I was stunned reading the NY Times this Sunday, article after article goes on to confirm my worst foreboding; or rather what were issues of foreboding are now here larger than life.
I. Where We Are Now; “All The Family to Dinner”
A great writer or trickster (often one and the same thing) is William Gaddis and in a few of his books he uses a fulcrum point of epiphany, of either finding what one fears or acquiring self knowledge of something one always was or knew but had hidden or was obscured. His key citation is of Emerson quoting Thoreau:
“What you seek in vain for, half your life, one day you come full upon, all the family at dinner. You seek it like a dream, and as soon as you find it you become its prey.”
That’s the feeling, the sense of dread but also one of “no way out” as you stumble upon the whole clan and find it all as you expected or imagined and the clan looking up, all of them, as they take you in and ready to respond to your intrusion.
I suspect this is the core feeling now for many depression economists of good character who like military commanders who learn their warcraft well but war finally occurs they are sickened and repulsed in the practice their craft and even at first falter. Depression Economists must feel that way now as they do know depressions and the mechanisms and the connections of them; but they also know the terrible wake the depression will lead. The economists and leaders they consul seem now like the person who just opened the door and there they are “all the family at dinner”. It seems most economists are silent and somewhat stunned and have yet to declare what their craft provides in prediction.
This is hopefully that stunned shock in finding what they seeked and explains the lack of vigor and action and intense commitment to forestall a tragedy now being shown by most economists, that it is just that, initial shock, as they stand looking the family over.
But the family, in the midst of dinner interrupted, will be, or is in midst of, taking action.
Back to the Sunday NY Times, once again a “movable feast” of gloom where only the tempo is picking up and more and more the results seem inevitable.
What is going on?
First, I know what is wrong in the majority of economic stances and views, and thereby what is wrong in resulting prognosis and prescriptions - a seriously misplaced moralism.
As we approach “our” depression, I am starting to realize that Keynes' most important attribute likely was that he was gay.
Why? I think it allowed him to consider economics and social construct with an absence of judgment, as I am sure as he was always on the anvil, in someway or somehow, of having to accommodate or explain or hide his homosexuality in Edwardian England; he knew firsthand the effect of the judgment on his homosexuality as a case of morality and likely realized that this was an avenue that provided little truth or improvement in the person judging him. This had to have developed a studied absence of values in Keynes economic thought, or applying the lenses of morality to viewing how an economy could take a crapper and how to get it out of that status. Yet this amoral stance was augmented with a very deep and fierce sense of civics. Keynes was a patriot.
Concentrating on civics and the status of civics, and freed from having to judge society, Keynes was able to see with a glance what almost all missed. That the core functionality and ability of the society was unchanged and the current times were actually more promising than prior times. The problem was the mechanism and structure of the economic structure of society and even there Keynes was a humanist and suggested that if Western societies wished to enjoy many of their finest attributes, then Western capitalistic democracies were required and always would have an inherent instability which would make for periodic crisis. That the central governments main purpose is to offset or make these periodic economic storms the least damage as possible. Minsky is of course the key “reader” of Keynes (how Minsky described his life’s work) who developed this aspect of Keynes which is most relevant to financial markets.
But Keynes not only felt that morality and qualifying merit in society was a totally useless avenue to pursue, but that it would even impede the solution.
All through this morning NY Times I see this terrible flaw of applying "judgment" in both the most usual analysis of how we got here and also in what the solution should be. All I read is economics as written in Leviticus. Blinder’s “Six Blunders” are all the blunders experienced formulated by base greed or selfish cunning gone astray. “..[P]eople in authority owe millions of Americans an apology.” September 11 was our fault as the NSA of the time Clarke told the 9/11 commission. Apologize! says Blinder.
Ben Stein this day and age’s Will Rogers or Mark Twain, our fabulist, recites tales of woe about a friend living in terrible denial who is likely gonna get it and get it good even though she is a “sweet lady”. But her shallow materialism and lack of reality is such a sin that this will be inevitable. Then he moves on to his own son’s lack of awareness of his plight. The core of the problem is American’s inability to be prudent and save. We must once again become a nation of savers and Stein suggests we should work harder and with greater acceptance to the reality of life.
