A Worse Crisis Is Yet to Come
Friedrich Nietzsche wrote:
“To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown -- the first instinct is to eliminate these distressing states. First principle: any explanation is better than none… The cause-creating drive is thus conditioned and excited by the feeling of fear …”
This weekend I turn 60 and have been a little more introspective than usual. I am often told that the letter I wrote well over three years ago on ubiquity and complexity theory and the future of the economy was the best letter I have ever done. I went back to read it, and it has aged well. I basically outlined how a financial crisis would unfold, and now it has.
On reflection, I think there are perhaps other, even larger, events in our future than the recent credit crisis and recession; yet, just as in 2006, there’s a great deal of complacency. But as we’ll see, there are fingers of instability building up that have the potential to create large disruptions -- both positive and negative -- in our future. And for the political junkies, I offer a brief insight into what may be one of the more intriguing behind-the-scenes developments in recent years. Now, to the letter.
“Any explanation is better than none.” -- Nietzsche
And in the investment game, it seems the simpler the explanation, the better. “The markets went up because oil went down,” we’re told (except that when oil went up, then there was another reason for the movement of the markets). But we all intuitively know that things are far more complicated than that. However, as Nietzsche noted, dealing with the unknown can be disturbing, so we look for the simple explanation.
“Ah,” we tell ourselves, “I know why that happened.” With an explanation firmly in hand, we now feel we know something. And the behavioral psychologists note that this state actually releases chemicals in our brain that make us feel good. We become literally addicted to the simple explanation. The fact that what we “know” (the explanation for the unknowable) is irrelevant, or even wrong, isn’t important in achieving the chemical release. And thus we look for reasons.
The credit crisis happened because of Greenspan’s monetary policy. Or maybe it was a collective mania. Or any number of things. Just as the proverbial butterfly flapping its wings in the Amazon triggers a storm in Europe, maybe an investor in St. Louis triggered the credit crisis. Crazy? Maybe not. Today we’ll look at what complexity theory tells us about the reasons for earthquakes, tornadoes, and the movement of markets. Then we look at how the world and that investor in St. Louis are all tied together in a critical state. Of course, what state and how critical are the issues.
Ubiquity, Complexity Theory, and Sandpiles
We’re going to start our explorations with excerpts from a very important book by Mark Buchanan, called Ubiquity: Why Catastrophes Happen. I highly recommend it to those of you who, like me, are trying to understand the complexity of the markets. Not directly about investing, although he touches on it, it’s about chaos theory, complexity theory, and critical states. It’s written in a manner any layman can understand: There are no equations, just easy-to-grasp, well-written stories and analogies.
As kids, we all had the fun of going to the beach and playing in the sand. Remember taking your plastic buckets and making sandpiles? Slowly pouring the sand into an ever bigger pile, until one side of the pile started an avalanche?
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Finally, a belated Happy Birthday John, do you feel any different at 60?
And thus begins the reasoning that leads us down the road to ruin.
The study of economics seems to have morphed from an effort to understand the production, distribution and consumption of goods and services to an effort to create some sort of magic black box that will allow us to avoid the consequences of greed and mismanagement. Credit has been elevated from its rightful place as a necessary evil to a panacea that will optimize economies, alleviate suffering and raise everyone's standard of living. In support of this effort we invent terms like the velocity of money and the multiplier effect. We fall prey to the urge found in all sciences to onduct experiments in such a way that they prove our hypothesis. We are impatient and don't want to delay gratification so we produce elaborate systems to explain why we can have it all now. Our egos and desires keep us from seeing that there is no perpetual prosperity machine.
We in the United States and other developed countries have lived through over three decades of over consumption. We have created an illusion of prosperity built on debt and cheap energy. When that was insufficient for our insatiable greed we told oursleves and unbelievablle lie about a 'service economy' and exported to our manufacturing base to developing countries to achieve the short term benefit of cheap labor. As a foreseeable result our current account defict exploded and the party was in danger of coming to an end so we doubled down with derivatives and sub prime mortgages.
The was all extremely foreseeable at least back to 2005 and if not for our unwillingness to see the obvious probably much earlier than that. And now, the cure is suppose to be more debt. How convenient that we are now 'forced' to spend more. If increasing debt is the answer how did the economy get sick in the first place?
