A new Rasmussen Reports national telephone survey finds that 64% of Likely U.S. Voters prefer a government with fewer services and lower taxes over one with more services and higher taxes. That’s unchanged from last month and consistent with findings in regular surveys since late 2006. 

In fact, a plurality of Americans have called for small government and lower taxes ever since the days of Reagan.

But it has never worked out like that:

So what’s the difference? Is it that voters outwardly claim to be in favour of smaller government, and then when it comes down to it choose the advocates of big government? I don’t think so — I think it is that voters aren’t being given a real choice.

Here’s the increase in national debt by President:

The reality is that — with the exception of Obama — Americans have again and again opted for a candidate who has paid lip-service to small government. Even Bill Clinton paid lip service to the idea that “the era of big government is over” (yeah, right). And then once in office, they have bucked their promises and massively increased the size and scope of government. Reagan’s administration increased the debt by 190% alone, and successive Presidents — especially George W. Bush and Barack Obama — just went bigger and bigger, in total contradiction to voters’ expressed preferences.

The choice between the Republicans and Democrats has been one of rhetoric and not policy. Republicans may consistently talk about reducing the size and scope of government, but they don’t follow through.Today Ron Paul, the only Republican candidate who is putting forth a seriously reduced notion of government, has been marginalised and sidelined by the major media and Republican establishment. The establishment candidate — Mitt Romney — as governor of Massachusetts left that state with the biggest per-capita debt of any state. His track record in government and his choice of advisers strongly suggest that he will follow in the George W. Bush school of promising smaller government and delivering massive government and massive debt.

As Libertarian presidential candidate and former New Mexico governor Gary Johnson put it:

Pick Obama, pick Romney, government’s going to be bigger. Government’s going to be more intrusive.

So will the American people eventually get what they want? To do that, they have to ditch the hierarchies and orthodoxies of the past. Ron Paul and his tireless band of youthful supporters look set to achieve a strong showing at the Republican convention, as well as so far winning party chairs in Iowa, Colorado, Alaska, and Virginia. The Republican party — currently dominated by ageing tax-and-spend boomer Republicans — is being taken over by the libertarian youth who crave small government at home, as well as a smaller foreign policy. Ron Paul has taken the majority of youth votes in a plurality of states in 2012. And even if Ron Paul is not on the presidential ballot, Gary Johnson — a consistent advocate for lower debt, lower taxes, and smaller government — seems set to take a large slice of the vote in November.

As the mainstream parties continue to defy a majority of voters’ will and accrue more debt and make government bigger and bigger (while failing to address problems of unemployment and underemployment)  it seems natural and inevitable that more and more Americans — especially young Americans (who tend more and more to be unemployed and underemployed) — will abandon the sclerotic big-government Republicans and Democrats.

Trouble is, things may go badly wrong before Americans get the chance to put a practitioner of smaller government into power. Already a majority of Eurasian manufacturing and resource-producing nations have ditched the dollar for bilateral trade. Dollars and treasury bonds have long been America’s greatest export — and the greatest pillar of support for growth in spending and welfare. With the dollar’s downfall, smaller government may not be a choice.

Sometimes, the greatest deeds are done by those who are just doing their jobs, like Judge Katherine Forrest who last week struck down the indefinite detention provision (§1021) of the National Defense Authorization Act (NDAA).

It would be all too easy in this age of ever-encroaching authoritarianism in America for a judge ruling on a matter like this to just go with the government line and throw water over the plaintiffs. After all, telling truth to power has consequences. Forrest was appointed by Obama, but after this ruling one wonders whether she is about to meet a career dead-end. Power — especially narcissistic power — does not like being told uncomfortable truths.

Everything about this case is shameful; it should be obvious to anyone who can read the Constitution that indefinite detention without trial (just like assassination without trial — something else that Obama and his goons have no problem practicing and defending) is hideously and cruelly unconstitutional. It defecates upon both the words and the spirit of the document.

It is directly and completely in contravention to the Fifth Amendment:

No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.

It is shameful that this law was proposed, it is shameful that any legislator would vote for it, and it is shameful that the President would sign it into law, albeit with a flimsy signing-statement claiming that he would not use the indefinite detention provision against American citizens.

