Government debt problems in Greece and some of its European neighbors have generated a lot of news over the past several weeks. Viewed with the long lens of history, this problem could generate a sarcastic, “So what’s new?”
Greece has spent 50% of the time since 1800 in default on its debt.
This is one of many startling thoughts in This Time is Different – Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff.
I recently read this book. It highlights how, “throughout history, rich and poor countries alike have been lending, borrowing, crashing—and recovering—their way through an extraordinary range of financial crises.”
“This time is different” is a misnomer usually explained as “We’re smarter now. We learned from the past. We have better data.” It’s rarely true.
Here are some notes and quotes I thought were worth sharing:
“What is certainly clear is that again and again, countries, banks, individuals, and firms take on excessive debt in good times without awareness of the risks that will follow when the inevitable recession hits. Many players in the global financial system often dig a debt hole far larger than they can reasonably expect to escape from … “
Although private debt certainly plays a key role in many crises, government debt is far more often the unifying problem across the wide range of financial crises.
The fact that basis data on government domestic debt is difficult to obtain “is proof that governments will go to great lengths to hide their books when things are going wrong.”
Economic theory tells us that it is precisely the fickle nature of confidence, including its dependence on the public’s expectations of future events that makes it so difficult to predict the timing of debt crises.
Economists do not have a terribly good idea of what kinds of events shift confidence and how to concretely assess confidence vulnerability.
Bubbles are far more dangerous when they are fueled by debt. The tech stock crash of 2000 caused only a light recession. The housing/mortgage issues later in the 2000s caused a huge recession.
“A few years back, many people would have said that improvements in financial engineering and the conduct of monetary policy had done much to tame the business cycle and limit the risk of financial contagion. This created a belief of invincibility of modern monetary institutions.”
Ignorance about debt wasn’t confined to the U.S., the Fed, or Wall Street banks. In April 2007, the International Monetary Fund’s World Monetary Outlook communicated that risks to the global economy “have become extremely low” and that, for the moment, there were “no great worries.” When the international agency charged with being the global watchdog declares that there are no risks, there is no surer sign that this time is different.
“Just as an individual can go bankrupt no matter how rich she starts out, a financial system can collapse under the pressure of greed, politics, and profits no matter how well regulated it seems to be.”
What is new this time is that an increasingly global economy means that trouble in one area can have greater impact on another.
Mohamed El-Erian, the Chief Investment Officer of PIMCO, the largest bond fund manager in the world expanded on this thought and compared the Greek situation to the subprime mortgage crisis in the U.S. that kicked off the global recession in 2007.
“At the beginning of ‘07, the general view was subprime was containable. It’s isolated. We heard those same words being applied to Greece. However, what we are learning is that we live in a very connected world and a major disruption somewhere in the world has to be taken seriously because of this connectivity.”
With the European Union and International Monetary Fund acting Monday with a package that pleased global investors, fear has been reduced. It doesn’t mean that problems are solved. Greece could still default on its debt and many nations—including the U.S.—have a lot of fiscal belt tightening to do as the world de-leverages from the great debt bubble.
Ultimately, though, we view these challenges like a series of potholes showing up in the road over the winter. They test the suspension of your car if you drive right into them but either they will get paved over or you’ll learn to drive around them.
For investors who have smartly diversified portfolios, damage will be reduced through exposure to holdings and markets that aren’t as sensitive to the solvency of companies or nations.
While each market correction creates risk aversion and a rush to “quality” investments (mostly perceived to be gold and U.S. Treasuries at the moment), we do not foresee a significant tactical adjustment to the personalized investment strategies we currently apply. If anything, the relative strengthening of the dollar leads us to tilt slightly in the favor of stocks of large U.S. companies that pay dividends.
~ Gary Brooks