9.6
Composite probability of domestic default as a share of the total default probability, 1800–2006
10.1
Capital mobility and the incidence of banking crises: All countries, 1800–2008
10.2
Real equity prices and banking crises: Forty episodes in emerging markets, 1920–2007
10.3
The number of banks in the United States, 1900–1945
10.4
Real GDP growth per capita (PPP basis) and banking crises: Advanced economies
10.5
Real GDP growth per capita (PPP basis) and banking crises: Emerging market economies (112 episodes)
10.6
Real central government revenue growth and banking crises: All countries, 1800–1944
10.7
Real central government revenue growth and banking crises: All countries, 1945–2007
10.8
Real central government revenue growth and banking crises: Advanced economies, 1815–2007
10.9
Real central government revenue growth and banking crises: Emerging market economies, 1873–2007
10.10
The evolution of real public debt following major postwar crises: Advanced and emerging markets
11.1
Changes in the silver content of the currency, 1765–1815: Austria and Russia during the Napoleonic Wars
11.2
The march toward fiat money, Europe, 1400–1850: The average silver content of ten currencies
12.1
The median inflation rate: Five-year moving average for all countries, 1500–2007
12.2
The incidence of annual inflation above 20 percent: Africa, Asia, Europe, and Latin America, 1800–2007
12.3
Currency crashes: The share of countries with annual depreciation rates greater than 15 percent, 1800–2007
12.4
Median annual depreciation: Five-year moving average for all countries, 1800–2007
12.5
The persistence of dollarization
12.6
The de-dollarization of bank deposits: Israel, Poland, Mexico, and Pakistan, 1980–2002
13.1
The proportion of countries with banking crises, 1900–2008, weighted by their share of world income
13.2
Real housing prices: United States, 1891–2008
13.3
Real housing prices and postwar banking crises: Advanced economies
13.4
Real equity prices and postwar banking crises: Advanced economies
13.5
Ratio of current account balance to GDP on the eve of postwar banking crises: Advanced economies
13.6
Growth in real per capita GDP (PPP basis) and postwar banking crises: Advanced economies
13.7
Real central government debt and postwar banking crises: Advanced economies
14.1
Cycles of past and ongoing real house prices and banking crises
14.2
Cycles of past and ongoing real equity prices and banking crises
14.3
Cycles of past unemployment and banking crises
14.4
Cycles of past real per capita GDP and banking crises
14.5
The cumulative increase in real public debt in the three years following past banking crises
14.6
Cycles of Institutional Investor sovereign ratings and past banking crises
14.7
The duration of major financial crises: Fourteen Great Depression episodes versus fourteen post–World War II episodes (duration of the fall in output per capita)
14.8
The duration of major financial crises: Fourteen Great Depression episodes versus fourteen post–World War II episodes (number of years for output per capita to return to its precrisis level)
14.9
The cumulative increase in real public debt three and six years following the onset of the Great Depression in 1929: Selected countries
15.1
Percentage change in real housing prices, 2002–2006
16.1
The proportion of countries with systemic banking crises (weighted by their share of world income) and U.S. corporate speculative-grade default rates, 1919–2008
16.2
Varieties of crises: World aggregate, 1900–2008
16.3
Varieties of crises: Advanced economies aggregate, 1900–2008
16.4
Varieties of crises: Africa, 1900–2008
16.5
Varieties of crises: All countries and Asia, 1800–2008
16.6
Varieties of crises: All countries and Latin America, 1800–2008
16.7
Global stock markets during global crises: The composite real stock price index (end of period)
16.8
Real per capita GDP during global financial crises: Multicountry aggregates (PPP weighted)
16.9
The contracting spiral of world trade month by month, January 1929–June 1933
16.10
World export growth, 1928–2009
16.11
The collapse of exports, 1929–1932
16.12
The sequencing of crises: A prototype
17.1
Change in Institutional Investor sovereign credit ratings of sixty-six countries, 1979–2008
BOXES
1.1
Debt glossary
1.2
The this-time-is-different syndrome on the eve of the Crash of 1929
5.1
The development of international sovereign debt markets in England and Spain
5.2
External default penalized: The extraordinary case of Newfoundland, 1928–1933
5.3
External default penalized? The case of the missing “Brady bunch”
6.1
France’s graduation after eight external defaults, 1558–1788
6.2
Latin America’s early days in international capital markets, 1822–1825
7.1
Foreign currency–linked domestic debt: Thai tesobonos?