More shameful still is the fact that when this challenge was brought that the Obama administration tried to dismiss it on a technicality — they tried to make the case that because none of the plaintiffs were to be indefinitely detained that they could not challenge the law. Judge Forrest’s investigation of this claim was revealing. Naomi Wolf notes:

Forrest asked repeatedly, in a variety of different ways, for the government attorneys to give her some assurance that the wording of section 1021 could not be used to arrest and detain people like the plaintiffs. Finally she asked for assurance that it could not be used to sweep up a hypothetical peaceful best-selling nonfiction writer who had written a hypothetical book criticizing US foreign policy, along lines that the Taliban might agree with. Again and again the two lawyers said directly that they could not, or would not, give her those assurances. In other words, this back-and-forth confirmed what people such as Glenn Greenwald, the Bill of Rights Defense Committee, the ACLU and others have been shouting about since January: the section was knowingly written in order to give the president these powers; and his lawyers were sent into that courtroom precisely to defeat the effort to challenge them. Forrest concluded: ”At the hearing on this motion, the government was unwilling or unable to state that these plaintiffs would not be subject to indefinite detention under [section] 1021. Plaintiffs are therefore at risk of detention, of losing their liberty, potentially for many years.“

Very simply, it is now obvious that the NDAA was written not to deal with terrorists or potential terrorists. After all, if the government has evidence that an individual or group is planning to commit a terrorist attack then they do not need an indefinite detention provision; all they need is to arrest such individuals and prove beyond reasonable doubt before a jury of their peers that a crime has been committed. That is how justice works — if the evidence exists you can bring a successful prosecution. After all if they do not have the evidence to prove that a group or individual was planning to commit an act of terrorism then they have no business arresting them or charging them with any offense. Suspects — lest we forget — are innocent until proven guilty.

These new powers have nothing to do with combatting terrorism. If the government has no evidence that can stand up in a court of law it has no business detaining anyone. No, this new power grab has an entirely different target — like the plaintiffs in this case: writers, investigative journalists, bloggers, philosophers, dissidents, human rights activists, libertarians, free-thinkers, tax protestors, critics of fractional-reserve banking, whistleblowers — people like Chris Hedges, Noam Chomsky, Daniel Ellsberg, Jennifer Bolen, and Birgitta Jonsdottir. People like Congressman Justin Amash and Congressman Adam Smith who tried to amend indefinite detention out of the bill. People like me — and to some degree, if you are reading this, people like you. 

The fact that the Obama administration could not give assurances about those who simply criticise U.S. foreign policy indicates very strongly that this power grab is about shutting-up and frightening critics of the U.S. government and the Obama administration.

But — for now —  §1021 of the NDAA, that implement of fascism, has been struck down and thrown out as “facially unconstitutional” as well as having a “chilling impact on First Amendment rights”.

We should be thankful for this brave judge’s actions, and for the plaintiffs’ actions in standing up to tyranny, and vigilant against future incursions.

On the other hand, every politician involved in writing, legislating and authorising this hideous unconstitutional law should be reminded of the words of the Declaration of Independence — it is the right of the people to alter or abolish any government that becomes destructive to liberty.

What is there to say about Facebook?

Why would anyone buy a company’s stock when they have no real profit pedigree? When their advertising profit in 2011 came to just over $1 billion, and their book value is the region of $100 billion, how can that really make any sense other than to the kind of nutcase zombie trader who takes Jim Cramer seriously? The sad truth is that people are just not clicking the ads; Facebook ads receive far fewer clicks than competitors such as Google’s AdSense.

If Facebook was floating with a book value of $5-10 billion (or around $2-4 per share) we would be talking about a serious business proposition, albeit one which is already rather saturated (given that there are 2.3 billion internet users, and Facebook already has its claws into 900 million of them). But at these levels? What are people paying for?

Some say the name recognition and momentum (but that’s just paying for hype) as well as the infrastructure and data that Facebook owns. Certainly five or six years of a big chunk of humanity’s likes and dislikes is a valuable database. But how do they monetise that? Does Zuckerberg have any credible plan?

The most under-reported piece of news of the day is surely that Zuckerberg does seem to have a plan. But it’s not very credible.

From the BBC:

Facebook has started testing a system that lets users pay to highlight or promote posts.

By paying a small fee users can ensure that information they post on the social network is more visible to friends, family and colleagues.

The tests are being carried out among the social network’s users in New Zealand.

Facebook said the goal was to see if users were interested in paying to flag up their information.

That’s their plan? That’s Zuckerberg’s big idea? Get users to pay to post premium content!? Did the well-circulated hoax that Facebook planned to get users to pay for use just turn out to be true? If they proceed with this (unlikely) it seems fairly obvious the world would say goodbye Facebook, hello free alternatives.

The truth is that Facebook is a toy, a dreamworld, a figment of the imagination. Zuckerberg wanted to make the world a more connected place (and build a huge database of personal preferences), and he succeeded thanks to a huge slathering of venture capital. That’s an accomplishment, but it’s not a business. While the angel investors and college-dorm engineers will feel gratified at paper gains, it is becoming hard to ignore that there is no great profit engine under the venture. In fact, the big money coming into Facebook just seems to be money from new investors — they raised eighteen times as much in their flotation yesterday as they did in a whole year of advertising revenue. For an established company with such huge market penetration, they’re veering dangerously close to Bernie Madoff’s business model.

