This Time Really Is Different

This is a reprint of my July 9, 2011 post, with a new introduction based on recent events — Dave

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The Reinhart/Rogoff Debacle

File under: Grasping At Straws

Make no mistake about it, the ongoing debate about economic policy in the United States is a political debate, and all such debates are divorced from the interests of America's citizens. Not only is the political system illegitimate, but there is also my old adage Politics Makes You Stupid.

Thus it came as no surprise that the work of Harvard economists Ken Rogoff and Carmen Reinhart, which related slow economic growth to public debt levels exceeding 90% of GDP, turned out to be flawed, or fatally flawed, depending on who you ask (it's politics). Their results could not be replicated with their own data because of various flaws in the statistical analysis, an Excel spreadsheet error, etc.

Conservatives have used their results to justify austerity in the United States. This is anathema to liberals, who believe a massive economic "stimulus" (via expanded public spending) will cause it to grow and grow, and that growth will eventually pay down the massive public debt. Neither view is grounded in Reality, but this misleading debate provides the necessary fodder for political posturing. Lately, if it weren't the Reinhart/Rogoff debacle, it would be something else.

Other, related work by the Harvard Two, which I allude to below, says that the sole cause of our protracted economic crisis is the fall-out from our having experienced a financial crisis, and it always takes (according to their historical research) a long time to recover from such crises. I responded to that convenient nonsense in This Time Really Is Different, which I have reprinted below.

Although I wrote this article in mid-2011, I found no need to change it. I don't bother with people like John Mauldin and Barry Ritholtz anymore, but thought it necessary to debunk them a few years ago.

This Time Really Is Different

As the economy goes down the drain, those who want to believe that America's problems are temporary face an unsolvable dilemma: how do you spin this ongoing disaster in such a way as to maintain your delusions about the future greatness of the United States? The latest jobs report was a case in point—"ugly" was the preferred word for describing it. John Mauldin is one of those who will grasp at any straw to remain hopeful about the future. I'll quote from his latest newsletter What Happened To The Jobs?

The US jobs report came out this morning, and it was simply dismal...

First, there were only 18,000 jobs created in June, the lowest since September 2010. While private employment rose by 57,000, government workers dropped by 39,000, continuing a trend as governments at all levels work to cut their budgets. Long-time readers know I think it is important to look at the direction of the revisions, and we got no help. May was revised down by 29,000 jobs and April a further down 15,000.

I saw some headlines and talking heads in the mainstream media saying the poor number was due to “seasonals,” and I just shook my head. If you are that reflexively bullish when presented with what was clearly a bad report, how can you be taken seriously?

Mauldin alludes to a problem from which he himself suffers: how do I take him seriously? Mauldin is an unabashed dyed-in-the-wool optimist who is loathe to admit that the American story will not have a Happy Ending. To show us just how bad things really are, Mauldin puts up the Employment/Population chart—the working portion of the U.S. population—and then purports to explain why things suck as badly as they do.

This Time Is Different

I have quoted at length in past letters from Ken Rogoff and Carmen Reinhart’s masterful work, This Time is Different. While the market may have been surprised by such a low jobs number, it is PRECISELY what is typical following a credit crisis, as they demonstrate in their book.

You may think Mauldin just pulled a rabbit out of his hat, and you're right, that's exactly what he did. You are meant to understand that this was a financial crisis, and the aftermath of financial crises is always really bad. This is the preferred explanation of "sophisticated" economic commentators who want to explain away what is happening in the United States, people like Barry Ritholtz.

In today’s Barron’s, Alan Abelson discusses a Reinhart & Rogoff paper (The Aftermath of Financial Crises) ... Note that we have discussed the fine work of R&R previously (here and here)...

... you should go read the original — that’s your weekend homework assignment. Meanwhile, here’s [some text from Reinhart & Rogoff]—

“Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics.

First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years.

Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment.

Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes. Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. Admittedly, bailout costs are difficult to measure, and there is considerable divergence among estimates from competing studies. But even upper-bound estimates pale next to actual measured rises in public debt. In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.”

I've got some news for people like John Mauldin, Barry Ritholtz, Carmen Reinhart and Ken Rogoff—this time is different, but not in the sense you intend. To understand what is happening in the United States, it is necessary to go far beyond an historical survey of financial crises. You must consider the specific historical circumstances that led to the current crisis. Such a review would include but not be limited to the following—

• The United States has been hemorrhaging manufacturing jobs for 30 years.
• Almost all of the income gains made during that time went to the top 10% of wage-earners, with most of them going to the top 1%. Wealth inequality grew accordingly.
• Health care costs have been soaring all that time.
• College tuition costs skyrocketed at a pace far beyond the rate of inflation.
• Households took on more and more debt to replace lost income.
• We had not one, but two, substantial economic bubbles during the last 15 years. Without those bubbles, how much would the U.S. economy have grown?
• The private debt to GDP ratio grew and grew, clearly indicating that more and more debt was required to add an additional point of GDP.
• The Federal Government more and more became the tool of monied special interests.

And so forth. You can find more detail in my post The Truth About The Middle Class. When people endorse Reinhart and Rogoff, we are supposed to understand that the Tough Times we're experiencing now have a well-defined beginning—the financial crisis after the fall of Lehman—and will have a well-defined end—however many years it takes to work through the credit problems. This is utter nonsense. The "historical obversations" I listed above are in fact the root causes of our current predicament.

And in each case, the historical trend has not changed, or has gotten worse. Households now have only slightly less debt than they did before the crisis, but trillions of dollars of housing wealth has disappeared. Health care costs continue to soar, as do college tuitions. Income gains still go to the wealthiest Americans. In short, nothing has changed.

That leaves those who want to believe that All Will Be Well with the same unsolvable dilemma we started out with: how do you tell a credible story that everything will turn out OK? I'm sorry, but no amount of convenient, hopeful rationalization is going to change the American disaster while the roots of the crisis remain in place. The financial meltdown was the proximate, not the ultimate, cause of America's economic woes.

This time really is different.

Comments

[Ben]

Is there any nation or territory on Earth where the economic system is working toward the long-term benefit of the people?