Of course, if we don't do something there will be extreme unemployment, rampant bankruptcies and untold hardship. These my friendly economists are what's known as 'consequences'. Consequences are good things. We learn to adapt our behavior to reality by dealing with consequences. Avoiding consequences ultimately leads to ruin as we delay learning through small, manageable consequences until they become large, unavoidable consequences. These consequences are the "fingers of instability" referred to in this article. They start with the small lies we tell ourselves that we are smart enough to cheat reality. That we can get something for nothing because 'deficits don't matter' or that all we really need is a different accounting method. They say you can't cheat an honest man but with the government and all of the expert economists telling us we can have it all are there any honest men left? Judging by the huge government spending of money we don't have and the markets reaction to this...precious few.
You don't need "chaos theory, complexity theory, or critical states" to understand what's happening. Just mix equal parts greed, arrogance, dishonesty and stupidity and you get the cake we call the American economy.
Now that we are caught in this trap and the jaws are tightening the experts would have you believe the answer is more of the same.
"There's a truism that goes a little like, “If something can't happen, then it won't.” Let me make a prediction: We won't have a trillion-dollar deficit in ten years. Why? Because it can't happen. The market simply won't allow it...." -
is probably the crux of why i don't believe the real market, people and their productive money, won't allow that portion of the market called stocks, to keep being bid higher and higher on that very same deficit type money in the quote -
i don't want the (stock) market to go down just to go down, i want it to begin to reflect what is really going on with people and their monies and their enterprises, which would then lay down a trust to invest and risk and grow...
anyway, great article john (had also read it in your email newsletter) - thanks!
Once again a great article.
I would like to make the comment, that the consumer has started to de-lever, but the financial world has not.
I think de-leveraging is inevitable. But:
1. If people won't buy our debt, interest rates rise, which will choke the economy.
2. If people won't buy out debt, the berries may be forced to cut spending
(very difficult but not impossible)
My point being that while interest rates may rise, they would be limited in the degree they could go up, as this would just enhance any deflation by further weakening the economy.
In my opinion the only way to get inflation is thru radical monetary policy and doing a Roosevelt "reset". But that did not happen until late 1933, after a period of prolonged deflation.
To me it's all about the debt. And if we de-lever GDP will be hit for a decade or two (I think we no longer have a choice, the die has been cast).
The best way out is to restructure debt, but our Berries will need to find the political will.
Since I feel unable to do anything about our country's financial future, I sit here and worry what I can control - my family's financial future. I am thinking that Armageddon maybe closer that even us pessimists are willing to believe.
I do not believe that the Chinese will continue to buy our debt at low interest rates as the dollar tanks and our country falls into a financial abyss. They have already voted with their feet by buying, and stock piling commodities.
What I would really appreciate is an article on plausible scenarios if interest rates do rise.
For example, I would think rising interest rates would crush the housing market. Prices would drop. On the other hand, if the dollar debases perhaps prices would eventually go up because of the price of replacement.
I guess what I am saying is that I would appreciate a follow-up article on your perceived consequences of rising interest rates.
Thanks again for all the great work you do!
I sent my thoughts in an email to some of my friends and title it "No Way Out."
What I don't know, however, is what, if anything, we can do about this at a personal level - or at ANY level.
Will the 2010 election be interesting? Will the same crew that has been driving the train for the past 30 years just be returned?
And my son is 18 and my daughter is 15. I think that all of us are trying to avoid the future "historical perspective" of looking back and thinking "how did I miss that?"
http://bilbo.economicoutlook.net
/blog/?p=5274
If currency doesn't equal wealth, then tracking a yearly currency "budget" for the national, monopoly currency owner makes no more sense than for a biological cell to track it's yearly adenosine budget. The budget we all need to be tracking is real wealth, not nominal currency. Those real wealth grains aren't even being accurately tracked, while minyans obsess over their local and national currency supplies.
Confidence, nationally and internationally is a word that fits into your comments somewhere around the choking part.
The big bang is on the way and as stated by many professors we need to get through this thing and start being productive from a world point of view.
Look at the energy we are all using to work out a riddle we aready have the answer for but the riddle keepers won't give us the prize. Pretty unfair in my mind but they are adults and we allow then to be I suppose.
regards
pete