On the other hand, they have plenty of time and money to try out various profit-making schemes. Eventually, they may hit on something big; Apple didn’t start out producing huge cashflow or sales, they got there the hard way. But it all seems like a big gamble on an outfit with big dreams but little moneymaking pedigree. I’d consider buying Facebook at $2-4 a share. But current valuations are a joke — and I don’t think the market is falling for it.

Even the NYT notes:

The company’s bankers had to buy shares to keep the stock from falling below its offering price, raising questions about how the stock will fare next week.

I am not exaggerating.

This is Finnish writer Pentti Linkola — a man who demands that the human population reduce its size to around 500 million and abandon modern technology and the pursuit of economic growth — in his own words.

He likens Earth today to an overflowing lifeboat:

What to do, when a ship carrying a hundred passengers suddenly capsizes and there is only one lifeboat? When the lifeboat is full, those who hate life will try to load it with more people and sink the lot. Those who love and respect life will take the ship’s axe and sever the extra hands that cling to the sides.

He sees America as the root of the problem:

The United States symbolises the worst ideologies in the world: growth and freedom.

He unapologetically advocates bloodthirsty dictatorship:

Any dictatorship would be better than modern democracy. There cannot be so incompetent a dictator that he would show more stupidity than a majority of the people. The best dictatorship would be one where lots of heads would roll and where government would prevent any economical growth.

We will have to learn from the history of revolutionary movements — the national socialists, the Finnish Stalinists, from the many stages of the Russian revolution, from the methods of the Red Brigades — and forget our narcissistic selves.

A fundamental, devastating error is to set up a political system based on desire. Society and life have been organized on the basis of what an individual wants, not on what is good for him or her.

As is often the way with extremist central planners Linkola believes he knows what is best for each and every individual, as well as society as a whole:

Just as only one out of 100,000 has the talent to be an engineer or an acrobat, only a few are those truly capable of managing the matters of a nation or mankind as a whole. In this time and this part of the World we are headlessly hanging on democracy and the parliamentary system, even though these are the most mindless and desperate experiments of mankind. In democratic coutries the destruction of nature and sum of ecological disasters has accumulated most. Our only hope lies in strong central government and uncompromising control of the individual citizen.

In that sense, Linkola’s agenda is really nothing new; it is as old as humans. And I am barely scratching the surface; Linkola has called for “some trans-national body like the UN” to reduce the population “via nuclear weapons” or with “bacteriological and chemical attacks”.

But really he is just another freedom-hating authoritarian — like the Nazis and Stalinists he so admires — who desires control over his fellow humans. Ecology, I think, is window-dressing. Certainly, he seems to have no real admiration or even concept of nature as a self-sustaining, self-organising mechanism, or faith that nature will be able to overcome whatever humanity throws at it. Nor does he seem to have any appreciation for the concept that humans are a product of and part of nature; if nature did not want us doing what we do nature would never have produced us. Nature is greater and smarter than we will probably ever be. I trust nature; Linkola seems to think he knows better. As George Carlin noted:

We’re so self-important. Everybody’s gonna save something now. Save the trees. Save the bees. Save the whales. Save those snails. And the greatest arrogance of all, save the planet. What? Are these fucking people kidding me? Save the planet? We don’t even know how to take care of ourselves yet. We haven’t learned how to care for one another and we’re gonna save the fucking planet?

There is nothing wrong with the planet. The planet is fine. The people are fucked. Difference. The planet is fine.

Linkola and similar thinkers seem to have no real interest in meeting the challenges of life on Earth. Their platform seems less about the environment and more about exerting control over the rest of humanity. Linkola glories in brutality, suffering and mass-murder.

Now Linkola is just one fringe voice. But he embodies the key characteristic of the environmental movement today: the belief that human beings are a threat to their environment, and in order for that threat to be neutralised, governments must take away our rights to make our own decisions and implement some form of central planning. Linkola, of course, advocates an extreme and vile form of Malthusianism including genocide, forced abortion and eugenics.

But all forms of central planning are a dead end and lead inexorably toward breakdown; as Hayek demonstrated conclusively in the 1930s central planners have always had a horrible track record in decision making, because their decisions lack the dynamic feedback mechanism present in the market.  This means that capital and labour are misallocated, and anyone who has studied even a cursory history of the USSR or Maoist China knows the kinds of outcomes that this has lead to: at best the rotting ghost cities of China today, and at worst the mass starvation of the Great Leap Forward resulting in millions of deaths and untold misery.

Environmentalists should instead pursue ideas that respect individual liberty and markets. There is more potential in developing technical solutions to environmental challenges than there is in implementing central planning.

