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Book Summaries Business

The Intelligent Investor Summary

The Intelligent Investor by Benjamin Graham is often cited as one of the best books on investment, most notably by Warren Buffet.

Graham lays the foundation for laymen by giving a sound approach to investment, written with simple language that is easy (albeit dated) to understand. You are presented with Graham’s personal investment philosophy and other potential investment philosophies based on the type of risk you are willing to tolerate.

For example, he doesn’t believe in speculation. Many people think about the stock market as a casino, where they can make money quickly by buying low and selling high. Graham thinks that this is the wrong approach. You don’t make money (sustainably) from buying and selling but from owning and holding securities, earning dividends and interest, and benefitting from their increase in value over many years.

Your main goal in investing should not be to make money, but to avoid losing money. That is the difference between an investor and a speculator.

Factors to consider when picking stocks

PE ratio is a measure of the valuation of a company’s stock. It has price in the numerator and earnings in the denominator. The higher the PE ratio, the more expensive the stock

PB ratio compares the price of the stock with its book. The higher the PB ratio, more expensive is the stock and vice-versa

Source

Trailing P/E should be less than 15 and P/E * P/B should be less than or equal to 22.5.

When considering what stock to buy, don’t simply buy cheap companies.

Consider the following indicators:

  • Earnings per share (growth > 30% over 10 years prior is a good sign).
  • Current ratio (Current Assets/ Current Liabilities) > 2.
  • Company offers dividends, with consistent dividend growth.
  • Avoid companies with negative earnings per share previous 3 years.
  • Speculate the right way: Buy low and sell high. Avoid the herd instinct to start buying more when stocks are at record highs. See financial crashes as opportunities to buy for cheap.
Chapter 1: Investment Versus Speculation

Keep investments and speculation separate. If you must speculate, make sure it is no more than 10 percent of investment funds.

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Chapter 2: The Investor and Inflation

Inflation is an investment concern because it depletes real wealth, and the purchasing power of profits and principal. Fixed income securities are usually most hard hit.

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Chapter 3: A Century of Stock Market History

It is important to learn about the history of the stock market, so that you understand how stock prices are related to earnings, cash flow, and dividends.

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Chapter 4: General Portfolio Policy: The Defensive Investor

The conventional wisdom is that the investor should match the amount they risk with their risk tolerance.

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Chapter 5: The Defensive Investor and Common Stocks

As long as the stock is not overpriced, buying them could protect against inflation and offer a higher return than bonds or cash in the long run.

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Chapter 6: Portfolio Policy for the Enterprising Investor: Negative Approach

Unless lower rated bonds and preferred stock have a huge upside, enterprising investors should avoid them. Lowe rated securities usually collapse in adverse markets.

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Chapter 7: Portfolio Policy for the Enterprising Investor: Positive Approach

An enterprising investor wants to achieve a higher than average rate of return. There are 4 ways in which this type of investor can go beyond the defensive investor.

Full Summary

Chapter 8: Mr. Market and Fluctuations

Mr. Market is the analogy given for the market. Imagine that you co-owned a company with Mr. Market.

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Chapter 9: Investing in Investment Funds

Investment funds are vehicles provide a convenient means for saving and investment, and potentially protecting investors from themselves.

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Chapter 10: The Investor and His Advisers 

Most investors are novices and make many mistakes. Drawdowns, high fees and expense ratios, and improper diversification are all common problems they face.

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Book Summaries Business

Range: Why Generalists Triumph in a Specialized World Summary (7/10)

Range: Why Generalists Triumph in a Specialized World by David Epstein argues that instead of aiming to hyper specialize, more people should be trying to gain multi-disciplinary experience. Instead of planning and implementing, they should be testing and learning. Specialization is necessary, but only after a sufficient test period.

In the past, people had to rely on their own experience to understand the world. But modern people are more scientific, more inclined to use abstract ideas and schemas to inform their understanding and are less reliant on their personal experiences. Premodern people missed the forest for the trees, while modern people miss the trees for the forest.

Flynn (they named the “Flynn effect” after him) conducted a study at one of the America’s top state universities to understand the correlation between GPA and critical thinking skills. He found that there was zero correlation.  

