The Problem is Fragility

Mainstream opinion on economic conditions at present is a steaming shitheap of errors.

Deluge of hopium from ABC (sponsored by Citigroup, no joke):

Stocks closed higher on Thursday after European leaders agreed on a plan to avert a Greek default and the Commerce Department announced third-quarter gross domestic product grew 2.5 percent, boosted by higher consumer spending, allaying fears that the economy is slipping into another recession.

The Dow Jones industrial average increased about 2.9 percent to 12,209 and the tech-heavy Nasdaq increased about 3.3 percent to 2,784 at the end of the day. The S&P 500 had its biggest monthly rally since 1974, according to Bloomberg, increasing 3.4 percent to 1,285.

The GDP rate was in line with what economists were expecting. The 2.5 percent growth rate is almost triple the 0.9 percent pace of economic growth in the first half of this year, which has been far too slow to generate any job growth. Unemployment has remained stubbornly high at over 9 percent.

The thing is, high unemployment and low GDP growth (now — ahem — magically cured) are (and always were) secondary problems. They’re the things that hurt, sure — but they’re not the cause of the illness — they’re just symptoms The main problem is systemic fragility, and the failure to understand the economy from a systemic perspective, and understand the systemic risks. If the financial system (both global and national) is not resilient to shocks and the unexpected, the system will unravel under the slightest pressure. As I have repeatedly explained, the Western economic paradigm is a highly fragile for two reasons: over-dependence on foreign goods and resources controlled by hostile nations, and the pattern of interconnected financial debt that leaves the system open to collapse if just one significant player collapses:

Not only did the bailouts disable creative destruction (the engine of innovation and social progress), they also created so much debt that they have already damaged the ability of future generations to save, invest and innovate.

Worse, they did nothing to address the fundamental fragility of the system. All of that interconnected debt means the system is still fragile to a default cascade, which means that if the system is to be “saved” again, it will require more bailouts and more debt-acquisition, further eroding the ability of taxpayers to save and invest, as governments tax and inflate the currency to pay down the debt.

I expect future generations to look back on this episode as a bizarre aberration. America — surely the greatest producer and innovator in the history of human civilisation — forgot how markets work and the notion of creative destruction, forgot that an empire dependent on hostile partners (i.e. China and the Arab world) is hugely fragile, and then forgot the fact that America emerged as a superpower as a director result of its status as a great creditor and manufacturer, and that the old European empires lost their superpower status through loss of productivity and massive debt acquisition.

The beautiful thing about artificial abstract systems is that they can be remade at will, unlike ecosystems or organisms. It would be so easy — in principle — to rip up the global financial system and start again, because it’s all abstract. But there are too many vested interests — creditors want their pound of flesh, consumers and businesses want stability and fear change, and so establishment economists and thinkers will hunt ceaselessly for any kind of confirmation for the idea that the system is stabilising, that things are getting better, that things can go back to normal, that prosperity will return.

Well, prosperity may return, at least for a few short years, before the mass of interconnected leverage crumbles back into the murk from which it came. And as credit contracts (as is inevitable in a fractional reserve system) employment will slump, GDP growth will stall, and anger will rise.

The danger is that next time, the gears and wheels of productivity that hold up the abstract falsehoods of finance and consumerism will fail. I am not really a fan of Ayn Rand, but the analogy of Atlas shrugging holds true — in this case, the workshops, mines, and factories of “poorer” exporters holding upon their shoulders the parasitic mass of the consumerist Western nations. It won’t be industrialists and capitalists shrugging — it will be shipyard workers, machine operators, truck drivers, coal miners and construction workers, squeezed and dispossessed. Why should wealthy Westerners live a lavish lifestyle subsidised by the blood sweat and productivity of poorer nations? Because America has nuclear weapons? Because it invades nations that threaten to trade oil in things other than dollars? That kind of belligerence is a house of cards — it works with Third World despots, but not with an angry, politically engaged and dispossessed mob. I see it in the Occupy protests — the police can beat and brutalise protestors, but belligerence doesn’t change anything — the protestors are a hydra, cut off a head and two grow back.