Then the ill understood and thereby fearful credit default swap bogey man is trotted out by Gretchen Morgenson, who has the be the world’s master in diving into and intelligently writing upon areas and topics of great import which she has not even a clue as to their inherent reality. It makes her columns rich fields to help put together your own thoughts together, and her columns are fertile pre-finished intellectual ideas, much as a sour mash is required to make in the end good bourbon. But she shows again the central error, the great danger as out pundits and observers wade in – CDS market was where folks “raking in” premiums like river boat gamblers while regulators let this immoral casino carry on with no supervision as if the gamblers were slipping them C-notes at the end of every session. Then she goes on to mangle a very sensible “rule of law” idea which is an open outcry market for CDS – but quickly removes herself form being accused of anything sensible and wades into bizarre margin requirements completely out of accord to the nature of risk. Again, morality, or lack thereof, seeps throughout her thinking.
And of course evoking the great film “The Talented Mr. Ripley” in Creswell and Thomas “The Talented Mr. Madoff” article puts this cheek to jowl to all the other articles.
It seems the USA has never lost its Winthrop and Puritanism, always lurking to remind us that all is God’s and all form His grace and if we do not understand whether or not we are “saved” and lead a moral life to assist us in this revelation – well we are to be flung into hell. This is really still the main economic theory ruling the land. We are a sinful and willful people who must be brought back to Yah-Weh, to Jehovah, to the correct way of life.
I think a Mayfair Crowd meticulously educated Cambridge gay man of impeccable refinement would have either totally missed this message and if he did note it he would have realized the huge road black that attitude presented to the solution. First in most considering the solution as just more of the immoral behaviors that brought us to the crisis in moving the spend thrift ways of the populace to the national balance sheet, and second with most considering punishment be meted out to those who brought this on us be a critical part of the solution (Apologize! Repent!) and some measures of the pain and suffering they caused are self realized.
Both of those approaches are a catastrophe on their own right. Or existing rules and regulations are more than enough to find and eliminate the Mr. Madoffs of this crisis and this is solved through empowering the Feds and adding a few beds to a federal penitentiary. Mr. Madoff in house arrest is not our finest moment. But to go on from there and start witch hunts and financial pogroms and to not accept the basic sound and good character of our business leaders and politicians is a route of self flagellation and an attempt to appease Jehovah and will eliminate the necessary business leaders and financial risk takers we will desperately need.
The path to being prudent savers and sober cautious livers of American life is also an avenue of catastrophe. The core driver of all pain and suffering we may receive shortly is the savings rate of Americans going from 0% to in excess of 5% in short order. The shock in the complimentary drop in consumption (“jam today or jam tomorrow”) will force a massive over capacity in American industry and service. In short a depression.
As Keynes said:
“The resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life.”
And more importantly:
“"...most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits--of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities...if the animal spirits are dimmed and the spontaneous optimism falters... enterprise will fade and die,"
The last quote taken from the all important “Chapter 12” of the “General Theory”
This exuberance, near irrational hope in a future better than today, a “rent” schedule of improvement of your lot in the future is the fundamental driver for all Western democratic capitalistic society. This central and indispensable notion of hope and spirit defies quantitative metrics and analysis and is not often embraced and more often than not shunned from debate and analysis and policy.
And this is the main attribute of the current crisis, despite our “audacity of hope” man in the White House, is actually the reverse – not only a crash in hope and spirits but even an embarrassment with our past enthusiasm. And a desire to stamp out the animal spirit and hope in some misguided and terribly cowardly and loathing of our present makeup in hopes a salvation results in the afterlife to save our sorry souls. This is what I think is really meant when we talk about the terrible burden a fiscal stimulus would impose on our future generations – it is really that to mollify or save ourselves from current pain and suffering prevents our salvation and throws into doubt our chances of the after-life.
II How We Arrived Here
The above American values of sin and redemption; crime and retribution – of seeing social values through a prism of morality and whether one is living a righteous life in the ways of the “elected” or “saints”, does allow society to bear down and produce great achievement under duress as our history shows. But it also has delivered great pain and suffering upon others who did not subscribe to our formula as to what the moral life is. It also is the greatest danger to reclaiming the “animal spirits”, the enthusiasm and belief in a manifest destiny, American exceptionalism which has also provided wonderful status of life from the third fourth generations of immigrants, towns in Mexico, and even African descendants who can become President.