Epstein, before being a journalist, was in grad school ad studied how changes in plant life might impact the subterranean permafrost. Years, later as an investigative journalist, he realized that he had committed statistical malpractice in one section of the thesis that earned him a master’s degree from Columbia University. Like many grad students, he only had to hit a button on the computer to do statistical analysis, he did not have to think deeply about how statistical analysis worked.

The stat program spit out a number summarily deemed “statistically significant.” Unfortunately, it was almost certainly a false positive, because I did not understand the limitations of the statistical test in the context in which I applied it. Nor did the scientists who reviewed the work. As statistician Doug Altman put it, “Everyone is so busy doing research they don’t have time to stop and think about the way they’re doing it.”

Range: Why Generalists Triumph in a Specialized World, David Epstein

The point being – it is possible to hyperspecialize without having a true understanding of what you are doing. But the deeper point is that this is not a one-off event.

The economy is made up of people who are hyper specialists. In the crash of 2008, insurance regulators regulated insurance, bank regulated banks, securities, securities regulators regulated securities, and consumer regulators regulated consumers, but no one looks across these markets. Because everyone specializes, no one is trained to identify systemic issues.

Fermi problems force you to think broadly, without detailed prior knowledge. The problem with formal education is that people are not trained to solve Fermi problems at all.

The Inside View

Daniel Kahneman and Amos Tversky counted the term “inside view.” When we make judgements, we take the inside view, based narrowly on the details of a particular project that is right in front of us.

Kahneman had a personal experience about the dangers of this tendency when he assembled a team to write a high school curriculum on the science of decision making. After a year of weekly meetings, he asked each person in the team how long they thought the project would take. The lowest estimate was one and a half years, and the highest estimate was two and a half years.

When Kahneman asked a team member, Seymour, who has considerable experience with designing curriculums how this one compared with other projects he had worked on, he thought for a while. Before this question, he thought it would take two years longer. Seymour said he hadn’t thought of comparing this project with the other he had worked on, but that about 40 percent of the teams he’d seen never finished at all, and not a single one he could think of took less than seven years.

Seymour realized that Kahneman’s group would never work on a project that might take six more years on a curriculum that might fail. After debating the new opinion for a few minutes, the group went ahead and trusted its average “about two years” estimate. They forged ahead and completed the project 8 years later. At which point, Kahneman was not even in the country or on the team anymore, and the agency that asked for the curriculum was no longer interested.

We are inclined to take the inside view, rather than considering the outside view. That is why entrepreneurs with a “me too” idea often do not consider the true likelihood that they will succeed or how long it will take them to build their business by comparing themselves to others. They will trust their own judgements that are based on unique surface features of their own business. The outside view is a very counter intuitive way of looking at things.

In a unique 2012 experiment, a business strategy professor, Lovallo and a few other researchers recruited Investors from large private equity firms who consider many projects in many different areas. The researchers theorized that if anyone would take the outside view it would be these guys.

The investors were told to assess a project they were working on with a detailed description of the steps to success and to return the project’s return on investment. They were then asked to write down their estimated ROI of similar projects to theirs which they knew about. In the end, the investors predicted that the return on their own project would be around 50 percent higher than the outside projects. They were asked to think more. They revised their estimates and were shocked at what they had done.

This phenomenon applies to many areas, from gambling on horse races to predicting who will win the election. The more internal details you learn about a scenario, the more likely you think it will be.  

A Problem Well Put

In one of the most cited studies of expert problem solving ever conducted, an interdisciplinary team of scientists came to a pretty simple conclusion: successful problem solvers are more able to determine the deep structure of a problem before they proceed to match a strategy to it.

Range: Why Generalists Triumph in a Specialized World, David Epstein

Less successful problem solvers tend to mentally classify problems only by superficial, overtly stated features. As Education pioneer John Dewey put it in Logic, The theory of Inquiry, “a problem well put is half-solved.”

Specializing Early

“Match quality” is a term economists use to describe the degree of fit between the work someone does and who they are—their abilities and proclivities.

Range: Why Generalists Triumph in a Specialized World, David Epstein

In England and Wales, students must apply to a specific major and specialize early. In Scotland, students were given a two year sampling period, and then chose what they wanted to specialize in.