If we are emitting excessive quantities of CO2 we don’t have to resort to authoritarian solutions. It’s far easier to develop and market technologies (that already exist today) like carbon scrubbing trees that can literally strip CO2 out of the air than it is to try and develop and enforce top-down controlling rules and regulations on individual carbon output. Or (even more simply), plant lots of trees and other such foliage (e.g. algae).

If the dangers of non-biodegradable plastic threaten our oceans, then develop and market processes (that already exist today) to clean up these plastics.

Worried about resource depletion? Asteroid mining can give us access to thousands of tonnes of metals, water, and even hydrocarbons (methane, etc). For more bountiful energy, synthetic oil technology exists today. And of course, more capturable solar energy hits the Earth in sunlight in a single day than we use in a year.

The real problem with centrally-planned Malthusian population reduction programs is that they greatly underestimate the value of human beings.

More people means more potential output — both in economic terms, as well as in terms of ideas. Simply, the more people on the planet, the more hours and brainpower we have to create technical solutions to these challenges. After all, the expansion of human capacity through technical development was precisely how humanity overcame the short-sighted and foolish apocalypticism of Thomas Malthus who wrongly predicted an imminent population crash in the 19th century.

My suggestion for all such thinkers is that if they want to reduce the global population they should measure up to their words and go first.

Feel like your wages are buying less in real terms?

They are:

Feel like your dollar is buying less, even though the financial press claims that the dollar is strong?

It is buying less — but so are the other fiat currencies:

Feel like the housing bubble hit you hard?

It hit you harder in gold-denominated terms:

Feel like you have less disposable income?

You do:

Feel like U.S. treasuries are really falling in value, even though the popular press keep telling investors that treasuries are priced at all-time highs?

John Maynard Keynes, Charlie Munger and Warren Buffett all said or implied that gold was a barbarous relic. But what’s the barbarous relic? The precious metal that shows prices without a veneer of manipulation, or the paper currency that smudges the true state of supply and demand through money printing, thus misleading markets and society? Charlie Munger says gold is not for civilised people, but in reality gold may be the most civilised currency of all — because it allows civilised people to purchase insurance against the risk of civilisation failing.

A central bank can claim to have demonetised gold. It can claim gold is a barbarous relic (even while keeping thousands of tonnes on its books), or just an “instrument to hedge tail risk” (although Jamie Dimon surely disagrees — J.P. Morgan prefers to “hedge tail risk” by making huge speculatory prop bets on credit derivatives).

But gold is still gold. It’s still that same shining yellow metal that investors have for thousands of years held up as a unit of account and store of value, and a medium of exchange.

Central bankers can’t just abolish history. On the other hand, history may very well abolish the central bankers and their fiat currencies.

With Europe on the brink yet again Germany will act.

The Greeks can’t carry on with the austerity being imposed on them. No country can be expected to endure annualized falls in GDP  of 7 percent or more,” he said, “and 50 percent youth unemployment for years on end.

On Tuesday we learned that the Greek economy shrank by another 6.2 percent in the latest quarter. It simply isn’t acceptable” Lynn said.

But Germany and the rest of the EU could come up with a Marshall Aid-style package for Greece. Very little of the bail-out money so far has gone to the Greeks. It has all gone to the bankers.

Forget talk of a ‘Grexit’. There will be a mega-bail-out—a ‘Grashall Plan’—instead.

And when it happens, the markets will rally on the news.

Who else would publish this? (That’s a redundant question — who else, besides J.P. Morgan and maybe a few government agencies, wouldn’t have fired Jim Cramer after what he said about Bear Stearns?)

At various stages in the last two years everyone from China, to Germany, to the Fed to the IMF, to Martians, to the Imperial Death Star has been fingered as the latest saviour of the status quo. And so far — in spite of a few multi-billion-dollar half-hearted efforts like the €440 billion EFSF —  nobody has really shown up.

Perhaps that’s because nobody thus far fancies funnelling the money down a black hole. After Greece comes Portugal, and Spain and Ireland and Italy, all of whom together have on the face of things at least €780 billion outstanding (which of course has been securitised and hypothecated up throughout the European financial system into a far larger amount of shadow liabilities, for a critical figure of at least €3 trillion) and no real viable route (other than perhaps fire sales of state property? Sell the Parthenon to Goldman Sachs?) to paying this back (austerity has just led to falling tax revenues, meaning even more money has had to be borrowed), not to mention the trillions owed by the now-jobless citizens of these countries, which is now also imperilled. What’s the incentive in throwing more time, effort, energy and resources into a solution that will likely ultimately prove as futile as the EFSF?

The trouble is that this is playing chicken with an eighteen-wheeler. While Draghi might be making noises about “continuing to comply with the mandate of keeping price stability over the medium term in line with treaty provisions and preserving the integrity of our balance sheet” (in other words, not proceeding with the fabled “mega-bailout” even if it fractures the Euro),  we may well see a full-blown financial meltdown (and of course, the ramifications of that on anyone who is exposed to the European banking system) unless someone — whether it is the ECB, or the Fed, or the IMF — prints the money to keep the banks going.