16.1
Global financial crises: A working definition
PREFACE
This book provides a quantitative history of financial crises in their various guises. Our basic message is simple: We have been here before. No matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities with past experience from other countries and from history. Recognizing these analogies and precedents is an essential step toward improving our global financial system, both to reduce the risk of future crisis and to better handle catastrophes when they happen.
If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government’s policies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly. Of course, debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge policy makers, investors, and ordinary citizens must never forget.
In this book we study a number of different types of financial crises. They includ
e sovereign defaults, which occur when a government fails to meet payments on its external or domestic debt obligations or both. Then there are banking crises such as those the world has experienced in spades in the late 2000s. In a typical major banking crisis, a nation finds that a significant part of its banking sector has become insolvent after heavy investment losses, banking panics, or both. Another important class of crises consists of exchange rate crises such as those that plagued Asia, Europe, and Latin America in the 1990s. In the quintessential exchange rate crisis, the value of a country’s currency falls precipitously, often despite a government “guarantee” that it will not allow this to happen under any circumstances. We also consider crises marked by bouts of very high inflation. Needless to say, unexpected increases in inflation are the de facto equivalent of outright default, for inflation allows all debtors (including the government) to repay their debts in currency that has much less purchasing power than it did when the loans were made. In much of the book we will explore these crises separately. But crises often occur in clusters. In the penultimate text chapter of the book we will look at situations—such as the Great Depression of the 1930s and the latest worldwide financial crisis—in which crises occur in bunches and on a global scale.
Of course, financial crises are nothing new. They have been around since the development of money and financial markets. Many of the earliest crises were driven by currency debasements that occurred when the monarch of a country reduced the gold or silver content of the coin of the realm to finance budget shortfalls often prompted by wars. Technological advances have long since eliminated a government’s need to clip coins to fill a budget deficit. But financial crises have continued to thrive through the ages, and they plague countries to this day.
Most of our focus in this book is on two particular forms of crises that are particularly relevant today: sovereign debt crises and banking crises. Both have histories that span centuries and cut across regions. Sovereign debt crises were once commonplace among the now advanced economies that appear to have “graduated” from periodic bouts of government insolvency. In emerging markets, however, recurring (or serial) default remains a chronic and serious disease. Banking crises, in contrast, remain a recurring problem everywhere. They are an equal-opportunity menace, affecting rich and poor countries alike. Our banking crisis investigation takes us on a tour from bank runs and bank failures in Europe during the Napoleonic Wars to the recent global financial crises that began with the U.S. subprime crisis of 2007.
Our aim here is to be expansive, systematic, and quantitative: our empirical analysis covers sixty-six countries over nearly eight centuries. Many important books have been written about the history of international financial crises,1 perhaps the most famous of which is Kindleberger’s 1989 book Manias, Panics and Crashes.2 By and large, however, these earlier works take an essentially narrative approach, fortified by relatively sparse data.
Here, by contrast, we build our analysis around data culled from a massive database that encompasses the entire world and goes back as far as twelfth-century China and medieval Europe. The core “life” of this book is contained in the (largely) simple tables and figures in which these data are presented rather than in narratives of personalities, politics, and negotiations. We trust that our visual quantitative history of financial crises is no less compelling than the earlier narrative approach, and we hope that it may open new vistas for policy analysis and research.
Above all, our emphasis is on looking at long spans of history to catch sight of “rare” events that are all too often forgotten, although they turn out to be far more common and similar than people seem to think. Indeed, analysts, policy makers, and even academic economists have an unfortunate tendency to view recent experience through the narrow window opened by standard data sets, typically based on a narrow range of experience in terms of countries and time periods. A large fraction of the academic and policy literature on debt and default draws conclusions based on data collected since 1980, in no small part because such data are the most readily accessible. This approach would be fine except for the fact that financial crises have much longer cycles, and a data set that covers twenty-five years simply cannot give one an adequate perspective on the risks of alternative policies and investments. An event that was rare in that twenty-five-year span may not be all that rare when placed in a longer historical context. After all, a researcher stands only a one-in-four chance of observing a “hundred-year flood” in twenty-five years’ worth of data. To even begin to think about such events, one needs to compile data for several centuries. Of course, that is precisely our aim here.