We are not a lazy nation but one of the hardest working on earth. Anyone who has wondered at traffic jams as the midnight shifts end in Manhattan or that one has to get on NY City parkways prior to 6:00 AM can easily observe that.
Families are careful and prudent, work hard and save, and plan carefully for their children’s future and lay the base for generational success. Our loathing to retire, to stop work, is obvious, and no developed nation on earth has fewer holidays taken.
Lazy and spendthrift we are not.
Large dreamers, the masters of the animal spirit (at least so far) we are.
So how did we get to this point if it was not a sudden and bizarre dedication to immoral or at best amoral behavior and an orgy of enjoyment of the present?
That comes to the second series of NY Times articles that caused me much stress this morning.
The first article was discussing the unemployment situation in China. Now it should be clear that this is not really representative of China, but the employable part of China – the 250 MM educated and technically adept workforce. The other 750 MM is still mired in a peasant and vassal like existence. But 250 MM is about equal to the entire populace of the USA and dwarfs the educated and productive part of the USA population. So it certainly has great impact. What’s more that amount of world caliber productive employable people was about 25 MM only 20 years ago, so this growth is truly an incredible achievement and something the whole world has great interest in maintaining and promoting. What’s more the growth in those becoming educated and trained and making the transition from peasant and urban poverty to this world caliber workforce requires China to maintain a 7% growth in GDP just to absorb, to break even. This part of the populace is the traditional source of revolution and social change in China. It is the core of the makeup of the Maoist revolution and the subsequent social organization post Imperial and kleptocratic China. China is also a plutocracy which unlike democratic regimes the people have a very narrow and small list of specific folks to target and blame if things go astray. So China must produce, in the long run, growth of at least 7% or massive social unrest will result. Tienanmen Square was the last showing of this beast and the fact China completely embraced this proto-capitalism model shows both the need and the great fear underlying Chinese structure.
In the 1990s, China had to design a system that would gainfully incorporate well over 200 MM people in short order or it would slide into anarchy and terror and absolutism. They have succeeded.
But, the major problem, and also a major attribute for China, was the emergence of a hegemon power which allowed globalism to exist, not seen since either the Edwardian England or “The Twelve Caesars” in Rome. That power, the USA, allowed globalism by becoming the “buyer of last resort” and by evoking “soft power” via mercantilism versus hard power of the “boots on the ground” like Rome or England. Though certain key outposts were maintained with “boots on the ground” like Okinawa or Korea, these forces were more often than not welcomed or even insisted upon by the host countries. Global trade flourished where to gain entry of the system a country would ascribe to pax Americana and in return could be the mercantilist rather than in the time of Britain, the major power was the mercantilist. Currencies and command economies could be managed and applied which deliberately set terms of trade such that the USA was eager to move production to these foreign locales. The USA itself was moving to another phase of economic production of service and technology and also finance which was the hub administrating this globalism network of trade. In short, the USA to prosper deliberately allowed itself to be “used” in being the recipient of uneconomic terms of trade of mercantilist systems.
Japan prospered under this pax Americana system, so too did the “Tigers”, and then so did China, the largest client of the USA system.
China was certainly aware of this “deal” and must have felt that they could take advantage of the USA as long as required until China could produce internal terms of trade such that the exporting part of the economy would become complimentary and supportive to a vibrant near self sustaining domestic economy. But that has yet to occur and as long as tiered elitist system carries on (albeit one based on national merit testing) large swaths of China are basically welfare states which exchange and support has to be forthcoming from the export sector. The fact that there are over 250 MM productive workforce now in China was supposedly self evident that this shift from export trade to domestic economy was a given. And any suspicious fellow had to only go to Shang Hai or make the tour of the “100 Cities” to have all suspicions cast aside and an eager fan of China would emerge – often with the added insight as to newly discovered errors in the central hegemon, the USA. It has even gotten to the point where the obvious shift from the hegemon to just one sorry member in a multi-polar world had befallen the USA. But again, the story in the NY Times shows China is still riding the dragon as all mercantilists do and that their power and prestige and ability to function as a society is a function of the USA status. Ergo the shock in Chinese students finding they cannot get jobs and the correlation of near one with Chinese economy with developments in the USA.