There are really two layers to bailing out the insolvent nations: the real bailout is of the banks who bought the debt, and the insolvent nations are just an intermediary. Should the insolvent nations become highly uncooperative, it seems more likely that the insolvent nations will just be cut out of the loop (throwing their citizens into experiencing a forced currency redenomination, bank runs, and even more chaos) while policymakers continue to channel money into “stabilising” the totally broken global financial system — because we know for sure that a big disorderly default will likely cause some kind of default cascade, and that is something I am sure that (based on past form) policymakers will seek to avoid.

Given that it is predominantly Germans who are in charge of Europe for the moment — with their unusual (at least in the West) post-Weimar distaste for Keynesianism —  it seems to me like we will see quite a lot of chaos (read: Euro exits) before the money printing begins in earnest. And the money printing may be far more ad hoc and decentralised than 2008 (read: The Fed may be on the hook for American exposure). Just as we have seen so far, the money will come at the last minute, and will just keep things ticking over rather than actually solving anything.

And ultimately, I think it is the social conditions — particularly unemployment levels — that matter more than whether or not the financial system survives. If the attendant cost of ad hoc bailouts (in the name of pretending to stick to the ECB mandate) is a continued depression, and continued massive unemployment and youth unemployment then politicians are focusing on the wrong thing.

The problem is that as conditions continue to fester and as solutions seem distant and improbable that Europe’s problems may become increasingly political. As the established (dis)order in Europe continues to leave huge swathes of people jobless and angry, their rage and discomfort will be channelled toward dislodging the establishment. As we have seen in Greece and France, that has already produced big lifts for both the Far Left and Far Right.

We already know, I think, that in Greece’s upcoming election the outsider parties will crush the establishment, with SYRIZA most likely emerging on top. A key metric for me in the next few weeks will be Golden Dawn‘s proportion of the vote.

Let’s not forget history:

Sadly, the answer is that most Obama supporters probably wouldn’t feel very much at all, because support for Obama has always been predominantly emotion-driven (he promised change “you can believe in”, not “change that I can logically convince you will be beneficial“).

But I digress. Charles Krauthammer weighed in on FOX yesterday to telegraph his opposition to bringing drone warfare to the skies of America.

Krauthammer said:

I’m going to go hard left on you here, I’m going ACLU. I don’t want regulations, I don’t want restrictions, I want a ban on this. Drones are instruments of war. The Founders had a great aversion to any instruments of war, the use of the military inside even the United States. It didn’t like standing armies, it has all kinds of statutes of using the army in the country.

I would say that you ban it under all circumstances and I would predict, I’m not encouraging, but I am predicting that the first guy who uses a Second Amendment weapon to bring a drone down that’s been hovering over his house is going to be a folk hero in this country.

The Founders were deeply opposed to the militarisation of civil society. There is all kinds of aversions to it and this is importing it because, as you say, it’s cheap, it’s easy, it’s silent. It’s something that you can easily deploy. It’s going to be, I think the bane of our existence. Stop it here, stop it now.

And this is a big deal. A recent report by Micah Zenko noted:

Worried about the militarization of U.S. airspace by unmanned aerial vehicles? As of October, the Federal Aviation Administration (FAA) had reportedly issued 285 active certificates for 85 users, covering 82 drone types. The FAA has refused to say who received the clearances, but it wasestimated over a year ago that 35 percent were held by the Pentagon, 11 percent by NASA, and 5 percent by the Department of Homeland Security (DHS). And it’s growing. U.S. Customs and Border Protection already operates eight Predator drones. Under pressure from the congressional Unmanned Systems Caucus – yes, there’s already a drone lobby, with 50 members — two additional Predators were sent to Texas in the fall, though a DHS official noted: “We didn’t ask for them.” Last June, a Predator drone intended to patrol the U.S.-Canada border helped locate three suspected cattle rustlers in North Dakota in what was the first reported use of a drone to arrest U.S. citizens.

But I’m going to go even further than the threat to civil liberties: I am fairly certain that the militarisation of U.S. airspace by drones is itself a huge national security threat. While Zenko notes that drones “tend to crash”, the downing of a U.S. drone over Iran late last year — supposedly via an Iranian hack — seems to suggest that it is possible for drones to be commandeered by hackers or hostile powers. And if that’s not the case today, then it almost certainly will be tomorrow. Putting drones into the air above the United States is like going to sleep on a bed of dynamite. It’s an invitation to anyone to try and commandeer a plane, possibly one stocked with high-tech weaponry.

