I have just finished reading a very inspiring paper by Reinhart and Rogoff. They put together key macroeconomic data and documented various types of crises going back 800 years, with a more detailed analysis of crises since 1800 (Napoleonic wars).

Why I find this paper an indispensable reading today? All people in finance are busy these days trying to figure out how the current subprime crisis in US will end? Will coordinated central bank efforts help to avoid global prolonged recession? Will dollar fall much further? Will USA escape “default trap” by inflating its economy? Is a threat of collapsing US banks (post Bear Stearns domino effect) any different than sovereign default threat in emerging markets? The dollar question is of particular interest as Martin Feldstein argues in his recent paper that dollar will have to fall in real terms, and the choice is between nominal depreciation and a deep decline of the US price level. In other words, a strategy of “inflating away from the huge external debt problem” will be adding to existing problem as it will mean less competitve dollar in the long run.

In order to find answers to these and other questions many economists look at the past episodes, and because long time series are not easily available, the “proper”period looked at are oil price shocks in 1970s and 1980s. Many people do that and conclude that this time around is different. As Reinhart and Rogoff document, it may be very misleading. They find striking regularities in the past centuries, crises (defaults, high inflations, high depreciations) were often preceded by surging commodity crises, by shocks from the world financial center hitting emerging markets. There is also a very high degree of contagion. There are also features that make crises of 1980s different, for example the magnitudes of currency depreciations were unseen since the Napoleonic wars.

Jeffrey Frankel once said that the average time between crises was about fifteen years, because it takes about fifteen years for the last trader that remembers the previous crisis to leave the trading floor of major investment bank. And when nobody remembers the same bad habits start all over again. Reinhart and Rogoff paper should be read by all those who did not live thorough previous crises. It may contribute to extending the fifteen year period.