Sturm und Angst Politischen Ökonomie
Thought German might fit the Wagnerian mood of the markets today in a brief post discussing the economy. A few links on related tangents that I found intriguing, and then a brief comment:
John Robb – A Real Nuclear Option in Finance
John relishes being not only out front but the edge thinker. He’s right that derivatives have to be addressed though I’m not qualified to comment as to “how”. I haven’t the faintest idea and the sums that derivative markets leverage vastly exceed our planetary GDP ( that’s right, not the economy of United States, the GDP of planet Earth) In particular, I wonder how you monkey with one class of derivatives without spooking the traders in other derivative instruments into stampeding us over a cliff in ten minutes. OTOH, Robert Paterson, who unlike me really does understand derivatives and the nuances of trading, agreed with Robb, who offered:
One solution: Nuke entire parts of the system. In short, destroy the system’s network connectivity. For example, credit default swaps ensure that failure will spread through internetworked contracts. Nuke CDS derivatives ($60 trillion or so) by making them illegal. Destroy parts of the network in order to save the remainder — firewalls and firebreaks.
Fabius Maximus – No coins, no COIN
FM sees the economic crisis forcing huge changes in American foreign policy, defense structure, military doctrine and acquisitions:
In most of these money is no object in the pursuit of security (or other goals, often quite chimerical). That is an exceptional way of thinking. More so when one considers how our current account deficit has steadily increased since 1971 (when we went off the gold standard) – and the even more rapid increase in the foreign debts that finances the annual deficit.
That era will close soon, and the United States will return to earth. Like everyone else, we will have to consider what foreign adventures we can afford before starting them – weighing their costs and benefits – and stop wars whose costs spiral out of control. This will force a military revolution more profound than any since WWII, when we entered the “money is no object” era for weapons and foreign wars.
….Not that the annual budget wars were not fought fiercely, but they will be conducted differently once budgets start their rapid and long-term decline. Like any organization thrust into radically changed environment, restructuring – drastic changes in structure and doctrine – will be needed.
Maritime, air, and land – our approach to all will change. Maintaining full-scale forces against purely theoretical future threats will become impossible. Seeking dominance in every theater will become unrealistic. Prioritization will become imperative.
FM also offers up A solution to our financial crisis . Right now, China, the leader in global dollar reserves is in a position where our crash is their crash and their crash may be the end of the PRC as we know it. Good time to strike a deal.
Tom at HG’s World cites Niall Ferguson in Ferguson’s greatest area of expertise, as an economic historian:
The End of Prosperity, or A Better Future?
Historian and author, Niall Ferguson penned this article in Time magazine, about the question that is on everyone’s mind if not their lips. “Are we headed into a second Great Depression?”He begins: “Congress’s initial rejection of the Bush Administration’s $700 billion bailout plan calls to mind an unhappy precedent. Back in 1930, the Senate passed the Smoot-Hawley Tariff Act, which raised duties on some 20,000 imported goods. Historians define this as one of the critical steps that led to the Great Depression – a tipping point when the world realized that partisan self-interest had trumped global leadership on Capitol Hill.”He explains what happened to tip the scales.“The U.S. – not to mention Western Europe – is in the grip of a downward spiral that financial experts call deleveraging. Having accumulated debts beyond what’s sustainable, households and financial institutions are being forced to reduce them. The pressure to do so results from a decline in the price of the assets they bought with the money they borrowed. It’s a vicious feedback loop. When families and banks tip into bankruptcy, more assets get dumped on the market, driving prices down further and necessitating more deleveraging. This process now has so much momentum that even $700 billion in taxpayers’ money may not suffice to stop it.”
Like Tom of HG’s World, I’ve been a big fan of Ferguson and have numerous books of his on my shelf . That said, it’s very odd to me that he not mention another parallel with the Great Depression of a Federal Reserve in the hands of a relatively new Chairman after the long tenure of an outsized and much respected predecessor. Or the inability of the Fed to effectively coordinate with European counterparts ( several days after loudly bloviating about American weakness/incompetence by the German Finance Minister it appears that he might have better spent his time addressing German and EU economic fundamentals. Good Lord, even by politician standards, what an asshole!) which back then scrambled to ditch the gold standard like a poor relation carrying hepatitis.
The solution, if you can call it that, from my crude perspective would be to gather the Fed with other central banks, treasury and it’s G-8 finance ministry counterparts plus China and the biggest sovereign funds and agree on a few, very simple, lowest common denominator “brakes” or safety nets to backstop the system, plus a 2 year “hot money” flight tax to give a window of time to let the markets settle and work out clear minded reforms rather tha jerry-rigged insider looting binges posing as band-aids. That and driving what money/credit remains toward entrepreneurship and innovation rather than another burst of McMansion consumption by a demographic of dudes without any verifiable means of support.