The Federal government would do well to quit groping Grandma at the TSA checkpoint, and start worrying about the potential negative side-effects of systems they are putting into place. All the TSA security theater in the world cannot stop a determined hacker from commandeering a drone.

Charles Krauthammer is right (and after the Iraq invasion which he championed I never thought I would say that): it could be the bane of our existence. Stop it here. Stop it now.

It’s going to be a painful time for the Greek people. But what about for Greece’s highly-leveraged creditors, who must now bite the bullet of a disorderly default? Surely the ramifications of a Greek exit will be worse for the international financial system?

J.P. Morgan — fresh from putting an LTCM alumnus in charge of a $70 trillion derivatives book (good luck with that) — is upping the fear about Europe and its impact on global finance:

The main direct losses correspond to the €240bn of Greek debt in official hands (EU/IMF), to €130bn of Eurosystem’s exposure to Greece via TARGET2 and a potential loss of around €25bn for European banks. This is the cross-border claims (i.e. not matched by local liabilities) that European banks (mostly French) have on Greece’s public and non-bank private sector. These immediate losses add up to €400bn. This is a big amount but let’s assume that, as several people suggested this week, these immediate/direct losses are manageable. What are the indirect consequences of a Greek exit for the rest?

The wildcard is obviously contagion to Spain or Italy? Could a Greek exit create a capital and deposit flight from Spain and Italy which becomes difficult to contain? It is admittedly true that European policymakers have tried over the past year to convince markets that Greece is a special case and its problems are rather unique. We see little evidence that their efforts have paid off.

The steady selling of Spanish and Italian government bonds by non-domestic investors over the past nine months (€200bn for Italy and €80bn for Spain) suggests that markets see Greece more as a precedent for other peripherals rather than a special case. And it is not only the €800bn of Italian and Spanish government bonds still held by non-domestic investors that are likely at risk. It is also the €500bn of Italian and Spanish bank and corporate bonds and the €300bn of quoted Italian and Spanish shares held by nonresidents. And the numbers balloon if one starts looking beyond portfolio/quoted assets. Of course, the €1.4tr of Italian and €1.6tr of Spanish bank domestic deposits is the elephant in the room which a Greek exit and the introduction of capital controls by Greece has the potential to destabilize.

A multi-trillion € shock — far bigger than the fallout from Lehman — has the potential to trigger a default cascade wherein busted leveraged Greek creditors themselves end up in a fire sale to raise collateral as they struggle to maintain cash flow, and face the prospect of downgrades and margin calls and may themselves default on their obligations, setting off a cascade of illiquidity and default. Very simply, such an event has the potential to dwarf 2008 and 1929, and possibly even bring the entire global financial system to a juddering halt (just as Paulson fear-mongered in 2008).

Which is why I am certain that it will not be allowed to happen, and that J.P. Morgan’s histrionics are just a ponying up toward the next round of crony-”capitalist” bailouts. Here’s the status quo today:

Greece no longer wants to play along with the game?

Okay, fine — cut them out of the equation. In the interests of “long-term financial stability”, let’s stop pretending that we are bailing out Greece and just hand the cash over to the banks.

Schäuble and Merkel might have demanded tough fiscal action from European governments, but they have never questioned the precept that creditors must get their pound of flesh. Merkel has insisted that authorities show that Europe is a “safe place to invest” by avoiding haircuts.

Here’s my expected new normal in Europe:

After all — if the establishment is to be believed — it’s in the interests of “long-term financial stability” that creditors who stupidly bought unrepayable debt don’t get a big haircut like they would in a free market.  And it’s in the interests of “long-term financial stability” that bad companies who made bad decisions don’t go out of business like they would in a free market, but instead become suckling zombies attached to the taxpayer teat. And apparently it is also in the interests of “long-term financial stability” that a broken market and broken system doesn’t liquidate, so that people learn their lesson. Apparently our “long-term financial stability” depends on producing even greater moral hazard by handing more money out to the negligent.

The only real question (beyond whether or not the European public’s patience with shooting off money to banks will snap, as has happened in Greece) is whether or not it will just be the IMF and the EU institutions, or whether Bernanke at the Fed will get involved beyond the inevitable QE3 (please do it Bernanke! I have some crummy equities I want to offload to a greater fool!).

As I asked last month:

Have the 2008 bailouts cemented a new feudal aristocracy of bankers, financiers and too-big-to-fail zombies, alongside a serf class that exists to fund the excesses of the financial and corporate elite?

And will the inevitable 2012-13 bailouts of European finance cement this aristocracy even deeper and wider?

In the wake of J.P. Morgan’s epic speculatory fail a whole lot of commentators are talking about regulation. And yes — this was speculation — if Dimon gets to call these activities “hedging portfolio risk“, then I have the right to go to Vegas, play the Martingale roulette system, and happily call it “hedging portfolio risk” too, because hey — the Martingale system always wins in theory.