The economic elite of the 20th Century learned to appease their malcontents by continuously raising the standard of living, expanding property ownership, and bringing plenty of food to tables, and new consumer goods to homes around the globe. If the economic elite of the 21st Century cannot learn to do the same I fear the malcontents will unleash hell.

 

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Eurotrash & Fragility

I haven’t covered the nascent European Financial Stabilisation Fund (EFSF) much lately, in spite of all the bureaucratic & ministerial scrabbling and wrangling to rescue the European status quo.

That’s mainly because I have grown (or shrunk?) to see most developments as irrelevant can-kicking.

At best, they can muster an American-style response: kick the can far into the future. But unless the underlying problems are solved (clue: they won’t be) then the system remains fundamentally broken.

That’s because monetary integration without integrated budgeting is a recipe for insolvency. Banana Republics can print money to pay their debts because they control their currency. Nations who don’t control their currency can’t devalue to pay their debts. They have to default, or hope for a bailout from the powers-that-be. And the problem at the heart of Europe is that fiscal integration is politically impossible (sorry Frau Merkel), for a myriad of reasons including (among others) nationalism, incompatibility, and the perception that the Mediterranean nations will leech off the more productive northern nations.

Of course, most of these constraints wouldn’t be there if the system was less fragile. In a fractional reserve banking system where (and this is crucial) the money supply (M2) is determined by private lending, a number of situations can lead to Irving Fisher’s debt deflation problem — with a shrinking money supply, debts become unrepayable, triggering a default cascade. These situations include bank failures, bank runs, credit contractions, price deflation and sovereign default — five phenomena that history teaches us are quite common. The scale of indebtedness makes systemic reform very difficult — creditors will demand that debts are honoured, so central banks continue with the instruments they have — competitive debasement, low-rates, expansionary monetary policy.

All that the sovereign debt crisis in Europe is revealing is the fragility in the systems — the fragility of the European political union, and the fragility of the fractional reserve banking system.

And if a fragile system isn’t allowed to collapse (or is not effectively reformed) when the problems are comparatively small (insert nonsensical rubbish about “systemic importance“, “economic infrastructure” and “too-big-to-fail” here) it will rumble on through many bailout-crisis-bailout-crisis cycles until it becomes too-fucked-to-bail, at which point the entire system collapses, and the debt is razed (either by default of hyperinflation or both).

The problem is that such climactic events usually have geopolitical implications: war, famine, upheaval, etc.

War: The Quickest Way to Kill a Protest Movement?

#OccupyWallStreet is the second incarnation of “mad as hell” since the 2008 corporatist bailouts that effectively killed American capitalism. The first incarnation — the Tea Party, initially a furious response to government bailouts of failed banks — was too easy to astroturf and transmute into right-wing ideologues spouting fire and brimstone on right-wing social issues. It was too easy to discredit for what Fox News, Judson Phillips and Glenn Beck made it into — a non-spontaneous anti-tax anti-Obama ranting brigade. The Tea Party, at least at the leadership level, ended up advocating Bush-Reagan military-industrial hegemony on steroids.

#OccupyWallStreet picks up where the original intentions of the Tea Party were strangled by Beck, Palin and Limbaugh. It’s anti-corporatist. Anti-bailout. Anti-corruption. Yes, many of the people there are old-school statist leftists who want to abolish and not restore capitalism. But there is no doubt that with the global economic apparatus largely failing to appease anyone but insiders and bankers, the hopey-changey sentiments (“we have to give Obama a chance!”) that have been keeping the revolution down can’t be silenced for long. People need jobs, prosperity, fulfilment, and (for better or worse) they’ll make mayhem until they get it.

