I’ve recently completed a book entitled This Time is Different: Eight Centuries of Financial Folly. It’s a book I highly recommend to anyone thinking of moving abroad. The title is a bit of a misnomer; the book looks mostly at financial crises of countries taking place in the last two centuries. That’s not really the book’s fault however. We simply don’t have very accurate financial records for much of the world before the 19th century. Also many of the world’s countries simply didn’t exist and were part of vast colonial European empires until the 1960s.
What data we do have suggests that default by a country’s government is a common practice. In fact just a few days ago as I mentioned in a previous post Vietnam devalued its currency to pay its debt. That is a default, and consequently Vietnam’s currency will be worth substantially less for it, and there may be other consequences.
The book describes how there are two types of defaults: external and domestic. External debt crises get all the media attention because the creditors are other countries and big investors. They complain tremendously if they don’t get paid, and will demand from a debtor nation considerable austerity in order to pay for debt. We see this happening with Greece, with tremendous pressure from outside countries and organizations being put on the Greek government to do everything it can to pay back its debt, regardless of what happens to the Greek people. Historically, the United States and the United Kingdom have even invaded countries they felt were defaulting on their debts in order to force them to pay.
Domestic defaults are more common, and get very little media attention. While some fiscally prudent countries like the United States, Australia and Canada have never had an external default in their history, every country in the world has had a domestic default. A domestic default could be a government renegotiating the terms of a class of debt only available to its citizens, or a local government (like a city or county) defaulting on its debt. Currently in the United States several states are renegotiating pensions with their employees and renegotiating debt terms. All of this is a form of domestic default.
The important lesson I take away from this book is that there are two tiers of countries. The first tier is the developed world in which countries in this tier rarely default on their external debt (there are a few exceptions like Greece). These countries are the richest and most developed in the world. By not defaulting on their debt, or only doing so rarely, they have stable currencies and generally growing economies.
The second tier of countries are those that default periodically. These countries are virtually every country in the developing world. A default means that their currency suddenly becomes worthless, and a political panic is soon to follow. Countries like Argentina and Uruguay suffered huge defaults within the last ten years and to this day have currencies that are not valued highly (a bonus for retired expats who seek to settle there as I have mentioned).
The book reminds us that financial stability is a rare thing. Even in wealthy countries that rarely if ever have an external default, you will still see banking crises such as the one the United States has just emerged from. According to the book, no country on earth has figured out how to get over banking crises, which is a frightening issue for any investor. If no country on earth has a safe banking system, where should I put my money?
The answer is that you should keep your money in banks in the developed world, and hope that governments will prop up the financial sector if things get really bad. As we saw in this last great financial collapse, the governments of the developed world stepped forward and guaranteed depositors money, and a Great Depression scenario was averted. But no one knows yet how to stop these crises from continuing to happen in the future.
The other lesson I came away with in this book is that you should avoid keeping your money in local banks if you live in the developing world. The developing world simply has not shown an ability to manage its finances well. Banks are often not guaranteed by the government, and depositors regularly lose their money in times of panic. No matter how good local investment vehicles seem to be, you had better avoid them or risk losing everything. Keep your money at home.
The good news is that countries seem to slowly mature and graduate to the first tier as they develop. Even the United Kingdom and France used to default on their external debt when they were ruled by Kings and Queens. But as they evolved into democracies, they learned to manage their finances and recognize the importance of fiscal discipline for the sake of their economy and currency. I think many investors realize this and understand that investing in Britain or France is far safer over the long run than a country like Brazil or Russia because of it.
All in all this book is a must read for the overseas investor or for someone considering retiring overseas. It is that rare book that gives a good overview of how the world as a whole works. Most books on economic history are consumed with looking at only one example and you are asked to extrapolate from that one example to every other country in the world. This Time is Different actually does look at the financial data of almost every country in the world and gives us the clearest picture yet of the world economy, and humanity’s efforts at overcoming the turbulence of the financial bust and boom cycle.
{ 1 trackback }