Reinhart Rogoff and Political Tribalism

I wrote a few days back about how Reinhart and Rogoff’s serious, academic, review of past and prospective debt restructurings seemed to provide policy support for financial repression – such as capital controls, fixed currency regimes, highly regulated banks, and hidden taxes on savings through forced public pension investments.

This post highlights one of my favorite things – intellectual, counter-intuitive, irony.  In particular I enjoy the irony of political affiliations that the Reinhart Rogoff paper inspires.


I don’t know Professors Carmen Reinhart and Kenneth Rogoff’s political views, and in the most important sense they don’t matter.  They’re economists, not political leaders.

In the post-2008 Crisis world, one of the ideological fault-lines has been to what extent governments should borrow and spend today, as a counter-cyclical buffer to the extremes of the economic downturn.  Or conversely, whether the heavily-indebted governments of the developed world need to pare down their already-extensive borrowing, to avoid an even more disruptive crisis of fiscal insolvency.

Paul Krugman – from the political left – has carried the banner for more debt-financed government spending.

Regardless of the professors’ politics, the political right has adopted Reinhart and Rogoff’s work studying the history of debt restructurings as academic ammunition in favor of the budget austerity favored by the political right.  This is logical.

To the extent Reinhart and Rogoff highlight fiscal profligacy and its consequences – for example in their book This Time is Different: Eight Centuries of Financial Folly  and in their recent IMF paper – it makes sense that they find supporters in the austerity camp.

I guess that’s why I enjoyed the irony that I recently wrote about, namely that their recent paper appears to justify financial repression.  The right-leaning austerity camp is probably the last group who would approve of an interventionist financial regime such as currency controls, explicit and hidden taxes on savings, and a heavily regulated banking sector.

Meanwhile, from the left, the critics of Reinhart and Rogoff’s history of debtors’ profligacy argue in favor of a much more severe regulatory regime when it comes to banking.  The natural political affiliations seem flipped in this situation.

Of course, the challenge as always is to figure out what we really think about complex topics, rather than just adopt what ‘our side’ thinks on a complex topic.  All of that reminded me of our tendency toward policy tribalism.

More on the irony of political affiliation

The best thing I read last week came from The Washington Post’s Ezra Klein, who highlighted our tendency to choose tribal affiliation over principal when it comes to policy preferences.  It’s worth reading his article in full, but I’ll try to summarize Klein’s article.

First, Jesse Myerson wrote a lefty Op-Ed for Rolling Stone Magazine, advocating five policies

1. Guaranteed jobs

2. Guaranteed incomes

3. Higher taxes on landlords

4.  A sovereign wealth fund to spread common ownership and

5. A public bank

Importantly, he cited Franklin Roosevelt, Martin Luther King, and some presumably left-leaning academics as supporters of his ideas.

Next, Dylan Matthews wrote a right-wing Op-ed for Ezra Klein’s Wonkblog, advocating the exact same policies, but citing conservative support for the ideas, such as The American Enterprise Institute, Milton Friedman, and Charles Murray.

The reaction: conservatives hated the first article and supported the second, while liberals, of course, praised the first and panned the second.

Klein goes on to cite the work of Stanford psychologist Geoffrey Cohen, who has shown that we consistently form our opinions about policies based on who we think supports the ideas – rather than the specific ideas themselves.

Do we really support the policy?  Or do we just support it because our political tribe supports it?  Are we thinking about stuff for ourselves or just figuring out which side our people are on?

To use a sports analogy (that I’m not sure really works): Do we really care about the guys on our team, or are we just rooting for laundry?[1]

I don’t know, but I will try to remember this.

Please see related posts on Reinhart Rogoff: Academia, Markets, and Click-bait

And the Reinhart Rogoff point that Financial Repression = less Financial Crises

Am I rooting for the players or laundry?

[1] When he played for my team, Johnny Damon represented the paragon of lovable caveman-hood.  But when he left for the Yankees, all that overdeveloped forehead (from, um, vitamin supplements I guess?) seemed gross.  When he played for my team, Wes Welker was a virtuous, fast-as-a-tiny-quantum-electron, tight-end.  When he crushed my spirit this past weekend with Satan Manning, well then.  Welker is such a loser and a sell-out, in his goofy space helmet.

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Financial Repression = Less Crises

Please see earlier post on the Reinhart Rogoff IMF paper

I wrote a few days back about how a serious, academic, review of past and prospective debt restructurings can be on the one hand useful, on the other hand not particularly predictive of market conditions, and on the third hand (I have three hands!?!) easily manipulated by the Financial Infotainment Industrial Complex into unhelpful click-bait.

But I want to also highlight an interesting, but less noted, point of the Reinhart Rogoff paper.  Namely, a world of financial repression leads to a lot less financial crises.

The big, ignored point, of the Reinhart-Rogoff paper

The most interesting insight of their paper – although one which contrasts sharply with the narrative that the Financial Infotainment Industrial Complex in the US would like to tell – is that the Financial Repression period (1945-1979) of economic policy-making correlates to a lower incidence of financial crashes, inflation-shocks, and banking crises.