With global youth-unemployment and underemployment soaring I only expect this movement to balloon and echo around the world. There is a danger — just like the Tea Party was co-opted into the Republican political apparatus — that #OWS will be co-opted into the establishment left. If Obama removed Geithner and hired Krugman and Elizabeth Warren, a significant chunk of the protestors might be placated — for now. But the problems sucking economies down can’t just be wished away. They can’t be solved by printing money and pumping it. They can’t be solved by digging ditches. And thanks to the creation of the internet, and the rise of Facebook and Twitter, until the system functions well enough to give the indignants what they want and need, they will keep causing a ruckus. As Reagan put it:

Information is the oxygen of the modern age. It seeps through the walls topped by barbed wire, it wafts across the electrified borders. … The Goliath of totalitarianism will be brought down by the David of the microchip.

And so it might seem this totalitarianism might be ended — and God’s workers furiously demanding as much liquidity and favours as is necessary to “save the system” (and their bonuses) with no consideration that the system might itself be the problem is surely a kind of financial totalitarianism.

Sadly, we know how that aphorism from Winston Churchill goes: that Americans will do the right thing — after they’ve tried everything else.

So a new war in the middle east may seem attractive to some elements of the Western establishment:

  1. Create a new post-9/11-style hard-to-question patriotism — “There’s a war on — we all need to rally together around the flag — the complainers and protestors must hate America”
  2. Put America back to work — in weapons factories, and on the front lines.
  3. Give the economy a large Keynesian injection — through war spending.
  4. Take out Iran, a powerful enemy of America — and send a threatening message to other uppity Eurasian autocracies like Russia and China.
  5. Curtail civil liberties & censor the internet — “There’s a war on — we all need to rally together around the flag — and those who don’t must be working to undermine America”
Let the war propaganda begin in 3…2…1…
The problem is, starting a new Eurasian war carries with it a whole host of risks — not least the possibility of an oil shock and a massive oil spike — and the real prospect of dragging Russia, China, India & Pakistan into the conflagration.

So would Obama authorise and support Netanyahu in instigating regime change in Iran?

Perhaps he might consider it — how else can he get a big stimulus bill through Congress, and divert attention from a failing American economy and growing civil unrest? But more worrying, I’m not even sure Obama matters.

From GulfNews:

In recent weeks, intense discussions have taken place in Israeli military and intelligence circles about whether or not to launch a military strike against Iran’s nuclear facilities. Apparently, the key question in the debate was how to ensure that the United States took part in the attack or, at the very least, intervened on Israel’s side if the initial strike triggered a wider war.

Reports of these discussions have caused considerable alarm in Washington and in a number of European capitals. Some western military experts have been quoted as saying that the window of opportunity for an Israeli air attack on Iran will close within two months, since the onset of winter would make such an assault more difficult.

Concern that Israel may decide to attack without giving the US prior warning is thought to be the main reason for the visit to Tel Aviv on October 3 of the US Defence Secretary Leon Panetta. His aim seems to have been to rein in the Israeli hawks.

The Shape of Global Parasitism

A couple of days ago Buttonwood over at The Economist touched on my favourite topics: the growth of the Western service industry, the death of Western manufacturing, and the deep interconnectedness of the global economic system. His hook was that most claims of parasitism are at best not-straightforward, and at worst are unfounded. From The Economist:

Are all manufactured goods intrinsically superior to services? Would you rather have a wig or a haircut? Just as there is only so much food we can healthily consume, there is only so much physical stuff we need. We have service-dominated economies because people like to consume services from TV programmes through video games to leisure activities like eating out. When General Motors sells a car, the chances are that it is selling it to someone who works in the services sector; so who is the parasite in this situation?

At the national level, we can say that most countries cannot produce all the things they need (or at least desire). Britain, for example, needs food from abroad. So it needs industries that can export stuff in order to generate the earnings that pay for imports. Here the bankers start to look a lot more valuable; Britain’s invisible earnings from financial services are highly valuable.

A more realistic question might be “would I rather have a factory making hair clippers, or a cabal of lawyers, financiers and bureaucrats who readily declare themselves too-big-to-fail and hose themselves down in taxpayers’ liquidity?”

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