In addition, standard data sets are greatly limited in several other important respects, especially in regard to their coverage of the types of government debt. In fact, as we shall see, historical data on domestically issued government debt is remarkably difficult to obtain for most countries, which have often been little more transparent than modern-day banks with their off–balance sheet transactions and other accounting shenanigans.
The foundations of our analysis are built on a comprehensive new database for studying international debt and banking crises, inflation, and currency crashes and debasements. The data come from Africa, Asia, Europe, Latin America, North America, and Oceania (data from sixty-six countries in all, as previously noted, plus selected data for a number of other countries). The range of variables encompasses, among many other dimensions, external and domestic debt, trade, national income, inflation, exchange rates, interest rates, and commodity prices. The data coverage goes back more than eight hundred years, to the date of independence for most countries and well into the colonial period for several. Of course, we recognize that the exercises and illustrations that we provide here can only scratch the surface of what a data set of this scope and scale can potentially unveil.
Fortunately, conveying the details of the data is not essential to understanding the main message of this book: we have been here before. The instruments of financial gain and loss have varied over the ages, as have the types of institutions that have expanded mightily only to fail massively. But financial crises follow a rhythm of boom and bust through the ages. Countries, institutions, and financial instruments may change across time, but human nature does not. As we will discuss in the final chapters of this book, the financial crisis of the late 2000s that originated in the United States and spread across the globe—which we refer to as the Second Great Contraction—is only the latest manifestation of this pattern.
We take up the latest crisis in the final four chapters before the conclusion, in which we review what we have learned; the reader should find the material in chapters 13–16 relatively straightforward and self-contained. (Indeed, readers interested mainly in lessons of history for the latest crisis are encouraged to jump directly to this material in a first reading.) We show that in the run-up to the subprime crisis, standard indicators for the United States, such as asset price inflation, rising leverage, large sustained current account deficits, and a slowing trajectory of economic growth, exhibited virtually all the signs of a country on the verge of a financial crisis—indeed, a severe one. This view of the way into a crisis is sobering; we show that the way out can be quite perilous as well. The aftermath of systemic banking crises involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources.
The first part of the book gives precise definitions of concepts describing crises and discusses the data underlying the book. In the construction of our data set we have built heavily on the work of earlier scholars. However, our data set also includes a considerable amount of new material from diverse primary and secondary sources. In addition to providing a systematic dating of external debt and exchange rate crises, the appendixes to this book catalog dates for domestic inflation and banking crises. The dating of sovereign defaults on domestic (mostly local-currency) debt is one of the more novel features that rounds out our study of financial crises.
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The payoff to this scrutiny comes in the remaining parts of the book, which apply these concepts to our expanded global data set. Part II turns our attention to government debt, chronicling hundreds of episodes of default by sovereign nations on their debt to external creditors. These “debt crises” have ranged from those related to mid-fourteenth-century loans by Florentine financiers to England’s Edward III to German merchant bankers’ loans to Spain’s Hapsburg Monarchy to massive loans made by (mostly) New York bankers to Latin America during the 1970s. Although we find that during the modern era sovereign external default crises have been far more concentrated in emerging markets than banking crises have been, we nevertheless emphasize that even sovereign defaults on external debt have been an almost universal rite of passage for every country as it has matured from an emerging market economy to an advanced developed economy. This process of economic, financial, social, and political development can take centuries.
Indeed, in its early years as a nation-state, France defaulted on its external debt no fewer than eight times (as we show in chapter 6)! Spain defaulted a mere six times prior to 1800, but, with seven defaults in the nineteenth century, surpassed France for a total of thirteen episodes. Thus, when today’s European powers were going through the emerging market phase of development, they experienced recurrent problems with external debt default, just as many emerging markets do today.
This Time Is Different: Eight Centuries of Financial Folly Page 2