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1-Page Summary of This Time Is Different
When You Hear “This Time Is Different,” Don’t Walk, Run
Every few decades, the economy’s leaders develop a false sense of security about the markets and the health of the economy. This is known as “this-time-is-different syndrome”, where they think that things will be different this time around than in previous times. They have been wrong before when thinking like this (during major economic downturns).
In each case, decision makers believed that the economy was different from previous times. In the 1920s, people thought that wars were no longer a threat and peace would be prevalent in their time. But this assumption proved to be false when World War II broke out soon after. In the 1980s, economists believed that high commodity prices and oil profits would keep the economy strong forever. However, these assumptions turned out to be wrong when oil prices dropped in 1986 and 1987 because of increased production by OPEC countries like Saudi Arabia. Before 2008 recession hit America, many people assumed that globalization and new technology had changed everything about business cycles so they wouldn’t happen again; but as we all know now it did happen again due to sub-prime mortgage crisis which led to global financial meltdown with severe economic consequences for millions of Americans who lost their jobs or homes during those years.
The most recent financial meltdown centered on the U.S. housing market, which regulators allowed to inflate despite a series of cautionary red lights. In 2005 and 2006, U.S. home price increases far outpaced growth in gross domestic product (GDP). In retrospect, home prices were clearly in a speculative bubble that eventually burst when it became clear how much debt Americans had accumulated trying to keep up with their neighbors’ McMansions. Even as inflation grew, former Federal Reserve Chairman Alan Greenspan argued that the economic situation was different because of newfangled financial instruments like mortgage-backed securities. He waved off concerns about the massive U.S current account deficit by theorizing that money from China, Japan and Germany was flowing into the United States as a safe haven for investors who feared European banks might collapse under their own weight or be nationalized by governments looking to shore up budgets at any cost.
Other leaders, however, were less concerned about the current account deficit. Ben Bernanke and Paul O’Neill believed that high savings rates abroad and low savings rates at home were part of a natural order. However, not everyone was as sanguine. Nobel Prize-winning economist Paul Krugman predicted an abrupt moment when the foolishness and “unsustainability” of America’s profligate international borrowing would become apparent to all. The trends gave reason for pause: household debt reached 80% in 1993, rose to 120% in 2003, then rocketed to 130% in 2006; subprime borrowers were trapped by loans whose initial low interest rates soon soared well beyond their reach; this time-is-different syndrome ran from 2005 to 2007.
The U.S. has the world’s largest, most sophisticated financial markets and they can handle massive inflows of capital. Developing economies will keep sending money to the U.S., which is a safe haven. Globalization sets the stage for higher leverage and larger debt loads in the US because it provides more opportunities for borrowing money, especially from other countries that have more cash than they know what to do with (China). The U.S.’s monetary policy institutions are better than any others in the world as well, so we should be able to handle anything else that comes our way financially without too much trouble or damage done by whatever crisis hits us next.