Malamud, an economist from Northwestern University, analyzed data for thousands of former students and found that college graduates in England and Wales were far more likely to leap out of their career fields than their later-specializing Scottish peers. Despite starting out behind in income because they had fewer specific skills, the Scots quickly caught up.

Quitters Never Win

Steven Levitt, coauthor of Freakonomics asked his readers who were considering life changes to flip a digital coin. Heads – they make the change, tails – they do not. 20,000 people responded, agonizing over everything from online dating, getting a tattoo, having a child, or pondering a job change. Six months later, those who flipped heads and changed jobs were much happier than those who did not. According to Levitt, the study suggested that “winners never quit and quitters never win” is poor advice.

Winston Churchill’s “never give in, never, never, never, never” is an oft-quoted trope. The end of the sentence is always left out: “except to convictions of honor and good sense.”

Range: Why Generalists Triumph in a Specialized World, David Epstein

Young and Foolish

The expression “young and foolish” describes the tendency of young adults to gravitate to risky jobs, but it is not foolish at all. It is ideal. They have less experience than older workers, and so the first avenues they should try are those with high risk and reward, and that have high informational value. Attempting to be a professional athlete or actor or to found a lucrative start-up is unlikely to succeed, but the potential reward is extremely high. Thanks to constant feedback and an unforgiving weed-out process, those who try will learn quickly if they might be a match, at least compared to jobs with less constant feedback.

Range: Why Generalists Triumph in a Specialized World, David Epstein

Short term planning sounds like a terrible life strategy but it is ultimately the most efficient.

Sunk Costs

A recent international Gallup survey of more than two hundred thousand workers in 150 countries reported that 85 percent were either “not engaged” with their work or “actively disengaged.”

Range: Why Generalists Triumph in a Specialized World, David Epstein

In that condition, quitting takes more guts, but the problem is that humans are bedeviled by the “sunk cost fallacy.” In The Confidence Game, professional poker player and psychology PhD Maria Konnikova explained that conmen know to begin by asking their marks for many small favors or investments before progressing to large asks. Once an investment has occurred, walking away becomes harder.

Van Gogh and Grit

Van Gogh was a paragon of persistence in the face of adversity. At each job he had, Vincent was convinced that if he worked harder than everyone around him, he would succeed. But then he would fail.

His interests constantly wavered. He first wanted to be an artist, devoted all his energy to one style and medium, then would abandon it soon thereafter.

 “I have been obsessed with a certain idea or project for a short time but later lost interest” is Van Gogh in a nutshell, at least up until the final few years of his life when he settled on his unique style and creatively erupted.

Van Gosh was an example of match quality optimization. He tested options with maniacal intensity and got the maximum information signal about his fit as quickly as possible, and then moved to something else and repeated, until he had zigzagged his way to a place no one else had ever been, and where he alone excelled. His grit, his sticking to one thing was not very impressive, but it didn’t matter in the end.

The End of History Illusion

Francis Fukuyama originally coined the term “the end of history” as meaning the end of the war of ideas since liberal democracy has emerged as the most sustainable form of government.

The “end of history illusion” refers to a common pattern in people that was discovered by psychologist Dan Gilbert. Each person, no matter what their age, tends to think that they will not change much in the future even though they acknowledge that they have a changed a lot in the past.

As we age, we tend to become more agreeable, conscientious, less neurotic, and more emotionally stable. But we tend to become lower in openness.

Plan-and-Implement versus Test-and-learn

The “plan and implement” model is the idea that we should make long term plans and execute them without deviation, as opposed to the “test-and-learn” model. We are commonly told that geniuses opt for the “plan-and-implement” model, but this is not true. For example, the myth about Michelangelo was that he used to envision a full figure in a block of marble before he ever touched it and would simply chip away the excess stone to free the figure inside. But he was a test-and-learn all-star. He constantly changed his plans. He left three-fifths of his sculptures unfinished, each time moving on to something more promising. And he was multiskilled, he was a sculptor, painter, master architect, and made engineering designs for fortifications in Florence.

Breadth is Tricky to Grow

Specialization is obvious: keep going straight. Breadth is trickier to grow. A subsidiary of PricewaterhouseCoopers that studied technological innovation over a decade found that there was no statistically significant relationship between R&D spending and performance. Seeding the soil for generalists and polymaths who integrate knowledge takes more than money. It takes opportunity.

