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Everything written about the economic crisis overlooks its true nature

Summary:   This site opened in November 2007 with three posts about this crisis, describing it as End of the post-WWII geopolitical regime.  Until we and our leaders understand this, we can neither appropriately respond to events nor prepare for future problems.  While the title overstates the situation (there are many who understand), it captures the key mental barrier we must cross in order to cope.  These are just guesses, but they have proven fairly accurate during the past 16 months.Contents
  1. Introduction
  2. The true nature of the crisis
  3. A quick summary of the situation
  4. Missed opportunities to mitigate the damage
  5. What comes next?
  6. Cohesion will be the key to success
  7. Perspective on these events

This post is a follow-up to This financial crisis is the transition to a new world; like birth, it is painful, 11 February.

(1)  Introduction

Most analysis of this financial crisis describes this as a cyclical event within our current financial regime.  So they see the unexpected “breaking” of institutions as an indicator of magnitude or unexpectedness (it’s a “black swan”).

  • bankruptcy of the US mortgage brokers in 2007,
  • banks and brokers in 2008, and
  • large non-financial corporations and even nations in 2009.

These things are neither unexpected nor oddities.  They were predicted in general terms for many years (see here for examples) and represent the very essence of the process:  the ending of the post-WII global financial system, and its evolution into another form.  If the change is sufficiently large, which I expect they will, this will be the end of the post-WWII geopolitical regime.

To prepare we must first understand.  Hence this series, the purpose of  which was perfectly stated by Milton Friedman in the Preface to his book Capitalism and Freedom (1962):

What then is the role of books such as this? Twofold, in my opinion. First, to provide subject matter for bull sessions. As we wrote in the Preface to Free to Choose: “The only person who can truly persuade you is yourself. You must turn the issues over in your mind at leisure, consider the many arguments, let them simmer, and after a long time turn your preferences into convictions.”

Second, and more basic, to keep options open until circumstances make change necessary. There is enormous inertia tyranny of the status quo — in private and especially governmental arrangements. Only a crisis — actual or perceived — produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.

(2)  The true nature of the crisis

The post-WWII global financial system has brought unprecedented prosperity to the world, unlike the 1815-1914 cycle, which benefited mostly the West.  However it quickly evolved serious imbalances.

  • First manifested by the late 1960’s decay of the Bretton Woods system,
  • which ended in 1971, when President Nixon ended the US dollar’s convertibility into gold,
  • followed by increasingly frequent financial crises around the world,
  • resulting in the last stages with the development of obviously unsustainable massive deficits and surpluses in current accounts and
  • massive growth in foreign debts and credits (national reserves and foreign debts).

That our leaders do not understand the larger process at work explains their otherwise incredible failure to adequately respond.  Experts like Henry Paulson and Ben Bernanke — the latter one of the world’s leading experts on the last such transition (aka the Great Depression) have acted with slow incremental steps — each responding to the previous phase of the crisis, not the one looming ahead.  This shows the failure of the “orientation” aspect of their Observation-Orientation-Decisison-Action (OODA) loop.

The result is a situation like the early stages of the Great Depression.  No nation could recovery until it went off the gold standard, breaking their “golden fetters“.  Nations made that leap into the future at different times, accounting for much of the difference between those who recovered quickly– and slowly.  Today governments burn their vital resources –time and money — fruitlessly attempting to save the post-WWII regime, an era that has already passed away.  Instead we must look ahead, building a new foundation for the American and global economies.

(3)  A quick summary of the situation

The crisis can be thought of as stress on the global economic machine which results in a “snapping” of links or components.  The breaking of each component increases stress on the others, leading to more damage.  Consumer demand and corporate investment decline, which in turn creates more stress leading to more snapping.

We can think of this in geophysical terms, as if God was putting torque on the world economy.  The fault line runs from

  • Asia — China, Japan, Korea
  • through North America — US, Mexico
  • to Europe — Eastern Europe and the PIIGS (Portugal, Ireland, Italy, Greece, Spain).

Each of these nations is under different forms of stress.

