What Makes This Crisis Different
Updated: Jul 15, 2020
In their book, This Time is Different, authors and economists Carmen Reinhart and Kenneth Rogoff (both of Harvard) examine historical financial crises and discuss the underlying patterns found among them. These patterns include things like corporate and consumer debt levels, inflation and deflation, and cycles in asset prices. They note the regularity with which financial crises occur and how little we seem to learn from the past when it comes to preparing for and handling crises in the present and future. They conclude with the belief that financial crises aren't that different from one to the next, saying: "More money has been lost because of four words than at the point of a gun. Those words are 'This time is different.'" This idea is important, especially if we believe that history is doomed to repeat itself. As we find ourselves amid the latest financial crises of our time, it's worth asking: "Is this time different?"
As with most things, the answer is a bit complicated. In some sense, the answer is no. Investing and doing business requires taking risks, and when we experience a financial pullback, the extent of those risks and the financial health of those making them are revealed for what they are. Businesses operating on tight margins and those who have taken on excessive risk are likely to feel the most considerable amount of hurt as economic productivity slows and spending dries up. Typically, financial crises do the work of rooting out inefficiencies and reallocating funds in a way that helps right the economy and put it back on track. Thus, what is truly unique about this financial crisis is that the economy was not broken when it began. Sure, we could argue that there were areas of the economy that had become overpriced as we treaded further into the longest expansion in modern history. Still, for the most part – businesses and consumers were in a healthy financial position.
Unlike the crisis in the late 2000s, this is not a crisis resulting from a failure in banking, investing, or economic policy. As Campbell Harvey, the economist who discovered the predictive power of an inverted yield curve, puts it:
"The important thing here is to realize that this economic predicament was triggered by a health crisis. The economic part is not a structural problem. In 2007, there was a structural problem. Banks were levered 40-1 and using our FDIC insured accounts as collateral. That structural problem caused great damage to our economy. Going into this, we didn't have a structural economic problem. The economy was healthy."
The last market selloff was triggered by an asset bubble caused by banks and individuals taking on too much risk. The recent market selloff and ensuing volatility were caused by a "natural disaster" of sorts, and that lends an element of uniqueness to how we should respond and what we should expect. Last time, we responded by bailing out the banks and stimulating the economy. This time - via the CARES Act and other stimulus measures - we are attempting to freeze the economy so that when we do find a cure to the pandemic side of the equation, individuals can return to their jobs, and the economy can resume. It's important to note that when and how it will resume remains uncertain.
A critical difference between crises resulting from natural phenomenons and those resulting from economic phenomenons is that the solution for a natural phenomenon is typically more explicit. When the stock market sold off in 2008 and the housing market crashed, the solution wasn't explicitly clear, which made the subsequent path to economic recovery unclear. This time, we know what needs to happen to get the economy on track: we need immunity. Until we can find a cure for Covid-19, we will continue to experience the effects of it – either in the form of shut-downs, a sicker population, or a mix of both. Given our expectation of a vaccine in the next 12-18 months, it's no surprise then that most economists expect the economy to see a bump towards recovery with a similar time frame.
It's important to note that while the solution for this crisis is more apparent, that still doesn't mean that we can predict the timing and movement of the economy. Despite the clarity of what is causing the downturn, this has still been one of the most volatile years in market history with the market drawdown in February setting a record for the fastest selloff in history. The economics of what is happening may be more evident than in past crises. Still, the pandemic side of the equation remains incredibly uncertain and will continue to lend to volatility for some time.
What we can rest assured of is that the world is not ending. While the pandemic itself lends uniqueness to this financial crisis, recessions and depressions themselves are not unprecedented. This is not the first time the world has experienced hardship, and it likely won't be the last. Even in the uniqueness of this moment in history, there are still patterns of resilience that we can lean on. In the aftermath of world wars, terrorist attacks, hurricanes, and even previous pandemics, we have rebuilt. I am confident that we will do so again.
Guinto, Joseph. “Why This Recession Will Be Different (and How to Keep It Mild).” POLITICO. POLITICO, April 13, 2020. https://www.politico.com/news/magazine/2020/04/13/why-this-recession-will-be-different-and-how-to-keep-it-mild-169427.
Reinhart, Carmen M., and Kenneth S. Rogoff. This Time Is Different: Eight Centuries of Financial Folly. Princeton, NJ: Princeton University Press, 2011.