Range: Why Generalists Triumph in a Specialized World, David Epstein

Fooled by Expertise

Paul Ehrlich was a Stanford biologist who argued in a 1968 book The Population Bomb that it was too late to prevent a doomsday apocalypse from overpopulation. Resource shortages would cause mass starvation. While the human population was growing exponentially, the food supply was not. Ehrlich was an accomplished butterfly specialist and knew that nature did not regulate animal populations delicately.

He laid out many scenarios that could unfold, ranging from best case to worst case. Even the best case scenario forecasted half a billion deaths by starvation. And then Ehrlich challenged the world to come up with a more optimistic vision.

Economist Julian Simon took up the challenge.

The late 1960’s was the prime of the “green revolution.”

Technology from other sectors—water control techniques, hybridized seeds, management strategies—moved into agriculture, and global crop yields were increasing. Simon saw that innovation was altering the equation.

Range: Why Generalists Triumph in a Specialized World, David Epstein

Instead of being the problem, population growth was going to be the solution since more good ideas and technological breakthroughs would emerge.

Simon proposed a bet. Ehrlich could choose five metals that he expected to become more expensive as resources were depleted and chaos ensued over the next decade. The material stakes were $1,000 worth of Ehrlich’s five metals. If, ten years hence, prices had gone down, Ehrlich would have to pay the price difference to Simon. If prices went up, Simon would be on the hook for the difference. Ehrlich’s liability was capped at $1,000, whereas Simon’s risk had no roof. The bet was made official in 1980.

Range: Why Generalists Triumph in a Specialized World, David Epstein

In October 1990, Simon found a check for $576 dollars in his mailbox. The price of every one of the metals declined. Ehrlich was wrong. Although malnourishment is still a global issue, it is not as big an issue as it once was. In the 1960s, 50 out of 100,000 global citizens died each year from famine. Today that number is 0.5.

Even though Ehrlich’s predictions were embarrassingly bad, he doubled down on them in another book. He argued that the timeline had been a little off but now the population bomb really detonated. Despite a long string of bad predictions, Ehrlich amassed a huge following and received prestigious rewards.

Simon became a standard-bearer for scholars who felt that Ehrlich had ignored economic principles, and for anyone angry at an incessant flow of dire predictions that did not manifest. The kind of excessive regulations Ehrlich advocated, the Simon camp argued, would quell the very innovation that had delivered humanity from catastrophe.

Range: Why Generalists Triumph in a Specialized World, David Epstein

But in the end, despite both of their successes in their respective domains, both were mistaken. When economists later examined metal prices for every ten-year window from 1900 to 2008, during which time the population of the world quadrupled, they discovered that Ehrlich would have won the bet 62 percent of the time. The catch was that commodity prices are a bad proxy for population effects, especially over a single decade.

The variable that both men thought would vindicate their worldviews had little to do with them. Commodity prices went up and down with macroeconomic cycles. A recession during the bet brought the prices down. The two men might as well have flipped a coin, yet both declared victory.

Both defended their ideas more strongly and continued to miss the value of the other’s ideas. Ehrlich was wrong about population and the imminent apocalypse but was correct on aspects of environmental degradation.

Simon was right about the influence of human genius on food and energy supply but was wrong when it came to the environment. The improvements in air and water quality did come, but not from technological initiative and markets, but from regulations that people like Ehrlich pushed for.

Intellectual sparring partners ideally would hone each other’s arguments so that they are both sharper. But the opposite happened with Ehrlich and Simon. Each man became more dogmatic as they amassed more information to support their own view, and the inadequacies of their models became starker. Some thinkers fall in love with their ideas, even in the face of contrary facts, and their predictions become worse as they amass more information about the world.

Confirmation Bias

Researches in Canada and the U.S started a study in 2017 by asking a well-educated and politically diverse group of adults to read arguments confirming their beliefs about controversial subjects. But when the participants were given the option of getting paid to read the contrary arguments, two thirds decided they would rather not look at them, let alone seriously consider them.