  • China from the need for growth to maintain social stability.
  • Japan from its aging population, massive governmental debt, and weakness following two decades of fighting deflation,
  • Korea from its massive external debts and collapsing exports,
  • the US from debt deflation, massive foreign debts (fortunately in US dollars) and coming collapse of consumer spending and export income,
  • Mexico from a losing war with organized crime and the coming collapse in oil revenue,
  • Eastern Europe from its massive foreign debts (worse, they’re denominated in foreign currencies),
  • and the PIIGS from a combination of the above.

The effect of other nations on the fault line cannot be reliably predicted, but offer great potential for unpleasant surprises.  To mention just one of the major unknowns, Can the European Monetary Union survive the next recession?

(4)  Missed opportunities to mitigate the damage

The opportunities to avoid the crisis lie in the past two or more decades.  At some level we knew that we must save more and borrow less, that our ever-growing trade deficits were a threat to future prosperity, etc.  We put those concerns aside, instead indulging in an orgy of consumer spending.  Larger houses, more cars per household, granite counter-tops, insane government spending for every politically powerful group — from insane defense spending to bountiful agricultural subsidies.

Now the party ends and the hang-over begins.  We fumbled our time as world hegemon and the world turns to something else — as yet unknown.

The fabric of our financial system began ripping in December 2006, as sub-prime mortgage defaults spiked up and the mortgage brokers went bust.  During the next 12 months the applied a series of bank-aids to the growing tear.  In September and October the global economy suffered a cardiac arrest, a brief but clear warning of what was to come.   Readers of the FM site had a ring-side seat:

  1. High priority report: a geopolitical sitrep on the financial crisis, 15 September 2008 — We’re in the “golden hour”
  2. A new sitrep, as we move into phase 3 of the financial crisis, 19 September 2008
  3. A sitrep on the financial crisis: why has the treatment been so slow, so small?, 8 October 2008
  4. Status report on the financial crisis: we’re at a critical point in time, 10 October 2008
  5. The economy is in shock. The effects of this will soon become visible, 11 October 2008
  6. Damage Reports from home and abroad, 12 October 2008
  7. The coming collapse in business spending – made visible today, 15 October 2008
  8. Miscelaneous news and thoughts about the financial crisis, 16 October 2008
  9. More reasons why the government will be taking over allocation of America’s capital, 27 October 2008
  10. The US economy must go to Defcon 1, 13 November 2008

November was the last opportunity for the government to “get in front” of the crisis — taking bold proactive steps to slow the decline.  I described the measures necessary on 25 September 2008 in A solution to our financial crisis, with details in 3 subsequent posts.  These needed to be done in November immediately after the election.

We missed that exit.  The government took some (not all) of these steps during the following 4 months, in a too-small and uncoordinated manner.  The last measure, the stimulus bill and closing down of the OTC derivatives markets will take effect during the next few quarters.  The former is too late; the latter might be too late.  For more on this, see Everything you need to know about government stimulus programs (read this – it’s about your money).

(5)  What comes next?

To use another bad analogy, the crisis has been traveling  during the past two years through the virtual space of “Wall Street” – the financial markets.  That has caused severe damage.  During the 4th quarter it made landfall at Main Street.  Now it travels through the real economy, leaving behind a trail of unemployed people and wrecked businesses.  Bankruptcies, poverty, and ruined hopes.

(a)  Government Policy

Governments incomes collapse, their expenses skyrocket.  Unemployment insurance, food stamps, medicaid.  People over 62 lose their jobs and draw Social Security and Medicare.

Both people and government of America have lived in a dreamland during the past two months.  Quarrelling and bickering about trivial while ignoring the storm about to descend.  As the depression descends upon the world, there will be scramble for large-scale government action.  Employ the unemployed, take massive steps to keep the economy alive until it recovers.   When we finally nationalize most of the major banks it will be page 3 news.  Unemployment and bankruptices — and government programs to fight these — will be on page one; instability abroad will dominate page two.

(b)  American politics

Hopefully people will forget the “do nothing and hope” recommendations of the Republican Party.  Otherwise it might face near-extermination in November 2010.