From Bloomberg:

The Volcker rule, part of the Dodd-Frank financial reform law, was inspired by former Federal Reserve Chairman Paul Volcker. It’s supposed to stop federally insured banks from making speculative bets for their own profit — leaving taxpayers to bail them out when things go wrong.

As we have said, banks have both explicit and implicit federal guarantees, so the market doesn’t impose the same discipline on them as, say, hedge funds. For this reason, the Volcker rule should be as airtight as possible.

Proponents of regulation point to the period of relative financial stability between the enactment of Glass-Steagall and its repeal. But let’s not confuse Glass-Steagall with what’s on the table today. It’s a totally different ball game.

To be honest, I think the Volcker rule is extremely unlikely to be effective, mostly because megabanks can bullshit their way around the definitional divide between proprietary trading and hedging. If anything, I think the last few days have proven the ineffectiveness, as opposed to the necessity of the Volcker rule. Definitions are fuzzy enough for this to continue. And whatever is put in place will be loopholed through by teams of Ivy League lawyers. What is the difference between hedging and speculation, for example? In my mind it’s very clear — hedging is betting to counterbalance specific and explicit risks, for example buying puts on a held equity. In the mind of Jamie Dimon, hedging is a fuzzy form of speculative betting to guard against more general externalities. I know that I am technically right, and Dimon is technically wrong, but I am also fairly certain that Dimon and his ilk can bend regulators into accepting his definition.

What we really need is a system that enforced the Volcker principle:

As Matt Yglesias notes:

Once bank lawyers finish finding loopholes in the detailed provisions, whatever they prove to be, the rule will probably have little meaningful impact.

The problem with principles-based regulation in this context is that you might fear that banks will use their political influence to get regulators to engage in a lot of forebearance. The problem with rules-based regulation in this context is that it’s really hard to turn a principle into a rule.

And I fear that nothing short of a return to Glass-Steagall — the explicit and categorical separation of investment and retail banking — will even come close to enforcing the Volcker principle.

Going even further, I am not even sure that Glass-Steagall will assure an end to this kind of hyper-risky activities that lead to crashes and bailouts.

The benefits of the Glass-Steagall era (particularly the high-growth 1950s and 1960s) were not solely derived from banking regulation. America was a very different place. There was a gold exchange standard that limited credit creation beyond the economy’s productive capacity (which as a Bank of England study recently found is correlated with financial and banking stability). But beyond that, America was creditor to the world, and an industrial powerhouse. And I’m sure Paul Krugman would hastily point out that tax revenues on the richest were as high as 90% (although it must be noted that this made no difference whatever for tax revenues). And we should not forget that it was that world that give birth to this one.

Anyone who worked in finance in the decade before Glass-Steagall was repealed knows that prior to Gramm-Leach-Bliley the megabanks just took their hyper-leveraged activities offshore (primarily to London where no such regulations existed). The big problem (at least in my mind) with Glass-Steagall is that it didn’t prevent the financial-industrial complex from gaining the power to loophole and lobby Glass-Steagall out of existence, and incorporate a new regime of hyper-leverage, convoluted shadow banking intermediation, and a multi-quadrillion-dollar derivatives web (and more importantly a taxpayer-funded safety net for when it all goes wrong: heads I win, tails you lose).

I fear that the only answer to the dastardly combination of hyper-risk and huge bailouts is to let the junkies eat dirt the next time the system comes crashing down. You can’t keep bailing out hyper-fragile systems and expect them to just fix themselves. The answer to stupidity is not the moral hazard of bailouts, it is the educational lesson of failure. You screw up, you take more care next time. If you’re bailed out, you just don’t care. Corzine affirms it; Iksil affrims it; Adoboli affirms it. And there will be more names. Which chump is next? If you’re trading for a TBTF bank right now — especially if your trading pattern involves making large bets for small profits (picking up nickels in front of steamrollers) — it could be you. 

I fear that the only effective regulation was that advocated way back before Gramm-Leach-Blilely by Warren G and Nate Dogg:

We regulate any stealing off this property. And we’re damn good too. But you can’t be any geek off [Wall] street, gotta be handy with the steel, if you know what I mean, earn your keep.

In other words, the next time the fragilista algos and arbitrageurs come clawing to the taxpayer looking for a bailout, the taxpayer must kick them off the teat.

UPDATE:

This was exemplified by the failure of LTCM which blew up unsuccessfully making huge interest rate bets for tiny profits, or “picking up nickels in front of a streamroller”, and by Jon Corzine’s MF Global doing practically the same thing with European debt (while at the same time stealing from clients).

