Doubts about debts: Reinhart, Reinhart and Rogoff on the nature of modern capitalism (1800 – 2010)

from Merijn Knibbe

I’ve  spent some quality time with Reinhart, Reinhart and Rogoff. They write about the long term development of debt and modern capitalism. It reads like a Post-Keynesian/Austrian/Institutionalist/Georgian economic history synthesis – interesting, as their findings are presented at, among other occasions, ‘The Federal Reserve Bank of Kansas city Jackson Hole Symposium’ of August, 2010.

R., R.  and R. have assembled an awe inspiring amount of data on GDP growth, private debt, government debt, domestic debt, external debt, unemployment, inflation and government defaults from about 1350 to the present. Some results:

1. Again and again (and again), waves of credit fuel booms which eventually go bust, shattering lives and disrupting societies. These busts are not just cyclical downturns – this is stuff like the Asian Crisis, the GFC, the Great Depression and a number of other episodes.
2. Recovery does not come easy. Market economies survive and adapt, albeit quite slowly if ‘phoney debts’ are not restructured quickly. The same holds to an even larger degree for growth, employment and prosperity. Even decades after the bust of a credit boom, unemployment is in almost all countries (except those which already knew high unemployment before the bust) higher than before the bust. Unemployment only comes down quite slowly, anyway.
3. About the same for economic growth: it easily takes a decade before economic growth is back to ‘the old normal’ (R, R@R might however mix up effects of the crises with long term changes in growth rates. According to the preliminary findings of P. Foldvary and J.L. van Zanden: before about 1880, maximum GDP growth seems to have been lower than after, while max. post 1970 growth rates in the ‘leading’ economies might be lower than before – R., R. and R. do not take account of this).
4. About the same for inflation: it stays lower than before the bust for an extended period of time.
5. ‘It’ happens everywhere and always. There are some lulls – most notably the 1948-1978 period – but irrational excuberance followed by default and crisis is no exceptional event. It’s part and parcel of the nature of the monetary beast.
6. Every emerging economy (no exception) has at least once experienced a serious credit bust and default (the data of Foldvary and Van Zanden make it possible to investigate if this also caused some countries to quite the ‘convergence club’ of growing emerging economies – but such things still have to be figured out, as R., R. and R. admit in a footnote.).
7. House prices seem to be some kind of leading indicator and there might be real estate cycles (the OECD (2011) has, quite recently, also discoverd that ‘housing’ can be a contributor to macro economic cycles…)
8. Credit growth (measured as a % of GDP) sometimes continues for some time after the bust – but eventually, deleverage follows (bad news for the UK and the Netherlands).
9. Countries which experience a serious credit bust and reorganize banking seem to be less prone to other busts for decades (for instance the Nordic countries and Canada during the GFC).
10. Governments do not need fiat money to manipulate the currency.

Where does this leads us, aside from the idea that it might be wise to teach students of economics a little history of economic thought and a little economic history?

First, Real World economies doe not tend to neo-classical General Equilibrium with perfect use of factors of production. Again and again (and again), the inherent forces of modern Real World capitalism change a healthy supply of credit  into reckless lending  which disrupts and dislocates economies. We’re listening to the song of the sirens, again and again (and again).   

The findings of R., R. @ R. (especially september 2010) underscore the ideas of Steve Keen on the recent World Economic Forum (WEF) report, as he expresses these on this blog: the long and the very long run do matter, when it comes to credit and debts and the WEF has (not ‘should’, but ‘has’) to pay more attention to this. As the WEF study does not use the R., R. and R. september 2010 data (presented at the Jackson Hole conference – this is not obscure stuff!) while it does cite studies published as late as november 2010, the McKinsey company which wrote the report could and should have done a better job. But maybe I shouldn’t expect the same standards from McKinsey as from my students. 

The report – which does contain a lot of usefull information – advises, in the end and among other things, to tie Odysseus to the mast – to resist the song of the sirens. But it advises to do this with thin, soft and weak silken threads, instead of titanium chains. This has to change – though even chains will, in the end, give way to the song of the sirens. Again. If I remember this well, it were anyway not the ropes binding the leader which prevented Odysseus his ship from crashing, but the wax in the ears of the underlings.

The report also does not adress the problem of asset inflation – which, according to R., R. and R., is a main problem  of credit fuelled booms. The siren-song proposal to double the amount of credit between now and 2o20, based upon 2000-2010 trends, therefore implicitely accepts that credit fuelled asset inflation in the run up to the GFC was not a bad thing – and that we should try this, again. If we manage to curb asset inflation (i.e. rising prices of houses, land and stocks), much less credit is needed. Anybody any proposals?

By the way, we do need a global metric of asset price inflation, I think. Money still is a national thing – but reckless credit isn’t.

Aside: the WEF report is fun, too. It states (p. 16): “There is potential for securitization to recover: market participants surveyed by McKinsey in 2009 (i.e.: the bosses of the Big Banks, M.K.) expected the securitization market to return to around 50% of its pre-crisis volume within three years. But to rebuild investor confidence, there will need to be increased price transparency, better data on collateral pools, and better quality ratings (emphasis added, M.K.).” In other words: the banks really, really did not know what they were doing at the time.

Literature

Földvári, P. and J. L. van Zanden. Global Income Distribution and Convergence 1800-2000, http://www.iisg.nl/research/income-distribution.pdf

OECD, ‘ Housing and the economy: policies for renovation. Chapter from forthcoming Economic policy reforms 2011, Going for growth (Paris, 2011). http://www.oecd.org/dataoecd/42/11/46917384.pdf

Reinhart, C. M. and K. S. Rogoff, This Time is Different: Eight Centuries of Financial Folly (Princeton: Princeton University Press, 2009)

Reinhart, M.C. and K.S. Rogoff, ‘Growth in a time of debt’, NBER working paper 15639 (January 2010)

Reinhart, C.M. and V.R. Reinhart, ‘After the fall’, NBER working paper 16334 (September 2010)

World Economic Forum in collaboration with McKinsey and company, ‘More credit with fewer crises. Responsibly meeting the World’s growing demand for credit’ (Geneva, 2010)