Celebrating Creative Destruction
Board: Macro Economics
Regardless of what you think of Reinhart and Rogoff, “This time it is Different”, published 2009, contains a huge database of 800 years of country defaults, banking crises, and currency debasements. Much of the material is new, having been compiled and consolidated by the authors from statistics collected all over the world. The point is, of course, that this time it is never different. This may not be a particularly profound conclusion, but the statistical evidence presented by the authors is nonetheless quite surprising both in terms of the number of the events chronicled, and the shape of the patterns that develop from these data. Rather than being black swans (uncommon and unpredictable events) financial crises are the inevitable result of economic cycles in a free market economy. While timing of a banking crisis may be hard to predict they are nevertheless unavoidable.
While I am certainly not opposed to regulation, many attempts to regulate are doomed from the start. The notion that we can eliminate market cycles is born of the same sort of hubris that says “this time is different”. Much of the fertilizer that feeds the hubris that inflates the bubbles comes from the belief that legislation passed after the last crash will make it different this time.
My personal take on the data presented is very different from the one drawn by the Authors, who seem quite concerned for the future of our economic system. For instance, one statistical table presented shows that for the 66 countries covered for the period from 1800 to 2008 there were 268 banking crises. From the Authors this generates a good deal of hand ringing where I find these statistics reassuring.
None of these 268 crises caused the sky to fall or brought an end to capitalism. Instead throughout this period the world economy survived and living standards increased, and Capitalism has become semi-ubiquitous.
Granted the rate of GDP increase varied substantially from economic system to economic system. An important point the authors ignore or perhaps missed entirely is that the rate growth of personal income and per capita GDP was substantially greater in the countries with the most banking crises. Clearly the number of crises in a particular country is indicative the length of time the country operated with free markets.
If we break the numbers down by region, African countries averaged 1.7 crises per country, Asia 3.7 per country, Europe 5.8 per country (7.4 per country if you ignore Russia, Romania, Poland, Hungry and Turkey), Latin America 2.9 per country, and North American wins with an average of 10.5 per country.
The top ten countries in the world in the number of banking crises during this 208 year period were:
United States 13
United Kingdom 12
Clearly, there is a strong relationship between free markets and the number of banking crises. But, if we admit this relationship, then are we not faced with the conclusion that the price of reducing these crises would result much slower growth in GDP per capita and lower living standards? It seems that one of the central ironies of life is that economic pain promotes growth. The authors do not mention this relationship. Hey, they are from Harvard, what would you expect. They are always looking for someone to blame and for way to solve a problems they can’t solve.
The United States has survived 13 banking crises since 1800 – not only survived but prospered, while Russia, Kenya, Angola, Hungry have had two, Romania, Angola, Algeria, and Zimbabwe, one. It is time to look at the business cycle as a natural function of a market economy. While we may not like the pain of the consolidation, we should see it as creative destruction looking for a ways to make the economy work better. We should accept the fact that there is really nothing we can to eliminate the pain. Just as long periods of prosperity inevitably lead bankers and investors to take on stupid risk, it is what we learn from the pain of the consolidation that propels the next period of prosperity. The data doses do a very proper job of supporting the writing of an author with a very different philosophy Nassim Nickolas
Taleb who writes in his book “Antifragile” that it is the type of volatility introduced by the economic cycle that not only allows capitalism to survive but helps to make it AntiFragile.
Will it be different this time? Will this great contraction be the end of our prosperity? Have we reached the end of our period of dramatic growth? Is the American empire as dead as the as the British Empire or we have turned into Japan? Or perhaps this time follow the same pattern as our previous 208 years and this great contraction be followed by a couple of decades of double digit growth in corporate earnings and PE ratio expansion?