This scheme won’t create any rainbows. It would be a tourniquet but better a tourniquet than an amputation. If we come out with a recession on the scale of 1981-1982 we should consider ourselves to be fortunate. The Great Depression has begun to pass out of living memory but reviewing the mistakes of those years might be instructive.
October 7th, 2008 at 1:10 pm
Funny to see all these economic "experts" opine.Buffett says if we do the right things its about a six month turnaround (granted this is best case)http://www.cnbc.com/id/26982338/page/2/He has a reasonably good track record of being right.Warren Buffett: Oh, I think confidence will come back. I will tell you this. This country is going — be living better ten years from now than it is now. It will be living better in 20 years from now than ten years from now. The ingredients that made this country, you know, the miracle of the world — I mean we had a seven for one improvement in the average American standard of living in the 20th century. Now, we had the great depression, we had two world wars, we had the flu epidemic. You know, we had oil shock. You know, we had all these terrible things happen. But something about the American system unleashed more and of a potential to human beings over that hundred years so that we had a seven for one improvement in — there’s never been any — I mean, you have centuries where if you’ve got a 1 percent improvement, then it’s something. So we’ve got a great system. And we’ve got more productive capacity now than we ever have. The American worker is more productive than he’s ever been. We’ve got more people to do it. We’ve got all the ingredients for a sensational future. It’s just that right now the athlete’s on the floor. But we — this is a super athlete.
October 7th, 2008 at 2:04 pm
Hi Gunnar,
.
I agree that America has ( or many Americans have – some do not or despise this for reasons of ideology) a culture of entrepreurial, innovative, dynamism. Buffet has probability on his side. However, we need to ensure that capital/credit markets direct their flows to entrepreneurs and start-ups and neither get locked into overregulation nor a preference for unreasonable levels of security. Policies that are contractionary ( by intent or not) have to be avoided as much as distorted incentives for lenders to ignore all fundamentals to accrue short term gains and then cry for bailouts. Risk-accepting but productive risk-taking should be favored.
October 7th, 2008 at 2:18 pm
A historical note: the average length of the 10 recessions since WWII is 10 months. Expanding our view — since this current events do not resemble any of these — the average lenght of the 32 recessions since 1855 is 18 months. Determining the start of this recession will be difficult for the NBER. Perhaps January, perhaps September.
.. .. ..
We can only guess at these things, but the severity of the financial fore-shocks suggest a long and deep downturn. Like 1973-75 or 1980-82 (the latter technically two recessions with a deep breath between them).
October 8th, 2008 at 1:31 pm
Gotterdammerung…
October 8th, 2008 at 2:31 pm
Probably not "Gotterdammerung". We can only guess at the significance of these events, but I suspect this is the start of a new world order — a new round in the great game. Let’s hope that, after the birth trauma passes, it is even better than the post-WWII era now fading away.
October 8th, 2008 at 2:38 pm
FM : Let us pray that things will work out accordin’ to your worldview…
October 9th, 2008 at 4:42 am
What we have to watch out for is a continuation of the trend where failure is unacceptable. Without failure, the entrepreneurial process does not work and we begin living off the returns from existing capital stock (i.e. a period of stagnation & depletion.) FM is correct, the post WWII paradigm is now irrelevant, however, if we adhere to the classic 18 month recession/bear market timetable this process should resolve itself by the end of Q2 ’09. I don’t think we work through this mess until the end of ’09.
As far as John Robb’s comment on the value/cost of CDS’s being $60 T, this is a misunderstanding. We need to be looking at the replacement cost (i.e. the margin put up to open the position), which is ~$2T. There are assumptions that are made when one holds this type of "insurance", so we can safely push the cost to $5T-$6T. Either way the costs are massive.
On the financial crises front, the rapidly increasing risk now is the desperate need of those on The Hill & on The Street to prop up asset prices. Their inability to understand how markets function is making them focus on prices and this is the principal mistake that is being made (which lead to the massive $700 B intervention.) The initial interventions (the Fed creating various lending facilities in early ’08) will lead to other interventions (the $700 B bailout), then other interventions, and so on. It is an unfortunate spiral that will probably end with price controls on multiple financial products, goods, & services. The effort to prop up prices for short term political & economic gain of a small group of individuals will end up costing us greatly (add in the hundreds of billions in unfunded & poorly funded private, municipal, state, & federal obligations it takes two generations to get back to where we are today.) Bleak picture overall, then again I am prone to the more pessimistic outlook… Hope for the best, but expect the worst afterall.
Regards,
TDL