Monday, March 31, 2008

How To (Mostly) Save The Financial System

First, do nothing. Yes, that's right: no bailouts, no alphabet soup programs from the Fed, no emergency liquidity injections, no "initiatives". Nothing beyond the customary daily operations - and make sure everyone knows it, particularly Wall Streeters.

What good will this do, you say? A ton of good, I say. Because it will immediately force everyone to accept and deal with reality, instead of hoping for "solutions" from the Fed, Treasury or Congress. The credit crisis is too widespread and ultimately beyond their intervention capacities; it is becoming increasingly obvious that conditions are deteriorating despite their efforts. There is too much debt compared to the earned income necessary to service it properly, so a large portion of it will go bad no matter what they do.

Now, throw in resource depletion plus environmental degradation. Debt is a one-way bet on rising future activity; scarcity and climate change are already forcing us to rethink the outdated Permagrowth model and we will soon be forced to abandon it altogether. Therefore, it is better to liquidate excess debt quickly, instead of wasting precious resources attempting to keep it afloat. Referring to a post from last July: putting patches on threadbare tires may temporarily prolong the Bong Bus trip, but will result in a catastrophic accident later. Better to stop now and force all the dopeheads to change the tires.

But what about the innocents, those middle-class depositors and investors who may see their lifetime savings disappear in a generalized credit melt-down? Fortunately (well, un-fortunately) they don't have all that much to lose: the vast majority of Americans (latest data from 2004) had much less than $100,000 in financial assets, including bank deposits, securities, 401(k)'s (see chart below, click to enlarge). Current programs in force like FDIC and SIPC will more than adequately cover them.

Financial Assets by Percentile of Net Worth (Chart: FRB)

The efforts currently being undertaken by the authorities are not directed at them. They aim at helping the very top, where most financial wealth resides: those debt instruments (and their issuers) that are owed by the bottom 90% of the people, but owned by the top 10% of them. I am most definitely no sans-culotte, but even to me this smacks of "Let them eat cake".

Unfortunately, instead of acting in the best interests of the vast majority of the people, we have now embarked on a course that leads to the following statement:

The analyst, Prashant A. Bhatia of Citigroup, said in a research report Friday, “It’s tough to have a liquidity-driven meltdown when you’re being backed by government entities that have the ability to print money.”

In whose interest is it to make our currency the harlot of the "free world"? Not the 90%, that's for sure. But here's the rub: pretty soon it won't be in the interest of the 10%, either.

In the early stages of the Great Depression then Secretary of the Treasury Andrew Mellon made the mistake of advocating liquidation because that was the way previous boom-bust business cycles worked ("Liquidate labor, liquidate stocks, liquidate farmers"). Like most short-sighted generals, he assumed he was fighting the previous war. It is the same with Bernanke, Paulson and Co. : like the Polish generals of 1939 they are stubbornly throwing masses of cavalry against Guderian's Panzers.

It is a familiar pattern of incompetency: the Iraq and Afghan wars are wasting hundreds of billions of dollars and hundreds of thousands of lives to prolong the Oil Era. The Fed and Treasury are destroying the good faith and credit of the USA to prolong the Debt Era. We will all suffer for it.


  1. Now, throw in resource depletion plus environmental degradation.

    Honestly, anytime I read reports about 'good news' in housing I want to puke. People who think it's good news that industrial-scale homebuilding is making a quick comeback must not have seen the way it ravaged huge tracts of land, e.g. in California.

    Debt is a one-way bet on rising future activity;...

    Exactly. To repay debt more money must be created, and the only way that happens now is the creation of more debt. Crazy. I liken it to the 'contract of generations' retirement system which most developed nations have -- the current (following) generations of workers are taxed to pay for the benefits of the retiring (previous) generations. Which works fine if a number of assumptions hold, including a continuously growing population, something no one really wants, and in any case is totally unsustainable. Which is crazy, if you think about it.

  2. Amen,

    as you said in your prior post "privatizing profits and socializing losses is crony capitalism, pure and simple."

    Let Wallstreet eat cake

  3. By the way, you are sounding a little like me now...

    "primum non nocerum"... First do no harm



  4. I agree.

    So, watching this unfold, can you/we make any predictions of the future?

    I see the US move away from a new world leader (free market, innovation) and toward being a follower of old world Canada and Europe (entitlement, big govt provided health care, regulation, etc).

    Is the next New World India and China and perhaps eastern Europe?

    Do you have any predictions on how this unfolds over the next 5-10 years?

  5. I'd take it one step further. Raise interest rates. The fundamental cause of this credit crisis is that risk and reward became disconnected and an asset pricing bubble emerged. The yield spread between junk and high quality became way too narrow.

    On the investment side, people were at all levels were chasing incremental returns for disproportionate amounts of marginal risk.

    On the credit side, buyers had an incentive to seek larger and larger mortgages because the premium they'd have to pay on the debt was so small.

    The rating agencies applied historical loss models to assets whose valuation weren't based on historical underwriting methodologies (why would anyone think that default rates based on 50 years experience on loans underwritten with 5%, 10% or 20% down would be valid for analyzing risk of default for 0% down, negative amortization, option arms?).