Any President would have looked bad in 1930.  Anyone taking office in 1932 — at the trough of the Great Depression — had the wind at his back, making it relatively easy to be a star.  President Obama will find that he was elected at a bad point in the cycle, in the equivalent of 1930 not 1932.   Obama must become the most difficult kind of healer, performing triage on the wounded.

  • Who gets aid?
  • Who is left to suffer, fighting their own path to survival?
  • Who is doomed, and so gets no aid?
  • From whom are necessary funds requisitioned to pay for all this?

If Obama succeeds even modestly, history might place him among our greatest Presidents.

(6)  Cohesion will be the key to success

Getting through this with a minimum of damage will require cohesion, both domestic and international.  Maintaining cohesion is responsibility of us all, but especially our the world’s leaders.

  1. The US maintained a high degree of social cohesion during the 1930’s.  No great increase in crime, no waves of rioting, no armed revolts.  Much has changed in American since then.  Much depends on doing so well again.
  2. Germany maintained cohesion (of a kind) by electing Hitler.  Let’s hope no major nation takes that option.
  3. National monetary, currency, and trade policies must be coordinated and cooperative.  The consequences of widespread “beggar thy neighbor” policies might be disastrous.
  4. The IMF will a massive transfusion of money, as many developed and emerging nations face the equivalent of bankruptcy.

(7)  Perspective on these events

How will this play out?  The end of this era will be like a singularity in astrophysics, where the rules break down.  We cannot see beyond it because we do not understand the choices that will determine our fate – let alone how we will choose.  It also resembles a singularity in that what lies on the other side is unimportant until 9or unless) one survives the passage through it.

I am confident that America will come through this, hopefully learning what we need do to build a better world.  It’s a matter of faith.

But we must realize that political and economic regimes come, and they go.  The post-WWII has brought incredible freedom and prosperity to America, but that does not make it eternal. As Queen Gertrude says to Hamlet (Act I, scene 2):

Good Hamlet, cast thy nighted colour off, And let thine eye look like a friend on Denmark. Do not for ever with thy veiled lids Seek for thy noble father in the dust: Thou know’st ’tis common; all that lives must die, Passing through nature to eternity.

** The movie “The Matrix” prominently featured a version of this: “All that lives must die.”

Afterword

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For information about this site see the About page, at the top of the right-side menu bar.

For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp interest these days:

About the causes of the crisis:

  1. The post-WWII geopolitical regime is dying, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  2. Diagnosing the eagle, chapter I — the housing bust, 6 December 2007
  3. Death of the post-WWII geopolitical regime – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  4. Let us light a candle while we walk, lest we fear what lies ahead, 10 February 2008 – Putting the end of the post-WWII regime in a larger historical context.
  5. A vital but widely misunderstood aspect of our financial crisis, 18 September 2008 — Too many homes.
  6. A picture of the post-WWII debt supercycle, 26 September 2008
  7. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  8. Causes of the financial crisis (no, its not the usual list), 29 October 2008
  9. Government policy errors and the Great Depession, 1 November 2008
  10. Economics is not a morality tale, 14 January 2009
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Originally published at Fabius Maximus and reproduced here with the author’s permission.

One Response to “Everything written about the economic crisis overlooks its true nature”

GuestFebruary 24th, 2009 at 4:22 pm

Fabius, if you could write an article about your thoughts on how this will impact “the little people”, IE, bank holidays, food shortages, a la Gerald Celente, I would love to read it.Thanks

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Emre Deliveli The Kapali Carsi

Emre Deliveli is a freelance consultant, part-time lecturer in economics and columnist. Previously, Emre worked as economist for Citi Istanbul, covering Turkey and the Balkans. He was previously Director of Economic Studies at the Economic Policy Research Foundation of Turkey in Ankara and has has also worked at the World Bank, OECD, McKinsey and the Central Bank of Turkey. Emre holds a B.A., summa cum laude, from Yale University and undertook his PhD studies at Harvard University, in Economics.

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