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Paying off debt is painful. It's like dying: you try to put it off as long as you can, but nobody runs an open tab forever. And just as you can't go to heaven without dying, when it's time to pay up, someone is bound to suffer.
This week brought news that Maine-based luxury yacht maker Hinckley, which has been building boats since 1928, is sinking. The problem is neither technical nor operational. It is philosophical. No one complains of the quality of the boats. Or even the prices (if you have to ask, you can't afford one). The firm sailed along nicely until 1997. Then the private-equity boys took the helm. The old Hinckleys who ran the shop looked upon debt as a form of sin. A little was fun. A lot was dangerous. In the 70 years they ran the place, they accumulated only $1m of debt. The new owners had a more modern view; they multiplied Hinckley's debt 20 to 40 times (exact figures are not available).
For much of history, failing to repay debt was seen not merely as a breach of contract, but a crime. People who failed to repay their debts were thought to have stolen from their lenders; they were put in prison. In the Middle Ages even a dead debtor's children could be sent to prison. Now, debtors routinely stiff creditors. Bankruptcy laws allow individuals and businesses to wash the slate clean. The debtor wears no scarlet letter. He's merely deprived of credit for a short time. Then he can go broke again. And who cares? Neither sin nor crime, debt is just business. Creditors routinely budget for a certain level of 'bad debt' losses; they regard it as a cost of doing business.
But few creditors are as forgiving – or perhaps as forgetful – as those who lend to governments. That is the conclusion of a new book by Carmen Reinhart and Kenneth Rogoff, This Time It's Different. The two document the history of eight centuries of "financial folly". What we learn is what we already knew. Borrowers are often perfidious, crises are usually insidious, and bankers are morons.
Just five years ago, Ben Bernanke looked out on the calm seas of the Bubble Era and liked what he saw. "The Great Moderation", he called it. Between the Asian Crisis of 1997-1998 and the Global Contraction of 2008-2009 no major economy experienced a banking crisis, default, or hyperinflation. Bernanke took the credit. It was due to "improved macro-economic policies", he said. He should have said it was just luck and left it at that. His macro-economic policies encouraged all sectors of the economy to borrow. We know what this did for Hinckley. Riding low in the water from too much debt heaped on its deck, when the winds picked up, it took on water.
But what's new, ask Reinhart and Rogoff? There are more wrecks in financial history than on the Cornish coast. Debt figures as the main culprit in almost every one. France defaulted on its sovereign debt eight times. Spain defaulted six times before 1800 and then another seven times later. Latin America, as the authors point out, would have been safer for bankers if the printing press had never made its way across the Atlantic.
Between hyperinflation, defaults and banking debacles – over two centuries – the banana republics scammed banks, mainly in London and New York, for billions. In the 1980s, Nicholas Brady tried to rescue New York bankers with his US-backed 'Brady bonds'. Readers of these columns can guess what happened next. Debt problems didn't go away. Within a few years, seven of the 17 countries that had undertaken a Brady-type restructuring had about as much or more debt than before. By 2003, four members of the Brady bunch had once again defaulted and by 2008 Ecuador had defaulted twice.
Even non-existent countries went bust. In 1822, "General Sir" Gregor MacGregor issued bonds from a fictitious country he called Poyais, whose capital, Saint Joseph, was described by the prospectus as having "broad boulevards, colonnaded buildings and a splendid domed cathedral". The bonds sold at lower yields than those of Chile. But it didn't seem to matter whether the country was real or not, all of them defaulted.
As for the present slump, the authors offer no predictions, but some guidelines. Based on their comparative data, in a downturn like this one (which they call the Great Contraction), real housing prices generally fall by 36% over a six-year period. GDP, in real terms, per head typically falls by 9.3%. Unemployment rates go up for five years, with a 'normal' increase of about seven percentage points. But the closest – and perhaps the only parallel to the present circumstance – is the Great Depression of the 1930s. Then world exports fell by 30% in 1932. Building activity fell 82% in America.
As the private sector sinks, government soon joins it. Tax revenues fall. Expenses rise (especially when the authorities are ready to do 'whatever it takes' to stir a recovery). Typically, say Reinhard and Rogoff, public debt grows 86% over a three-year period after a financial calamity. Then come catastrophes caused by too much debt in the public sector. The UK and US are now running deficits of more than 10% of GDP, a level that often triggers disasters. So stay tuned. Currency devaluations, government defaults and hyperinflation are still ahead.
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