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TinHat - Economics and other fiction

Articles by Andrew Starling

Milestones on the path to financial meltdown

Some slight negativity in the title there. Yes. The meltdown in question is the collapse of the Western financial system. Right now (November 2014) it doesn't look in great shape. The main sign of disease is that the patient needs to take so much medicine, a medicine called Quantitative Easing. And despite enormous doses there's little sign of recovery. I could write thousands of words on what ails the patient, on what's wrong with the world economy, but the doubters might reject the arguments. Instead I'm going to take a very different approach. If the Western financial system is failing, it will be a slow process and there should be milestones along the way. So let's identify the milestones. Then we'll be able to tick them off and see the process in action. What I'm suggesting here is forget the theory, which is open to too much debate, and watch what happens in practice. If we see the milestones then we'll know which route we're on.

Conveniently that means I can get away with just a few hundred words on the theory behind the destruction. Let's do that as simple bullet points...

  1. The Western economic model requires perpetual economic growth. That growth has either stopped or slowed to snail's pace.
  2. The Keynesian fix is to print money. That's working to some extent, it's probably slowing the destruction, but not stopping it.
  3. The Keynesian fix is causing its own problems. Asset bubbles and unproductive use of capital, minimal return on savings.
  4. Governments are now monetizing their debt. Monetizing debt means printing money to cover the difference between expenditure and income. The printed money buys your own government bonds. It's terrible behaviour so nobody admits to it. The excuses/lies for why it's not really happening involve lots of jargon and long words.
  5. All the Western economies have a demographic problem, an ageing unproductive population.
  6. The pack leader in the race to destruction is Japan. It's post-industrial, has terrible demographics, experienced a massive asset bubble in housing, and now has borderline deflation – the worst outcome for a Western economy.
  7. Consumers are no longer getting their historical share of the spoils. What little wealth is created goes directly to the rich. Irrespective of morality, that's a huge problem for Western economies as consumers are the main engine of growth. When consumers don't have money, growth stalls.
  8. The Western financial system is out of control. The lure of easy wealth has attracted people with no morality. They are now embedded in the financial system.
  9. The Western financial system has subverted democracy. Through financing political parties and owning media it ensures that election results favour its own agenda.
  10. The net amount of financial derivative products is more than ten times the size of the world economy, maybe more than fifteen times. Many of these derivatives are incomprehensible. The tail has outgrown the dog.
  11. The USA is a declining power. How it reacts to this demise is wildcard number one.
  12. Wildcard number two is China. Does it need the West to prosper? Maybe. Maybe not.

It's quite a list. I have no intention of justifying every entry, and perhaps it doesn't even matter if one or two are wrong. The question is whether our institutions of national and international government are capable of tackling such a list or whether they will progressively fail. I am inclined to think they will fail, primarily due to point 9, the subversion of democracy. But on the optimistic side the world has often overcome great challenges in the past and there is always a chance it will do so again. I will become more optimistic if the people of the West manage to wrest control of their governments back from corporations. There's little sign of that right now.

And so on to the less contentious part. If the Western financial system is going to fail, what milestones do we pass along the way?

Japan

An easy start. If great swathes of Quantitative Easing work for Japan then there's hope for every other nation. We'll know if they work because deflation will be conquered. So there's our first milestone, deflation in Japan. If the current massive level of QE fails to control deflation in Japan we have passed our first milestone.

Deflation elsewhere

There is already deflation elsewhere – Greece, with Spain and Portugal borderline, and possibly Ireland. Maybe we are talking a series of milestones here, and their size. Let's be more specific.

Permanent QE or monetization

When a region or nation openly admits that its QE operations will be permanent, or admits that it is engaged in a long term policy of monetization of debt, we have passed another milestone. Japan may be the first.

The Keynesians go quiet

The Financial Times and The Economist (both owned by the same corporation) are full of Keynesian battle cries. More QE! Print more! Hey, you Germans, stop blocking the ECB! Maybe they are right. Who am I to argue? But like football supporters on the losing side, they may go quiet, or at least subdued. If they do, the problem is worse than they thought and we have passed another milestone. It may be hard to notice, as the Keynesian cries will simply go missing.

Sabre rattling

Most likely the US against China or Japan against China. When the sabres come out, we are in a worse position than when they were sheathed. It means there is a need for distraction and blame.

