Wall Street. So, for example, in Korea, what we call the Asian financial crisis they labelled the IMF crisis. There is still a lot of bitterness. They believe that essentially the IMF took advantage of their liquidity crisis – that’s really what it was, it wasn’t fundamentally an economic crisis – and used that as an excuse to force open capital markets in Korea to the benefit of all the Goldman Sachses, Citigroups and so forth that wanted access to that market. All the American policymakers – Larry Summers, Bob Rubin – still swear that they had very pure motives in doing all of this, that this was just what was good for Korea. But behind that was, in fact, a tremendous amount of lobbying on the part of these big banks that had a direct self-interest in Asian financial liberalisation."