Nial Ferguson is wrong, it is not Chimerica but rather Rome and Egypt, Athens and the Aeolian wheat growers in the Black Sea, the UK and India, and so on. What is different is none of those vassals to the hegemon had 1 billion people of which 250 MM are literate and technically adept. Whatever the form that China pursued, the threat to USA security was always apparent. A strategy to be able to defend the USA and utilize the Chinese presence in constructive ways insisted on China being a core focus of all USA foreign policy efforts.
Before being elected in 1968, Nixon made several tours of the world ostensibly as the spokesman for Pepsi-Cola. One such tour was in Germany where the elder statesman and leader Adenauer, the father of modern Germany, pleaded with Nixon that the USA must be mindful of the USSR successes in propaganda and pressure on Europe, that Europe was being ignored by the USA with their preoccupation with Vietnam and a history of China bashing. Adenauer suggested rapprochement with China to split the China-USSR axis and open a new front against the USSR. At the same time various leaders in Eastern Europe such as Romania’s Ceausescu also hinted that China may be an important counter to USSR power. Nixon went on to SE Asia and noted that the real heavy hand were not Maoist, but rather Neo-Stalinist with roots in Europe (Sorbonne) or Russia. Nixon also visited Chaing Kai-Shek in Formosa and when Chaing told Nixon the time was ripe to invade the mainland, he realized what a shaky and delusion ally Taiwan had become.
Then Nixon went through the process of leaving Viet Nam – which was really an evacuation - and it was important to at least have China standstill. In the crux of the Cultural Revolution Mao saw sense in this and he did.
The ability to work with China was a surprise and noted by the USA and in 1972 Nixon made his historical visit to Mao and the seeds of the partnership were laid.
From that point on China left the domain of the geo-political Kennan “containment” strategy which eventually destroyed the USSR, and was offered to join the pax Americana mercantilist system that Korea, Japan, Singapore, and even to some degree Indonesia was enjoying. The ravages of the Cultural Revolution taught China that the Jefferson/Trotsky periodic and constant revolution would not work given the size and unwieldiness of China. So trade and mercantilism was the answer. Tiananmen Sq clinched this as being the paradigm.
The USA had a choice of either continuing to contain China as they had the USSR and all the treasure that would require, or allow China access on disproportionate terms in China’s favor to the USA markets. The choice was to double the soldiers in Japan or in the indefensible Korea and add three more carrier task forces; or allows that part of growth required in China to maintain stability to be based upon selling into the USA markets. Basically it was (and still is) “guns or butter”. Unequal terms of trade were to be manageable as shown by the success in accommodating Japan and Korea and to some degree Germany in the same way. In the 1960s the USA was supposedly going down the tubes as German trade and German sound DM were obviously superior, and in the 1980s the same thought was applied to Japan. Germany was able to successfully raise productivity and allow the DM to float so that part of their trade surplus was not the results of manipulated currency but soundly based on equable terms of trade. Not only that German domestic demand increased substantially so that trade with the USA was not critical. Japan found that when limits of trade were reached and the USA was adversely affected to the point it was not longer tenable; the USA simply moved the Yen to sub 100 and eliminated the excess trade that was manipulated. Peaceful and close alignment allowed a managed response to this problem form Toyota plants in Georgia to Japan’s own domestic markets stressed, but still the “lost decade” that followed the currency change the USA insisted upon still showed the USA hegemonic position and power. An important and critical part of a weaker power having unequal advantageous terms of trade with a stronger power is the assumption of debt or assets in the end market assets, otherwise the mechanism which enable the mercantilist trade flow cannot be enabled – which is basically the Yen kept at levels cheaper than any “true” purchasing parity or real value vis a vis the dollar.
