Carmen Reinhart: Short Memories Setting Up Next Financial Meltdown

Monday, 23 Jun 2014 07:35 AM

By John Morgan

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Carmen M. Reinhart, one of the world’s most cited female economists, has studied the history of financial crises and human nature for decades.

For an interview in the Credit Suisse Bulletin, the professor of international finance at Harvard University summed up what she has learned: We forget too quickly and repeat our mistakes.

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“After a crisis, precautions are typically taken. But then they are circumvented or we think they are no longer necessary. The essence of the ‘this time is different’ syndrome lies in the assumption that crises only happen to others. Or they only happened in the past and today we are smarter.”

While each financial crisis may be different, Reinhart says they follow a familiar script: the excesses are often funded by borrowing, whether the bubble is in real estate, stocks, government bonds or commodities.

“Assets seem to grow endlessly, with profits in these markets rising unabated. You can always borrow more and invest more. These euphoric stages are an old phenomenon, they have existed for centuries. However, confidence is an unstable and uncertain commodity. Suddenly lenders retreat, whether because of a rumor or because something actually happened.”

In Reinhart’s view, the seeds of the next global financial crisis have already been planted. She suggested too much capital is once again flowing into emerging markets, which she predicted sooner or later will end in currency crashes, banking crises, and debt and inflation problems.

In the developed West, she noted per capita income has returned to pre-crisis levels only in the U.S. and Germany, while it could still take the rest of Europe years longer to recover.

According to Reinhart’s research, stimulus efforts by central banks are usually futile. “You can certainly wish for growth, but historically it almost never happens that you, so to speak, grow out of debt.”

The cost of avoiding financial meltdowns can also be severe, she believes.

“The question you have to ask is this: Is it better to have loved and lost everything than never to have loved at all? Should we regulate so heavily that we prevent recession but also any possible upturn? Or do we have to take into account periodic crises?"

Last week, the World Bank downgraded its forecast for the global economy for 2014, citing a frigid American winter and the political crisis in Ukraine. The forecast came out before the full impact of the chaos in Iraq could be taken into account.

The Associated Press reported the World Bank still predicts the world economy will grow faster this year, at a 2.8 percent clip versus 2.4 percent in 2013. But its new estimate is weaker than the 3.2 percent expansion the bank predicted in January.

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