It’s worth clicking on this screenshot of the Reinhart Rogoff figure on historical crises.  They made an index of banking crashes, currency runs, hyperinflation, and debt defaults/restructurings, weighted by country.  Spikes in crises all occur in the the ‘open markets’ periods, but rarely happen during ‘financial repression periods.’

Financial Repression = Less Crises


Only in the more liberal (with a small “L,” meaning “less-controlled”) economic period they study (1900-1939 and 1980-Present) did we experience very high spikes in financial crashes, inflation-shocks and banking crises.  Correlation is not causation – I hasten to add – but it’s so clear from their graph of financial shocks that Reinhart and Rogoff have to acknowledge it.

Is financial repression a good thing?

Now, no card-carrying member of the mainstream Financial Infotainment Industrial Complex wants to be caught dead advocating a more interventionist financial regime.   Among the financial news I read on a regular basis – The Wall Street Journal, Business Insider, Bloomberg – basically nobody is going to write “Hey, let’s gum up the financial markets to reduce the probability of financial crises,” which led me at first to think that this under-reported correlation in the Reinhart Rogoff paper has no support in media and politics.

The more I thought about it,[1] however, the more I realized that the idea of financial repression leading to fewer crises actually does have plenty of support.  I just usually don’t read that media.

In Washington, Senator Elizabeth Warren – an ex-academic colleague of Reinhart and Rogoff – represents the view, as far as I can tell, that if we regulate Wall Street a lot more – to the point of financial repression – then we won’t experience a replay of 2008.

In financial media, when I read Matt Taibbi in Rolling Stone or Gretchen Morgenson in the New York Times, my sense is that they share Warren’s basic view.  The point of regulating Wall Street is to create a system of financial repression sufficient to dampen financial excess, which will in turn dampen financial crises.

I don’t share what I interpret as the Warren/Taibbi/Morgenson[2] policy view, but I think Reinhart and Rogoff’s paper provides some academic ammunition for their views.

Please see related post on Academia, Markets, and Click-bait inspired by the Reinhart Rogoff paper

Please also see related post Reinhart Rogoff  and the irony of political affiliations



[1] Fine, it actually wasn’t me thinking about it, it was my wife who made the next point.

[2] I’m sure any one of this troika would be offended, each for their own reason, that I have lumped them together, as if they share a common world view.  No doubt there are important distinctions. Oh well.  My blog.  I get to do the lumping.  I lump them together because I don’t ever see evidence in their writing that they evaluate members of the for-profit financial world on the terms of the for-profit world.  In place of that, I see a lot of evidence of moralistic tsk-tsking about profit-seeking.  “Why oh why don’t those financiers consider the children first???”  I’m paraphrasing of course.

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1930s Style Debt Defaults?

1930s_breadlineA sometime gold-coin buyer and a frequent reader of Bankers Anonymous sent me a message a few days ago, linking to the CNBC headline “1930s-style debt defaults likely, says IMF,” and with the simple question: “Mike – True?”

Harvard economists Carmen M. Reinhart and Kenneth S. Rogoff’s latest paper, commissioned by the IMF and published in December 2013, re-raises the specter of sovereign default in the so-called ‘developed world,’ warning of restructuring, restrictive capital controls, and debt write-offs.

Their paper was rewarded and echoed with headlines from Business Insider like “Extreme Debt Means 1930s-Style Defaults May Be Coming to Much of the Western World” and CNBC’s “1930s-style debt defaults likely, says IMF,” the headline that prompted my reader’s email to me.

This seemed like a great opportunity to reflect on the problem of different, confusing, contradictory messages constantly streaming from the Financial Infotainment Industrial Complex.

Academia, Click-bait, and Markets

Those headlines, loosely based on the Reinhart and Rogoff IMF paper, are a great example of the giant gulf between financial academia, click-bait, and actual markets. Each information source follows its own rules and logic – but mixed up together provide a cacophony of worse-than-useless dis-information.

First, academia on its own terms

Professors of international economics should consider a wide variety of scenarios, and they should present historical data, as Reinhart and Rogoff have done, with their book This Time is Different: Eight Centuries of Financial Folly.

[I confess I have not yet read this, but I suspect I will find this a useful addition to other books I have enjoyed on sovereign debt defaults, such as A Century of Debt Crises in Latin America: From Independence to The Great Depression 1820-1930 by Carlos Marichal.]

I enjoyed the Reinhart and Rogoff paper, with its useful historical data, reminding readers that sovereign debt defaults in Europe are not particularly rare.  In addition, sovereign defaults sometimes come hidden in sheep’s clothing – as when a combination of capital controls, high inflation, or forced ‘savings’ from captive sources such as workers’ pensions effectively bail out overly indebted governments.

