Tuesday, June 26, 2012

Reflections on This Time is Different, Part 1

This Time is Different

I'm still working on Reinhart and Rogoff's book on financial crises. Over eight centuries, they walk through how each society tells itself a narrative of exceptionalism while walking straight into the same old trap that has been the downfall of many nations and empires before it, debt. More specifically, debt built up during a boom phase of the cycle that wreaks havoc during the bust phase of a cycle. Put a little more eloquently and repetitively (in some variation): 

“We have been here before. The instruments of financial gain and loss have varied over the ages, as have the types of institutions that have expanded mightily only to fail massively. But financial crises follow a rhythm of boom and bust through the ages. Countries, institutions, and financial instruments may change across time, but human nature does not”.

Or put another way: 
 “More money has been lost because of four words than at the point of a gun. Those words are ‘This time is different’.

The story goes like this:

(Que the Rocky theme while stealing a line from Six-Million-Dollar Man).

With new financial innovations at hand, we are better at managing risk than ever before. Gentlemen, we can build [it]. We have the technology. We have the capability... Better than [it] was before. Better... stronger... faster.  Irrational Exuberance takes hold...

Then something happens. It all falls apart. Rocky loses the first movie. 

On a much smaller scale that is widely geographically distributed, I saw this in a study that I participated in on economic conditions in small communities when the hydrofracking boom came to town. The Boom phase would happen and, people believing that it will never end, take out significant levels of debt in order to capitalize on what they believe is the new economic norm. New apartments are built. Old restaurants double their capacity. Schools hire more teachers than ever before. Things are good for a few years. Better than anyone can ever remember.

Then the gas runs dry. Bust. It doesn't happen slowly; it happens overnight. No time to adjust. What seems like a manageable debt load is no longer as incomes half. The speed in which confidence is lost is faster than the speed of light. New homes are abandoned before they are ever completed. Thirty year old restaurants are shutting their doors. The local government, which was a beacon of employment stability, is laying people off. Things are bad for the forseeable future. Worse than anyone can ever remember.

The gas company moves down the road to find the next sweet spot; leaving the town to fend for itself.

Boom. Bust. Repeat.

Here's GIPSI (Also known as PIIGS - Greece, Italy, Portugal, Spain, Ireland):

See how the Debt to GDP ratio moves over time? That's the denominator moving - GDP-  not the numerator, debt. Manageable to unimaginable overnight. 

This time is not different. No one is exceptional.

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