Now here is the rub and the key element to all the above and the main issue regarding the current economic crisis. That asset accumulated in the importing country’s currency has to be maintained at the purchased value otherwise it becomes impossible to maintain the currency level that allows the unequal terms of trade. In fact, in many ways, this asset does not exist but is the record of whatever economic fiction the exporting country applied to prompt the trade. Further most developing countries have an internal axis of fiction as well, or “trades of decline” as Jane Jacobs calls them where the currency generating areas of the economy have to send transfer payments or repatriations to the non-producing areas. Often those areas are also parts of the country where dissension and social pressure can evolve. So Japan had both the ever accumulating fiction of supposed wealth in US Treasuries, but if it were touched the fiction of the Japanese manipulated currency becomes apparent, and also large transfer payments were being made to non-productive areas of the country and sectors to maintain certain important cultural legacies or core support for the LDP party (rise farmers and rural elderly – Hokkaido). In the end Japan accepted their position and to maintain political power those in charge zombified the banks and the country “ate” the lost decade.
China is in the same status as Japan but perhaps in even more dire position.
The trillions of US Treasury are a brittle support edifice which if touched could uncover the true competiveness and status of China. This is perhaps why such deep concern is expressed in any loss that Chinese money management produces in dollar assets. Further more this asset creation that China required to balance the “fiction” in the terms of trade was massive and also occurred when the USA was not in a strong growth phase as Japan enjoyed in the 80s, and even in support during the 90s. USA had just entered a long war in the post 9/11 world as well as suffered wrenching re-organizations in corporate governance post Enron and Tyco and WorldCom, and was emerging from a market mania in dot com economy crashing. The absorption of the Chinese capacity for good destined to the USA market, realized through fictional pegs in the currency, is growth or is one side of a Pacioli identity which has to find another side. If the major cash flow realized destined to China has to be maintained in stable and unobtrusive US Treasuries, otherwise a “true” accounting occurs, then a proxy asset liability structure has to be developed in the USA.
And there you have it. Sub prime RMBS. I cannot think of any other market that might have occurred to fill that imbalance. But noting what has happened in the past, through a chain of causality, American financial institutions insisted that this time the assets would be AAA unlike times past when the investment was in EMD or other volatile assets. Not only this but to a lesser degree the whole world affiliated with the USA was allowing China to do this – and the whole world through various financial chains led back to the USA and then to RMBS. RMBS structures then established an absolutely standard bubble in the core asset – the USA home. Risk control was applied but based on data sets of past where such international flow did not exist and the regional makeup of mortgage banking provided a risk ameliorating profile which made the ratings agency and internal data reasonable in the support of the AAA rating. People were not fools but for not seeing how a market dominated by regional USA economy had become and integrated global market. There was to be no portfolio effect.
This also allows parameters as to the size of the USA problem – it is roughly in synch with the size of the Chinese (and to a lesser degree some other Asian exporters and oil producers) story.
All of this is good news and bad news. First perceived in this way – which is the correct and valid version of how we got here I feel – takes the average American person and society off the hook. We have a sub prime crisis because we did not want to risk putting young Americans in harms way on the Asian battlefield. And that remains the problem as there is still an excellent case to be made that to provide these imbalances to continue will allow a more secure and peaceful world. To eliminate these imbalances and insist on China (and others) to exist solely on the realities of their own domestic markets would lead to war as it is very unlikely that the current leadership of China will “take the fall” and fess up and admit they blew it in face of 200 MM very well educated and angry Chinese youth. Japan did take the fall, but we also cushioned the blow and worked closely with great respect with the Japanese nation. China will likely try and buy time and diversion by moving first on Taiwan and then perhaps India and then assist North Korea to be a great problem. If USA does not realize why this occurring we may respond with protecting Taiwan and at the very least a full war footing will be adopted. But that is if China responds as normal folks will. After Tiananmen, Chinese leadership actually reversed the direction of governance, the assassinated Hu Yaobang’s policy was instituted and Zhao Ziyang deposed. That steady and enlightened ability to move in such dramatic fashion to repair error has much to do why one should be hopeful. Also, despite Geithner’s jingoism on “manipulation” and the USA leadership inability to perceive the crisis as I outline above and instead pursue their own “blame game” and moralistic based crusades, despite this dismal start the USA may check up and realize what has happened and what could occur.
But still, the NY Times now “on any given Sunday” sickens me and frightens as to date I do not see these positive trends forthcoming.
Instead I see “all the family to dinner”
The above is long dated realized volatility for SPX - 220 days of realized volatility which is about 1 year.