Nationalism and tribalism

It's on the increase and I'm not sure what level qualifies as a milestone. Certainly when Eurozone countries start looking to reintroduce their old currencies then it will have become significant. But I think overall it's too hard to measure.

Bond failures

All nations are now beholden to bond holders. I guess it will be a milestone if any country tries to break out those shackles. They will be stepped on, of course. But merely trying will be a significant step. South America is always a good bet for reluctant bond captives. Buena suerte.

Stock market crash

An easy one. Yet on a cyclical basis we are due for a crash anyway, so it won't be the perfect milestone. There might be more subtle indicators to observe:

Property

Prices are in bubble so some decline is no big deal. What we don't want is the Japanese-style long-term fall. Unfortunately that makes property prices a bit of a useless milestone because a fall for a few years wouldn't be of much consequence. It's a decade we're looking for.

Tightening of government

If the system is going to fail, there will be civil unrest. In preparation for civil unrest, government will need greater control. Unfortunately governments have a habit of extending control anyway, so it may be difficult to observe. Look for expanding police forces, greater riot control budgets, limitations on assembly, loosening of judicial procedure, misuse of anti-terrorist laws, closure of alternative news sources, limitations on social media.

Pronouncements of government

If the system is going to come unglued, the population needs to be prepped, our expectations need to be modified. The usual mechanism is TV news. We should see more than the usual amount of morbid financial reportage. A stock market crash will make this very hard to observe as we'll be overwhelmed with negative nonsense and it won't be so clear whether we're being intentionally programmed to expect destitution.

Statistics and damned lies

Government statistics are already unreliable but as the situation worsens they should become distinctly unreal. Already we can see from everyday experience that growth figures and inflation figures are falsified. The next step is when we experience deflation, with prices clearly going lower, but officially it doesn't exist. That will be another milestone.

Pension schemes

These depend very much on business as usual, world growth and not too much instability. When they start to go pop at frequent intervals it will be a bad sign. Hope that yours is one of the first to go, as it will be propped up by government. For the later ones there won't be enough money.

Municipals are another target

In the early twentieth century, the financial markets had a purpose, helping industry. Now in the early twenty-first century they've entirely outgrown that purpose, yet they still need to make a percentage. They're parasitic and don't mind killing their host to survive. Individual investors were the first in line but they've been almost entirely killed off, so the organism needs to find another weak host to feed off. Pension funds are prime territory. The other weak area is municipal funds, money invested by local government. If my assessment is right, municipals will find themselves targeted by the sharp operators of the financial system and some won't survive.

Commodity prices

Dollar-adjusted prices for metals and agricultural produce should continue to go down, to a level where producers go bust. So a rash of bankrupt producers will be a milestone.

The dollar, gold

There are many people out there who will tell you which way these will go, whether they will skyrocket or fall. I'm not one of them. I don't think the mechanisms involved are rational or predictable, so I will not be using them for milestones. Indeed I think it would be a mistake to read much into their movements. Please don't mail me to tell me about the once in a lifetime opportunity I'm missing in gold. You'll merely be doing it to strengthen your faith in your own actions. And I will write back to tell you that, which you won't like, so let's just sidestep the conflict.

Failure of a mysterious derivative

I don't know which one it will be, but pretty much out of the blue some financial derivative will fall apart and it will be a great surprise and nobody will really understand it or be able to explain it properly. It will, however, be extremely expensive to fix, and it will be a major milestone. Packages of US auto loans might be the candidate that replaces 2007 home loans.

Failure of a little known bank

Bank failures are already commonplace in the US, but dealt with in a graceful manner. We need to see a failure somewhere that causes people to lose money. It's already happened in Cyprus, the question is where next? How about the Ukraine?

Sequestration

Inevitable as the system begins to fail, assets of little people will be sequestered. It won't be called sequestration, of course, the label will be far more user-friendly. It will still be a milestone.

So there is my milestone list, not in a particular order. I don't see the order as all that important. It's also obvious that a few of these milestones can be passed without significant meaning. I can hardly claim that government statistics getting worse or a rise in nationalism qualifies as the end of the Western financial system. But passing a mass of these milestones is a different matter. What I'm intending to do is refine this list and watch it over time, perhaps report back every six months or so.

Thanks for reading.

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