“Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that ‘this time is different.’ That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy.”
– This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)
When does a potential crisis become an actual crisis, and how and why does it happen? Why did most everyone believe there were no problems in the US (or Japanese or European or British) economies in 2006? Yet now we are mired in a very difficult situation. “The subprime problem will be contained,” said now controversially confirmed Fed Chairman Bernanke, just months before the implosion and significant Fed intervention. I have just returned from Europe, and the discussion often turned to the potential of a crisis in the Eurozone if Greece defaults….
Greece is running a budget deficit of 12.5%. Under the Maastricht Treaty, they are supposed to keep it at 3%. Their GDP was $374 billion in 2008 (about â‚¬240 billion). If they can cut their budget deficit to 10% this year, that means they will need to go into the bond market for another â‚¬25 billion or so. But they already have a problem with rising debt. Look at the following graph on the debt of various countries….
When Russia defaulted on its debt and sent the world into crisis in 1998, they had total debt of only â‚¬51 billion. Greece now has â‚¬254 billion and added another â‚¬8 billion this week, and needs to add another â‚¬24 billion (or so) later this year. That’s a debt-to-GDP ratio of over 100%, well above the limit of the treaty, which is 60%.
Read it all.