This Time Is Different: Eight Centuries of Financial Folly Read online

  THIS

  TIME

  IS

  DIFFERENT

  THIS

  TIME

  IS

  DIFFERENT

  Eight Centuries

  of Financial Folly

  CARMEN M. REINHART

  KENNETH S. ROGOFF

  Copyright © 2009 by Princeton University Press

  Published by Princeton University Press, 41 William Street,

  Princeton, New Jersey 08540

  In the United Kingdom: Princeton University Press, 6 Oxford Street,

  Woodstock, Oxfordshire OX20 1TW

  press.princeton.edu

  All Rights Reserved

  Thirteenth printing, and first paperback printing, 2011

  Paperback ISBN 978-0-691-15264-6

  The Library of Congress has cataloged the cloth edition of this book as follows

  Reinhart, Carmen M.

  This time is different : eight centuries of financial folly/

  Carmen M. Reinhart, Kenneth S. Rogoff.

  p. cm.

  Includes bibliographical references and index.

  ISBN 978-0-691-14216-6 (hardcover : alk. paper)

  1. Financial crises—Case studies. 2. Fiscal policy—

  Case studies. 3. Business cycles—Case studies.

  I. Rogoff, Kenneth S. II. Title.

  HB3722.R45 2009

  338.5′42—dc22

  2009022616

  British Library Cataloging-in-Publication Data is available

  This book has been composed in Goudy text

  with Trade Gothic and Century italic by

  Princeton Editorial Associates, Inc., Scottsdale, Arizona

  Printed on acid-free paper. ∞

  Printed in the United States of America

  13 15 17 19 20 18 16 14

  To William Reinhart,

  Juliana Rogoff,

  and Gabriel Rogoff

  CONTENTS

  LIST OF TABLES

  LIST OF FIGURES

  LIST OF BOXES

  PREFACE

  ACKNOWLEDGMENTS

  PREAMBLE: SOME INITIAL INTUITIONS

  ON FINANCIAL FRAGILITY AND THE FICKLE

  NATURE OF CONFIDENCE

  PART I

  Financial Crises: An Operational Primer

  1

  Varieties of Crises and Their Dates

  Crises Defined by Quantitative Thresholds:

  Inflation, Currency Crashes, and Debasement

  Crises Defined by Events: Banking Crises

  and External and Domestic Default

  Other Key Concepts

  2

  Debt Intolerance: The Genesis of Serial Default

  Debt Thresholds

  Measuring Vulnerability

  Clubs and Regions

  Reflections on Debt Intolerance

  3

  A Global Database on Financial Crises

  with a Long-Term View

  Prices, Exchange Rates, Currency Debasement,

  and Real GDP

  Government Finances and National Accounts

  Public Debt and Its Composition

  Global Variables

  Country Coverage

  PART II

  Sovereign External Debt Crises

  4

  A Digression on the Theoretical

  Underpinnings of Debt Crises

  Sovereign Lending

  Illiquidity versus Insolvency

  Partial Default and Rescheduling

  Odious Debt

  Domestic Public Debt

  Conclusions

  5

  Cycles of Sovereign Default on External Debt

  Recurring Patterns

  Default and Banking Crises

  Default and Inflation

  Global Factors and Cycles of Global External Default

  The Duration of Default Episodes

  6

  External Default through History

  The Early History of Serial Default:

  Emerging Europe, 1300–1799

  Capital Inflows and Default: An “Old World” Story

  External Sovereign Default after 1800: A Global Picture

  PART III

  The Forgotten History of Domestic Debt and Default

  7

  The Stylized Facts of Domestic Debt and Default

  Domestic and External Debt

  Maturity, Rates of Return, and Currency Composition

  Episodes of Domestic Default

  Some Caveats Regarding Domestic Debt

  8

  Domestic Debt: The Missing Link Explaining

  External Default and High Inflation

  Understanding the Debt Intolerance Puzzle

  Domestic Debt on the Eve and in the

  Aftermath of External Default

  The Literature on Inflation and the “Inflation Tax”

  Defining the Tax Base: Domestic Debt or the Monetary Base?

  The “Temptation to Inflate” Revisited

  9

  Domestic and External Default:

  Which Is Worse? Who Is Senior?

  Real GDP in the Run-up to and the Aftermath of Debt Defaults

  Inflation in the Run-up to and the Aftermath of Debt Defaults

  The Incidence of Default on Debts Owed to

  External and Domestic Creditors

  Summary and Discussion of Selected Issues

  PART IV

  Banking Crises, Inflation, and Currency Crashes

  10

  Banking Crises

  A Preamble on the Theory of Banking Crises

  Banking Crises: An Equal-Opportunity Menace

  Banking Crises, Capital Mobility, and Financial Liberalization

  Capital Flow Bonanzas, Credit Cycles, and Asset Prices

  Overcapacity Bubbles in the Financial Industry?

