...John Mauldin quoting excerpts from Kenneth Rogoffs 'This Time is Different' book with views of his own.
“Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence—especially in cases in which large short-term debts need to be rolled over continuously—is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!, confidence collapses, lenders disappear, and a crisis hits.
“Economic theory tells us that it is precisely the fickle nature of confidence, including its dependence on the public's expectation of future events, that makes it so difficult to predict the timing of debt crises. High debt levels lead, in many mathematical economics models, to ‘multiple equilibria’ in which the debt level might be sustained—or might not be.
“Economists do not have a terribly good idea of what kinds of events shift confidence and of how to concretely assess confidence vulnerability. What one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does. When countries become too deeply indebted, they are headed for trouble. When debt-fueled asset price explosions seem too good to be true, they probably are. But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.”
Did you read it again? If not, then do so. Burn it into your memory. It is the crux of the issue.
Here's how I reacted to that quote in my 2010 letter. Remember, this was just a couple of years after the US subprime crisis. A similar crisis was unfolding in Europe, especially Greece.
“How confident was the world in October of 2006? I was writing that there would be a recession, a subprime crisis, and a credit crisis in our future. I was on Larry Kudlow's show with Nouriel Roubini, and Larry and John Rutledge were giving us a hard time about our so-called ‘doom and gloom.’ If there is going to be a recession you should get out of the stock market, was my call. I was a tad early, as the market proceeded to go up another 20% over the next 8 months.
“As Reinhart and Rogoff wrote: ‘Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!, confidence collapses, lenders disappear, and a crisis hits.’
“Bang is the right word. It is the nature of human beings to assume that the current trend will work out, that things can't really be that bad. Look at the bond markets only a year and then just a few months before World War I. There was no sign of an impending war. Everyone ‘knew’ that cooler heads would prevail.
“We can look back now and see where we made mistakes in the current crisis. We actually believed that this time was different, that we had better financial instruments, smarter regulators, and were so, well, modern. Times were different. We knew how to deal with leverage. Borrowing against your home was a good thing. Housing values would always go up. Etc.
“Now, there are bullish voices telling us that things are headed back to normal. Mainstream forecasts for GDP growth this year are quite robust, north of 4% for the year, based on evidence from past recoveries. However, the underlying fundamentals of a banking crisis are far different from those of a typical business cycle recession, as Reinhart and Rogoff's work so clearly reveals. It typically takes years to work off excess leverage in a banking crisis, with unemployment often rising for 4 years running.
“The point is that complacency almost always ends suddenly. You just don't slide gradually into a crisis over years. It happens! All of a sudden there is a trigger event, and it is August of 2008. And the evidence in the book is that things go along fine until there is that crisis of confidence. There is no way to know when it will happen. There is no magic debt level, no magic drop in currencies, no percentage level of fiscal deficits, no single point where we can say ‘This is it.’ It is different in different crises.
“One point I found fascinating… when it comes to the various types of crises which the authors identify, there is very little difference between developed and emerging-market countries, especially as to the fallout. It seems that the developed world has no corner on special wisdom that would allow crises to be avoided or allow them to be recovered from more quickly. In fact, because of their overconfidence—because they actually feel they have superior systems—developed countries can dig deeper holes for themselves than emerging markets.”
John of 2024 here again. Reading that now, I see I was describing what I’ve elsewhere called a collapsing sandpile, or a “Minsky Moment.” Debt is sustainable until it suddenly isn’t. Some event, some last grain of sand, triggers the hidden fingers of instability and it all collapses. And anything can be that trigger.
This is why debt crises are so destructive. By their nature, no one is prepared because no one sees them coming. A few expect them, yes, but they never know the timing. History shows over and over that in a debt crisis, everything is fine and then it’s not. The transitions happen fast.