Psychology professor Dan Kahan has showed that the more scientifically literate adults are more likely to become dogmatic about polarizing topics in science. Kahan thinks it is because they become better at finding evidence to confirm their feelings.

Stents

Interventional cardiologists specialize in treating chest pain by placing stents—a metal tube that pries open blood vessels. It is very intuitive. When patients have chest pain, and imaging shows a narrowed artery, a stent is placed to open it and prevent a heart attack. It has become a reflex in cardiologists. But randomized clinical trials that compared stents with more conservative forms of treatment show that stents for patients with constant chest pain prevent no heart attacks and do not extend the lives of patients.

But interventional cardiologists only see a tiny part of a complicated system. Stents are always implemented even when it is proven not to be necessary for many patients.

The Flu

In 2015, Casadevall showed that biomedical research funding rose exponentially over a recent thirty-five-year period, while discovery slowed down. Life expectancy in countries at the biomedical cutting edge, like the United Kingdom and the United States, recently declined after decades of improvement.

Range: Why Generalists Triumph in a Specialized World, David Epstein

The flu kills hundreds of thousands of people each year worldwide while humanity fights it with a clumsily produced vaccine from the 1940’s.

The 2008 Crash

Creativity researcher Simonton has shown that more work creates more duds, which increases the chances of success among eminent creators. Edison had more than a thousand patents, most were unimportant, and was rejected for many more.

His failures were legion, but his successes—the mass-market light bulb, the phonograph, a precursor to the film projector—were earthshaking. Sandwiched between King Lear and Macbeth, Shakespeare quilled Timon of Athens. Sculptor Rachel Whiteread achieved a feat akin to Geim’s Ig Nobel/Nobel double: she was the first woman ever to win the Turner Prize—a British award for the best artistic production of the year—and also the “Anti-Turner Prizer” for the worst British artist. And she won them in the same year.

Range: Why Generalists Triumph in a Specialized World, David Epstein

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Chapter 9: Investing in Investment Funds (The Intelligent Investor)

Investment funds are vehicles provide a convenient means for saving and investment, and potentially protecting investors from themselves.

But the investor should expect no more than average results. But beware of high fees, excessive trading, and erratic fluctuations in performance.

Be wary of outperformance, it may indicate speculative behavior on the portfolio.

The defensive investor should probably be satisfied with an index fund or closed-end fund selling at a discount.

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Chapter 8: Mr. Market and Fluctuations (The Intelligent Investor)

Mr. Market is the analogy given for the market. Imagine that you co-owned a company with Mr. Market, a man who, each day whether he is a good mood or in a bad mood, will buy or sell his shares in the company.

The analogy is to make the point that irrational investment is a reality. There is no scientific formula that each investor applies, and no singular rational way of thinking. Investors are people, they get emotional, they are at time too optimistic, and at other times, too pessimistic.

As an intelligent investor, you should do your homework. Your goal is not to beat the market, but to look to buy when Mr. Market is underestimating the value of his shares, and to sell when Mr. Market overestimates it. That is, never compare yourself to others, always focus on perfecting a sound strategy and having faith in it for the long run.

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Chapter 7: Portfolio Policy for the Enterprising Investor: Positive Approach (The Intelligent Investor)

An enterprising investor wants to achieve a higher than average rate of return. There are 4 ways in which this type of investor can go beyond the defensive investor. . Buying in low priced markets and selling in high priced markets, buying growth stocks, buying bargain issues, and buying “special situations”.

The enterprising investor can divide his portfolio differently from the 50 percent stock, 50 percent bond/cash plan of the defensive investor. An equity allocation for the enterprising investor can range from 25 to 75 percent.

Growth stocks are usually many times overestimated by the markets.

To buy bargain issues, the enterprising investor needs to find stocks that are undervalued, due to disappointing earnings or general disfavor. Usually, a good buy is a well-established company priced well below its average historical price and previous average price/earnings ratio.

The final option for the enterprising investor would be to find a special situation, where a small company would likely be acquired by a large company.

In the end, you cannot have it both ways. You must choose, either to be a defensive investor, or an enterprising investors. There is nothing in between.

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Chapter 6: Portfolio Policy for the Enterprising Investor: Negative Approach (The Intelligent Investor)

Unless lower rated bonds and preferred stock have a huge upside, enterprising investors should avoid them. Lowe rated securities usually collapse in adverse markets.