As Nassim Taleb described in The Black Swan this strategy — betting large amounts for small frequent profits — is extremely fragile because eventually (and probably sooner in the real world than in a model) losses will happen (and, of course, if you are betting big, losses will be big). If you are running your business on the basis of leverage, this is especially dangerous, because facing a margin call or a downgrade you may be left in a fire sale to raise collateral.

This fragile business model is in fact descended from the Martingale roulette betting system. Martingale is the perfect example of the failure of theory, because in theory, Martingale is a system of guaranteed profit, which I think is probably what makes these kinds of practices so attractive to the arbitrageurs of Wall Street (and of course Wall Street often selects for this by recruiting and promoting the most wild-eyed and risk-hungry). Martingale works by betting, and then doubling your bet until you win. This — in theory, and given enough capital — delivers a profit of your initial stake every time. Historically, the problem has been that bettors run out of capital eventually, simply because they don’t have an infinite stock (of course, thanks to Ben Bernanke, that is no longer a problem). The key feature of this system— and the attribute which many institutions have copied — is that it delivers frequent small-to-moderate profits, and occasional huge losses (when the bettor runs out of money).

The key difference between modern business models, and the traditional roulette betting system is that today the focus is on betting multiple times on a single outcome. By this method (and given enough capital) it is in theory possible to win whichever way an event goes. If things are going your way, it is possible to insure your position by betting against your initial bet, and so produce a position that profits no matter what the eventual outcome. If things are not going your way, it is possible to throw larger and larger chunks of capital into a position or counter-position again and again and again —mirroring the Martingale strategy — to try to compensate for earlier bets that have gone awry (this, of course, is so often the downfall of rogue traders like Nick Leeson and Kweku Adoboli).

This brings up a key issue: there is a second problem with the Martingale strategy in the real world beyond the obvious problem of running out of capital. You can have all the capital in the world (and thanks to the Fed, the TBTF banks now have a printing-press backstop) but if you do not have a counter-party to take your bets  (and as your bets and counter-bets get bigger and bigger it by definition becomes harder and harder to find suitable counter-parties) then you are Corzined, and you will be left sitting on top of a very large load of pain (sound familiar, Bruno Iksil?)

The obvious real world example takes us back to the casino table — if you are trying to execute a Martingale strategy starting at $100, and have lost 10 times in a row, your 11th bet would have to be for $204,800 to win back your initial stake of $100. That might well exceed the casino table limits — in other words you have lost your counter-party, and are left facing a loss far huger than any expected gains.

Similarly (as Jamie Dimon and Bruno Iksil have now learned to their discredit) if you have built up a whale-sized market-dominating gross position of bets and counter-bets on the CDX IG9 index (or any such market) which turns heavily negative, it is exceedingly difficult to find a counter-party to continue increasing your bets against, and your Martingale game will probably be over, and you will be forced to face up to the (now exceedingly huge) loss. (And this recklessness is what Dimon refers to as “hedging portfolio risk“?)

The really sickening thing is that I know that these kinds of activities are going on far more than is widely recognised; every time a Wall Street bank announces a perfect trading quarter it sets off an alarm bell ringing in my head, because it means that the arbitrageurs are chasing losses and picking up nickels in front of streamrollers again, and emboldened by confidence will eventually will get crushed under the wheel, and our hyper-connected hyper-leveraged system will be thrown into shock once again by downgrades, margin calls and fire sales.

The obvious conclusion is that if the loss-chasing Martingale traders cannot resist blowing up even with the zero-interest rate policy and an unfettered fiat liquidity backstop, then perhaps this system is fundamentally weak. Alas, no. I think that the conclusion that the clueless schmucks at the Fed have reached is that poor Wall Street needs not only a lender-of-last-resort, but a counter-party-of-last-resort. If you broke your trading book doubling or quadrupling down on horseshit and are sitting on top of a colossal mark-to-market loss, why not have the Fed step in and take it off your hands at a price floor in exchange for newly “printed” digital currency? That’s what the 2008 bailouts did.

Only one problem: eventually, this approach will destroy the currency. Would you want your wealth stored in dollars that Bernanke can just duplicate and pony up to the latest TBTF Martingale catastrophe artist? I thought not: that’s one reason why Eurasian creditor nations are all quickly and purposefully going about ditching the dollar for bilateral trade.

The bottom line for Wall Street is that either the bailouts will stop and anyone practising this crazy behaviour will end up bust — ending the moral hazard of adrenaline junkie coke-and-hookers traders and 21-year-old PhD-wielding quants playing the Martingale game risk free thanks to the Fed — or the Fed will destroy the currency. I don’t know how long that will take, but the fact that the dollar is effectively no longer the global reserve currency says everything I need to know about where we are going.

The bigger point here is whatever happened to banking as banking, instead of banking as a game of roulette? You know, where investment banks make the majority of their profits and spend the majority of their efforts lending to people who need the money to create products and make ideas reality?