History, bunk and the bond market
–Laurence Copeland is a professor of finance at Cardiff University Business School . The opinions expressed are his own–
The title says it all: “This Time is Different” by Reinhart and Rogoff tells how, for centuries, monarchs and, later, nation states have persuaded lenders to forget their chequered credit record and trust them yet again with loans on relatively easy terms. Although, by the nineteenth century, Western European countries had mostly reached a stage where their reputation seemed worth preserving at some cost, more or less from the moment they achieved their independence the South American countries established a tradition of default which they have guarded jealously to the present day, and as Reinhart and Rogoff make clear, Greece has defaulted at regular intervals ever since it became an independent nation in 1832.
Yet the tale they tell flies in the face of common sense, as well as running counter to the faith in the rationality of capital markets which used to be widespread but is now confined to a diminishing band of true believers. After all, with such spotty credit records, you would expect sovereign borrowers to be able to raise loans only by paying prohibitively high interest rates. Yet however much attention they may pay to credit history in their consumer lending division, when it comes to sovereign borrowers, bankers seem to believe with Henry Ford that history is bunk, or as the CEO of the world’s then-biggest bank put it in the 1970’s: “Countries don’t go bust”.
Sure enough, this year, lenders have finally come to their senses with respect to the euro zone countries, but not before our bankers – yes, the ones whose skills are as rare as those of a Lionel Messi and need to be rewarded accordingly – had lent them vast sums at interest rates that took no account whatever of their respective creditworthiness, and indeed they are still doing the same with their lending to Britain and America.
To be fair, it is not only bankers who seem to ignore history. After all, you might have thought after the chastening experience of the early 1990’s, when the housing market crashed and the tabloids introduced the British public to the idea of negative equity, the UK would be immunised against another housing boom for at least a generation or two. But no, within a decade the British were again mortgaging up to the hilt while repeating the mantra “You can’t lose on bricks and mortar….you can’t lose on bricks and mortar….” (American readers should remember that British mortgages don’t have a no-recourse option).
Can we therefore jump to the conclusion that, where economics is concerned, we all have the memory of a goldfish? The difficulty is that there are obvious counterexamples. The standard explanation of why Germany is so reluctant to join Europe’s binge-spenders and so determined to prevent the ECB printing money as incontinently as the Fed is the “memory” of their hyperinflation and its consequences – the destruction of the middle-class as the bedrock of democracy and the rise of Nazism. The inverted commas are required because, since the process started in 1923, there can be virtually nobody left who can actually remember what it was like to carry a day’s wages home in a wheelbarrow. Presumably, the story still influences attitudes among the German public at large because it has been passed down through two or three generations or, more likely, because it was (and presumably still is) a central part of the history their kids are taught in school.
Maybe then the vital difference is that most economic disasters are soon forgotten because they have few lasting consequences outside the economic sphere – or, at least, few that can be traced back directly to their origin. For example, the experience of near-bankruptcy in 1976 kept Britain’s fiscal policy on the straight-and-narrow for about 15 or 20 years, but within less than a generation, we were back to our old ways of tax-a-lot-and-spend-even-more — yet able to fund our profligacy at record low yields. Perhaps it is only when it is written in blood that the past lives on in the memory of the public at large or of the bond traders who (mis)manage our money.
Meanwhile, as he looks down on the country for whose independence he died, it seems that Lord Byron is far from bitter. In fact, this morning he emailed me the following sardonic ditty:
It seems I threw my life away
To free the Greeks from Turkish thrall.
Since then, with loans that they could ne’er repay
The Greeks, though they produce damn all,
Enjoyed a life of ease and play.
But debts, as you know, never fall.
They keep on rising anyway.
Now Greeks at Germans’ beck and call
Are slaves again, as in my day!