It is good to avoid foreign bonds. But ETF’s have mitigated for this problem, so do mutual funds that specialize in foreign bonds and lower-rated securities.

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Chapter 5: The Defensive Investor and Common Stocks (The Intelligent Investor)

As long as the stock is not overpriced, buying them could protect against inflation and offer a higher return than bonds or cash in the long run.

Four rules for the defensive investor.

  1. Adequate diversification (between 10 and 30 issues)
  2. Large, outstanding, conservative companies (top 30 percent of industry)
  3. Each company should have 20 years of continuous dividend payments.
  4. The price you pay should be limited to – 25 times average earnings over past 7 years. 20 times earnings over last 12 months.

Abandon growth stocks. Too expensive and risky.

Don’t try to beat the market. Concentrate on learning the difference between price and value with small investments. The investor’s rate of return in the long run will depend on their knowledge, discipline and skill in paying a reasonable price for their investments.,

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Chapter 4: General Portfolio Policy: The Defensive Investor (The Intelligent Investor)

The conventional wisdom is that the investor should match the amount they risk with their risk tolerance. But Graham says that the amount of risk that is taken should depend instead on the amount of intelligent effort the investor is willing and capable of expending and doesn’t depend on age either.

The defensive/passive investor should expect an average return. The enterprising investor can expect higher returns.

The defensive investor can divide his portfolio between stocks and bonds/cash. Portfolio rebalancing should happen when valuations change the asset allocations.

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Chapter 1: Investment Versus Speculation (The Intelligent Investor)

Keep investments and speculation separate. If you must speculate, make sure it is no more than 10 percent of investment funds.

There is intelligent investment, but also intelligent speculation.

Intelligent investing includes: 1) analyze soundness of business’ fundamentals. 2) a plan to prevent catastrophic loss. 3) pursuit of reasonable return.

To speculate means to bet that the market price will conform to your expectations. Stupid speculation is when you speculate while you believe you are investing, speculating without the necessary knowledge and skill, and speculating with money you cannot afford to lose.

Many on wall street promote speculation because it produces money for the industry. Trendy formulas and systems are promoted, they may work for a while, but they all end up failing.

A successful speculator must act ahead of the latest trend. This is in contrast to intelligent investing, where trends don’t matter.

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This Time is Different Summary (9/10)

…the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that “this time is different.”

This Time is Different places 200 years of financial crises under sharp scrutiny. Reinhard and Rogoff note that financial fallouts occur in clusters and with surprising consistency, intensity, and duration.

They examine the causes of currency crashes, hyperinflation, and government defaults (international and domestic debts). Some countries weather their financial storms better than others, but short memories make it too easy for crises to recur.

The advice, that the old rules of valuation no longer apply, is followed up by confident rhetoric by government leaders and financial professionals, that we are smarter and better than we were before.

The weight of evidence of this book suggests that we should be skeptical when we hear the words, “this time is different.” It almost never is.

Below is a list of the main themes that I found to be most important in This Time is Different with summaries of each.

External Debt Crises

External debt crisis is when a government defaults on its external debt obligations. Typically, but not always, this loan is denominated in a foreign currency, and held mostly by foreign creditors.

The largest default on record is held by Argentina. In 2001, it defaulted on more than $95 billion in external debt.

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Debt Intolerance

Debt intolerance is a syndrome in which weak institutions and political systems make external borrowing a tempting prospect for governments, to avoid difficult decisions with regards to spending and taxing.

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Domestic Debt

To stabilize inflation in the late 1980’s, the Mexican peso was tied to the U.S dollar via an official exchange rate band. It was a peg to the U.S dollar. In early 1994, the peso came under speculative pressure after the assassination of a Mexican presidential candidate Colosio.

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Banking Crises

Countries can outgrow a history of repeated bouts with high inflation, but no country yet has graduated from banking crises.

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Currency Collapses

Countries that experienced a prolonged period of inflation often experience dollarization (heavy use of foreign currency as transaction medium, unit of account, and store of value).

Practically, the use of foreign hard currency in trade, or the indexation of bank accounts and bonds is possible.

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