  The Fiscal Legacy of Financial Crises Revisited

  Living with the Wreckage: Some Observations

  11

  Default through Debasement:

  An “Old World Favorite”

  12

  Inflation and Modern Currency Crashes

  An Early History of Inflation Crises

  Modern Inflation Crises: Regional Comparisons

  Currency Crashes

  The Aftermath of High Inflation and Currency Collapses

  Undoing Domestic Dollarization

  PART V

  The U.S. Subprime Meltdown and the

  Second Great Contraction

  13

  The U.S. Subprime Crisis: An International

  and Historical Comparison

  A Global Historical View of the Subprime

  Crisis and Its Aftermath

  The This-Time-Is-Different Syndrome and the

  Run-up to the Subprime Crisis

  Risks Posed by Sustained U.S. Borrowing from the

  Rest of the World: The Debate before the Crisis

  The Episodes of Postwar Bank-Centered Financial Crisis

  A Comparison of the Subprime Crisis with

  Past Crises in Advanced Economies

  Summary

  14

  The Aftermath of Financial Crises

  Historical Episodes Revisited

  The Downturn after a Crisis: Depth and Duration

  The Fiscal Legacy of Crises

  Sovereign Risk

  Comparisons with Experiences from the

  First Great Contraction in the 1930s

  Concluding Remarks

  15

  The International Dimensions of the Subprime Crisis:

 
; The Results of Contagion or Common Fundamentals?

  Concepts of Contagion

  Selected Earlier Episodes

  Common Fundamentals and the Second Great Contraction

  Are More Spillovers Under Way?

  16

  Composite Measures of Financial Turmoil

  Developing a Composite Index of Crises: The BCDI Index

  Defining a Global Financial Crisis

  The Sequencing of Crises: A Prototype

  Summary

  PART VI

  What Have We Learned?

  17

  Reflections on Early Warnings, Graduation,

  Policy Responses, and the Foibles of Human Nature

  On Early Warnings of Crises

  The Role of International Institutions

  Graduation

  Some Observations on Policy Responses

  The Latest Version of the This-Time-Is-Different Syndrome

  DATA APPENDIXES

  A.1. Macroeconomic Time Series

  A.2. Public Debt

  A.3. Dates of Banking Crises

  A.4. Historical Summaries of Banking Crises

  NOTES

  REFERENCES

  NAME INDEX

  SUBJECT INDEX

  TABLES

  1.1

  Defining crises: A summary of quantitative thresholds

  1.2

  Defining crises by events: A summary

  2.1

  External debt at the time of default: Middle-income countries, 1970–2008

  2.2

  External debt at the time of default: Frequency distribution, 1970–2008

  2.3

  Risk and debt: Panel pairwise correlations, 1979–2007

  3.1

  Countries’ share of world GDP, 1913 and 1990

  6.1

  The early external defaults: Europe, 1300–1799

  6.2

  External default and rescheduling: Africa, Europe, and Latin America, nineteenth century

  6.3

  Default and rescheduling: Africa and Asia, twentieth century to 2008

  6.4

  Default and rescheduling: Europe and Latin America, twentieth century to 2008

  6.5

  The cumulative tally of default and rescheduling: Africa and Asia, year of independence to 2008

  6.6

  The cumulative tally of default and rescheduling: Europe, Latin America, North America, and Oceania, year of independence to 2008

  7.1

  Interest rates on domestic and external debt, 1928–1946

  7.2

  Selected episodes of domestic debt default or restructuring, 1740–1921

  7.3

  Selected episodes of domestic debt default or restructuring, late 1920s–1950s

  7.4

  Selected episodes of domestic debt default or restructuring, 1970–2008

  8.1

  Debt ratios at the time of default: Selected episodes

  8.2

  Inflation and domestic public debt: Selected episodes, 1917–1994

  9.1

  Output and inflation around and during debt crises

  9.2

  Who gets expropriated, residents or foreigners? Preliminary tests for the equality of two proportions (binomial distribution), 1800–2006

  10.1

  Debt and banking crises: Africa and Asia, year of independence to 2008

  10.2

  Debt and banking crises: Europe, Latin America, North America, and Oceania, year of independence to 2008

  10.3

  Frequency of banking crises: Africa and Asia, to 2008

  10.4

  Frequency of banking crises: Europe, Latin America, North America, and Oceania, to 2008

