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Sunday, June 27, 2010

This time is different

The just finished the Book "This Time Is Different: Eight Centuries of Financial Folly" by Reinhart and Rogoff. I can't say it was written for general public consumption. It was both data rich and poor simultaneously. They did a remarkable job of amassing financial data dating back hundreds of years .However, there were large gaps in the database and many assumptions regarding how to fill in these holes.

The lessons of the book were actually very straight forward and included:
1. All entities both private and public have immediate vested interests in hiding financial data, particularly relating to debt. This makes historical assessments regarding the role of debt in financial meltdowns difficult.
2. Financial meltdowns of various types (bank defaults, sovereign debt defaults, currency debasements) tend to be preceded by increased amounts of debt, financial bubbles (especially real estate), and relaxation of financial regulations (innovations).
3. The frequency of defaults of various types throughout history is much higher than we are led to believe and contemporary financial structures may not have lessened the frequency of impact of economic meltdowns.
4. The timeline for the development of financial meltdowns is unpredictable in that debt expansion and asset inflation may go on for an extended period of time before the meltdown events actually unfold.

Perhaps the most striking conclusion I can draw from their findings relates to how we might deploy strategies to avoid financial meltdowns. As the title implies, at any given point in time, one of the characteristics which marks the times prior to economic calamity is the "This time is different" mentality. The very development of tools to prevent events such as the Great Depression or The Second Great Contraction may very well increase the likelihood they will happen again. Perhaps the best defense against such events is the understanding that they can happen which serves to temper our use of debt and leverage.

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