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Economic Recovery? History Says No Way. Not Yet.

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Take a long enough perspective, and it is no surprise that what some had been calling the GGBAT (the Greatest Global Boom of All Time) ended with the GGRSGD (the Greatest Global Recession Since the Great Depression). Both the boom and its panicky finale fit neatly into a long, human tradition of greed, self-deception and financial folly. And, never mind the Dow at 10,000. Eight centuries of history suggest the GGRSGD is a long way from over.

That, anyway, is one of the cheery conclusions you take away from This Time It's Different: Eight Centuries of Financial Folly, a book co-authored by economists Carmen Reinhart of the University of Maryland and Harvard's Kenneth Rogoff. The title, in case you didn't notice, is ironic. The authors' point is that it's never different: the temptation to justify reckless financial behavior as long as it's profitable in the short run is as old as lending. We're human. We can't help it. Sigh.

Professor Reinhart, who this spring gave CBS MoneyWatch a sneak peak into her book's insights, met with us editors yesterday. She is disarming, funny, deeply knowledgeable and, as her publicist put it, about the only economist you'll meet who wears Chanel. What she is not, is optimistic.

Some findings from her research:
  • Every crisis is preceded by a boom in which people convince themselves that the ordinary rules no long apply. Reinhart recalls visiting Asia in the mid-1990s with the International Monetary Fund, where she worked at the time, and being told in country after country that currency crises could never happen there. "We're too productive, we have too high a savings rate," she was told. "Crises only happen in places like Latin America." That stuck with the Cuban-born Reinhart, especially when the Asian currency crisis hit three years later.

Americans take a second seat to none in our capacity to fool ourselves.

  1. "Profits don't matter" : Internet-bubble wisdom, circa 1999
  2. "Deficits don't matter": George W. Bush fiscal policy, allegedly voiced by Dick Cheney
  3. "Credit quality doesn't matter": conventional magical thinking during the GGBAT

What that says about our ability to recognize future bubbles in their formative years and head them off is not very encouraging.

  • History suggests we've got a long way to go. Banking crises like the one we're in tend to stick around. On average it takes six years for home prices to recover, five years for unemployment to turn around and two years for the economy to come back.
  • We're acting Japanese and don't know it. We lectured the Japanese during their lost decade on the need to bite the bullet and deal with zombie banks. But now, in the same pickle as the Japanese were, we're acting with the same irresolution. Remember how TARP was supposed to get troubled assets off the banks' balance sheets? They're still there.

And like us, the Japanese flooded their economy with stimulative cash that helped jump start growth. By the mid-1990s, though, central bankers and government lost their nerve and began to tighten up. That helped turn a lost five years into a Lost Decade. It's a repeat of the Japanese mistake that worries Reinhart the most about our current situation.

  • Watch out for Treasuries. Almost every financial crisis going back in history has led to a huge surge in sovereign debt. On average, it doubles, and the surge frequently leads to default. In this crisis, the U.S. has made pikers of such world class debtors (and defaulters) as Argentina and Indonesia. Our debt has tripled in a year to $1.2 trillion. A default on U.S. Treasuries is impossible. A downgrade or hyper-inflation, not so impossible.
  • Don't trust anyone telling you that they've found a way around risk That applies equally to insurance salesman selling equity indexed annuities and to central bankers telling you they're smarter than their predecessors.

If you're thinking about acting on this outlook, remember that Reinhart and Rogoff's grasp of history doesn't necessarily give them a failsafe grip on the future. History isn't kind to prognosticators either, however far back their data goes. (See Jeremy Siegel, Stocks for the Long Run.) But after talking to Reinhart, I'm double checking my allocations to U.S. Treasuries and thinking of adding more to my inflation-adjusted bonds. If you can't learn from history, as George Santayana said, you could be doomed to subpar real returns.

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