As a former emerging markets bond guy I read Reinhart and Rogoff’s work with much interest.  Here’s a summary of their main points, and my reactions:

  1. Drastic sovereign debt restructurings are historically more common than many realize, and come in a variety of forms.  [Totally agree]
  2. Financial repression, while brutal and inefficient, probably reduces financial excess, and therefore financial crises.   [Totally agree]
  3. The 5 year-old crisis we are in will involve more explicit restructuring of sovereign debt in the so-called ‘developed’ world, presumably peripheral Europe.  [Mmm. Squinting. That depends.  Doubtful.]
  4. We will see a return of ‘financial repression’ in the ‘developed world.’ [I see no evidence of this.  Or, I guess it depends how you define ‘financial repression.’]


But what about the click-bait?

Reinhart and Rogoff are legitimate economists (at a reasonably decent University) so it’s not surprising that they have produced serious work on historical sovereign debt restructurings.  I wonder, however, to what extent they anticipated (and even encouraged?) the click-bait aspect of their paper.

“1930s-style debt defaults likely, IMF says” is a totally misleading version of their report.

“Ex-Goldman bond salesman may make billions blogging his random opinions, says blogger,” is a headline I could write about myself, but it would have as much relationship to the probabilistic truth as that CNBC headline has to the IMF report.

Unfortunately, CNBC – and the rest of the Financial Infotainment Industrial Complex – runs on nonsense click-bait, so people like my reader who sent me the email query get pummeled with emotionally-charged or scary bullshit, on an hourly basis.

Market Data

How do I know that – on a probabilistic basis – both the click-bait headline as well as points 3 & 4 of the Reinhart-Rogoff paper can be safely ignored?

Because what neither academia, nor the click-bait-setting members of the Financial Infotainment Industrial Complex typically take into account is that we have a ton of aggregated financial information available in markets about exactly their topic.  Right now.  At all moments.

The bond market

At any given moment – with updates on a minute-by-minute basis – the most–informed people in the world on sovereign risk – with the most to gain or lose financially – are indicating the probability of default on all sovereign debts.

Bond traders – at mutual funds, hedge funds, banks, insurance companies, and broker-dealers – control the flow of capital into or out of investments in sovereign debt.

Yield or bond spread indicate aggregate market perceptions of risk by the most knowledgeable and interested people in the world.

The constant buying and selling of bond traders sets a price, in yield terms, that tells us a lot about what the odds of default are.  The higher the yield, the higher the controller of capital is demanding to take the risk of the bond.  In aggregate, the self-interested decisions of bond traders give a very full view of the total risk associated with these bonds.

The most common way bond traders compare the relative risk of sovereign debt is through a ‘spread,’ which means the additional yield investors receive over the yield of a riskless bond yield.[1]  A 1% bond yield spread, or as bond traders would actually say, “100 basis points”[2] spread over an equivalent riskless bond, indicates that highly informed and highly interested investors find the bond mildly, but not extraordinarily, riskier than a ‘riskless’ bond

Most of us do not see the minute-by-minute information on government bond spreads but we can access it, updated at least daily, on the global government bond yield pages of financial news sources like The Financial Times or Bloomberg or The Wall Street Journal.

Why so much about the bond markets?

Why am I going into this excruciating detail about the bond markets?  Because if you know something about how the bond markets work, and what information they convey, you can interpret both the Reinhart-Rogoff thesis on defaults and the Financial Infotainment Industrial Complex’s click-bait headlines for what they are.

In sum:

Reinhart-Rogoff: Improbable

CNBC’s headline: Nonsense

How do I know this?  Because the bonds markets give us bond spreads on the sovereigns they reference.  Here are some select 10-year bond spreads this week from The Wall Street Journal’s global government bond page:

Italy:  97 basis points (less than 1% yield premium)

Portugal: 225 basis points (2.25% yield premium)

Spain: 88 basis points (less than 1% yield premium)

The bond market is saying, with these spreads, that it finds these European bonds mildly risky, but not terribly risky.  Default, while possible, is highly improbable over the next ten years.

Of course, Greece already restructured its sovereign debt, so Reinhart-Rogoff’s ‘prediction’ came true.  But since they published their ‘prediction’ in December 2013, however, they really can’t take credit for being nearly 2 years late.

So, no, 1930s-style defaults are neither likely to happen nor likely to be widespread, as implied by the IMF paper, and by CNBC’s headlines.  Of course, anything can and will happen with markets, but the smart money’s not betting on that, and you shouldn’t either.  Leave the fear-mongering to Harvard economists and click-bait headline writers.

Please see related post:  The biggest, mostly ignored, point of Reinhart Rogoff’s IMF paper.


[1] Among bond traders primarily trading in US $ Currency, a ‘riskless bond’ for the purpose of determining bond spread, is usually a similar maturity US Treasury.  Bond traders in Europe or Japan might use a different riskless bond as the basis for comparing risk in their own currency.  We can argue about whether US bonds, or Japanese bonds, or German bonds are actually ‘riskless,’ and traders do, but traders also need a convention for comparison, so US Treasuries often serve that purpose regardless of whether its truly ‘riskless’ in the absolute sense.

[2] A basis point is 1% of 1%.  Hence, 100 basis points for every 1% in yield or yield spread.  If we say 5 basis points, or 5bps, (pronounced “5 bips”) that means 0.05% in yield, or spread terms.

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