  10.5

  Summary of the incidence and frequency of banking crises, 1800 (or independence) to 2008

  10.6

  Summary of the incidence and frequency of banking crises, 1945 (or independence) to 2008

  10.7

  The effect of a capital flow bonanza on the probability of a banking crisis in a sixty-six country sample, 1960–2007

  10.8

  Cycles of real housing prices and banking crises

  10.9

  Creative accounting? Bailout costs of banking crises

  11.1

  Expropriation through currency debasement: Europe, 1258–1799

  11.2

  Expropriation through currency debasement: Europe, nineteenth century

  12.1

  “Default” through inflation: Asia, Europe, and the “New World,” 1500–1799

  12.2

  “Default” through inflation: Africa and Asia, 1800–2008

  12.3

  “Default” through inflation: Europe, Latin America, North America, and Oceania, 1800–2008

  13.1

  Post–World War II bank-centered financial crises in advanced economies

  14.1

  Fiscal deficits (central government balance) as a percentage of GDP

  15.1

  Global banking crises, 1890–2008: Contagion or common fundamentals?

  16.1

  Indexes of total building activity in selected countries

  16.2

  Unemployment rates for selected countries, 1929–1932

  17.1

  Early warning indicators of banking and currency crises: A summary

  17.2

  Institutional Investor ratings of sixty-six countries: Upgrade or demotion, 1979–2008

  A.1.1

  Prices: Consumer or cost-of-living indexes

  A.1.2

  Modern nominal exchange rates

  A.1.3

  Early silver-based exchange rates

  A.1.4

  The silver content of currencies

  A.1.5

  Index of nominal and real gross national product and output

  A.1.6

  Gross national product

  A.1.7

  Central government expenditures and revenues

  A.1.8

  Total exports and imports

  A.1.9

  Global indicators and financial centers

  A.1.10

  Real house prices

  A.1.11

  Stock market indexes (equity prices)

  A.2.1

  Public debentures: External government bond issues

  A.2.2

  Total (domestic plus external) public debt

  A.2.3

  External public debt

  A.2.4

  Domestic public debt

  A.3.1

  Banking crisis dates and capital mobility, 1800–2008

  A.4.1

  Banking crises: Historical summaries, 1800–2008

  FIGURES

  P.1

  Sovereign external debt, 1800–2008: Percentage of countries in external default or restructuring weighted by their share of world income

  2.1

  Ratios of external debt to GNP: Defaulters and nondefaulters, 1970–2008

  2.2

  Definition of debtors’ clubs and external debt intolerance regions

  5.1

  Sovereign external debt: Countries in external default or restructuring, unweighted, 1800–2008

  5.2

  Sovereign external debt: Countries in external default or restructuring, weighted by share of world income, 1800–2008

  5.3

  Proportion of countries with banking and external debt crises: All countries, 1900–2008 (unweighted)

  5.4

  Inflation crises and external default, 1900–2007

  5.5

  Commodity prices and new external defaults, 1800–2008

  5.6

  Net capital flows from financial centers and external default, 1818–1939

  5.7

  Duration of external default episodes, 1800–2008

  6.1

  Spain: Defaults and loans to the Crown, 1601–1679

  7.1

  Domestic public debt a
s a share of total debt: All countries, 1900–2007

  7.2

  Domestic public debt as a share of total debt: Advanced economies, 1900–2007

  7.3

  Domestic public debt as a share of total debt: Emerging market economies, 1900–2007

  7.4

  Share of domestic debt that is long term: All countries and Latin America, 1914–1959

  7.5

  Sovereign domestic debt: Percent of countries in default or restructuring, 1900–2008

  8.1

  Ratios of public debt to revenue during external default: Eighty-nine episodes, 1827–2003

  8.2

  Ratios of public debt to revenue during external default: Frequency of occurrence, 1827–2003

  8.3

  Ratios of public debt to revenue during external default: Cumulative frequency of occurrence, 1827–2003

  8.4

  The run-up in government domestic and external debt on the eve of external default: Eighty-nine episodes, 1827–2003

  8.5

  Domestic public debt outstanding: China, 1895–1949

  9.1

  Real GDP before, during, and after domestic and external debt crises, 1800–2008

  9.2

  Domestic and external debt crises and GDP, three years before crisis and year of crisis, 1800–2008

  9.3

  Consumer prices before, during, and after domestic and external debt crises, 1800–2008

  9.4

  Domestic and external debt crises and inflation, three years before crisis and year of crisis, 1800–2008

  9.5

  Who is expropriated, residents or foreigners? The probability of domestic and external default, 1800–2006