Category Archives: 1 Perspective

A different scale of leverage has accelerated our progress and imbalances

As has been discussed over the past months, the economic imbalances around the world have grown beyond normal measures for some years now.  Trade imbalances, government debt, consumer spending have all been beyond expectations in the US and other mature economies.  With the tremors of collapse touching many since the cracks in US housing started to show in July have focused the attention of analysts who are increasingly focused on the scale of the mountain of credit that has accumulated over the past 5 – 10 years.  Last month’s commentary characterised the pyramid-scheme type of credit accumulation that has been allowed by financial derivatives: dicing and splicing of financial assets to create derivatives more and more removed from the reality of the underlying instruments.  Analysts have increasingly focused on the dysfunction that occurred in the sub-prime lending niche as rating agencies, investment banks, asset managers, lenders, mortgage brokers and other fiduciaries became caught up in the game of singing the same tune: “doesn’t the emperor have lovely new clothes”.  And this deluded song had been taken up by all of us from regulators to consumers.

Historically one could expect that the multiple of credit to cash (which together underlie money for the economy) might be of the order of 10:1.  But this has grown, perhaps by a factor of 10, as credit builds upon credit to build an economy based on leverage.  We have bought a wonderful life, but have not recognised the mortgage secured on our future.

The challenge is to deflate this balloon of credit in an orderly manner.  And this is made difficult by the need to change human behaviour, to change our expectations.  It will be impossible for developed economies to continue the illusion because the natural resource constraints are bringing the reality of debt from “the future” to today.  There is no doubt that the currently used measures of economic growth, focussed on GDP, can only show a flat or negative trajectory while the global financial system deleverages.  This requires that regulators, governments and business must either adjust to alternative methods of economic measurement, which are increasingly advocated, or suffer the pain of depression era economies.

It is not certain how long the illusion will remain.  We all want to retain it, especially since our cultures and measures of progress are slaves to the notion that more consumption is desired, ad infinitum.  But I do not expect it to hold for long because the imbalances have reached the ends of the earth.  Our economic systems have become contained by our natural world, both by physical resource interconnectedness and virtual communications. We must learn to live together or the pain of adjustment will be gruesome.

The best advice for taking a step in the right direction is to not be afraid of letting go of the illusion.  Enlightened individuals and leaders have already started to do so.  Make an effort to recognise that you have enough and focus your energy on building relationships with family and friends, not business.

Hope is not the answer; living in reality is

By coincidence a number of comments received on last month’s musings (both News and Views and Review) drew attention to hope. Whether a quantitative or qualitative observer of life, people seem to want a hopeful sign that everything is going to be alright. It would be fantastic if that could be. But it is only fantasy. Whether your god is religion or science, the fact of nature is that there is order. And that order even extends into our virtual world of money: that world which interprets participants’ values.

But hope is not a strong foundation for planning for the future.   It is teh foundation upon which the sub-prime mortgage market ballooned during the past 5 years.  We must be drawn to the concerns of the World of Money because, while players continue to say its all fine, the actual foundation looks shaky. We know that we’ve had a good run of obtaining credit on the promise that we will pay for our consumption in the future.  But as we realise that we’ve borrowed more tahn we can hope to repay, we start to take desperate measures.  The delusion of asset prices increasing while the economic news is so dire and regulatory authorities are reacting as if there is a problem, suggests that we are desperate to continue the illusion.  Unfortunately this can only lead to trouble.  First inflation.  And if this becomes gross, then the efficiency of financial markets will be compromised, participants will be unwilling to risk what they have on the uncertain future and our ability to operate as a cohesive market will dissipate.

If, however, we allow our feet to resettle on the ground, bring our expectations back in to the realm of nature, and stop confusing consumption with happiness, the adjustment will be easier, even pleasant.  But it requires that we appreciate the human values upon which communities thrive, not the belligerent values upon which individuals rise.  Do not confuse this with a step backward.  It is in fact a step forward, but a big one.  It is elevating humanity from bestial constraints of a simple organism to the self-aware delight of a fully conscious being.  It is humanity working together as one and interdependent on nature.  The stimulation of space age technology will flourish, but we must be relish the stimulation of natural systems too.  This means making space for nature; which means moving aside.