    Now that some sanity has returned to the market and people have realized that risk and return have to be better correlated, debt prices are falling because the market are so spoked that it is unwilling or unable to properly value the debt. Therefore, you've go nobody willing to step in and buy it. This creates and every greater downward spiral.

    I would submit that interest rates need to rise so that buyer with cash (of which there are plenty of) can step into the market and acquire the assets (be they the CDO's or the underlying assets) at prices that will offer them a genuine reward for the risk they take.

    By doing nothing the fed is still not doing enough. The best way to burst an asset pricing bubble is to raise rates. The short-term effect to people holding the inflated assets is greater because those prices will fall dramatically but the market then resets itself and liquidty returns.

    The problems we are facing will not be corrected until the markets start functioning effectively and the liquidty follows.

    The current strategy cannot succeed because it tries to artificially prop up a failed marketplace.

  6. You've raised some very important and interesting questions.

    We can all agree that everything that the government is now doing is at best useless. At least we can be grateful that, so far at least, Congress hasn't done anything super-stupid, like the Smoot-Hawley law that they passed the last time.

    But the question is: Suppose everyone abandons their fantasy states of denial. Is there anything that can be done that would actually help?

    The analogy I use is being threatened by a huge tsunami. What the government is doing now is analogous to denying that the tsunami is coming, and just building a few sandcastles on the beach for protection. What would really be needed is for everyone to work together and move to higher ground. Such a solution would never be politically possible, but ignoring politics, it would be the best solution for society.

    So, with regard to the financial situation, there is no politically possible solution. But I think the interesting question is -- ignoring politics, what WOULD be the solution that would do the least damage? What solution would correspond to everyone running for higher ground?

    John J. Xenakis
    Web site:

  7. Hellasious:


    There you go again using them fancy words, however, this time, thanks for the link....

    I whole heartedly agree with your post.... Paulson / Bernake are transparently naive. So transparent in fact, that it appears that they are speaking to us in the only language that they dare speak. "Bushspeak..."

    I have attached a link to an article that you will find interesting... And guess what...." You can read the original in French....

    The Rich Stand Accused
    By Louis-Gilles Francoeur
    Le Devoir
    Saturday 06 January and Sunday 07 January 2007

    Great post and good luck,


  8. Xenakis, good point. The psychology of the situation is really the driver here just as it has been for Japan. Americans have become use to a designer life style that until recently was only afforded the very wealthy. The wealthy used real income to pay for the various vactions, home remodel and other perks while the middle class has relied on debt.
    Preparing America for the coming economic downsizing and accepting a lifestyle not based on excessive consumption will be very dificult without significant social unrest.

  9. It is important not to forget that this is the Bush administration we're talking about here. Bernanke was Bush's top economic advisor before he "failed upwards" to Fed Chairman. Both he and Paulson are "loyal bushies". It is folly to expect any more or better out of the governemnt response to the financial crisis than we got out of its responses to the various wars and other catastophes Bush has overseen.

    We're facing a financial Katrina, and they're going to take care of the US economy the same we they took care of New Orleans.

  10. "Americans have become use to a designer life style that until recently was only afforded the very wealthy."

    I think i profoundly disagree with this. With the explosion of easily acquired debt, americans found themselves paying twice as much for the SAME lifestyle. Everyone wants to bash people who got into mortgages they couldn't afford, but the lifestyle that should have been affordable to them, based on their education and their work habits, ballooned up in price to the point where pretty much nothing made any sense.

    I keep trying to think of the negative effects of this 'global systemic meltdown' and most of what i can think through hurts the hedge funds, the financial firms and the lenders. (all of whom, i must profess, i think we could happily do without.)

    Would it make any real difference to the rest of us at all?


  11. John J. Xenakis I'd be interested in hearing what you think is the metaphorical "higher ground" in this situation?

    Personally, I'm not sure there is one. I believe that #1 home buyers who paid too much have to eat that loss. It's harsh and it's not nice to think about but a $250,000 home bought for $300,000 that has to be sold now means that somebody has to lose $50,000. There's no way around that.

    #2 the holders of the paper are going to lose money. That debt instrument with a historical cost basis of $300,000 now has a market value of $250,000. Again, there's no way around that.

    #3 potential new buyers of either the debt instruments or the underlying housing assets are going to largely stay on the sidelines until it is clear that a bottom has emerged. Catching a falling knife is never a good strategy.

    I would submit that accelerating the development of a bottom (for both the debt and the asset) gets participants back into the game and liquidity into the market.

    I'll throw out some ideas for addressing some of the problems without consideration to the political viability of each AND without consideration/evaulation of the long-term impact of the proposal. The proposals would serve to stability the housing market and add liquidity in the short-term:

    1. Allow some sort of preferential tax treatment (i.e. exclusion from income or reduced tax rate) on the gain on the sale of foreclose homes. This boosts the after tax return and would increase demand for them.

    2. Allow a tax credit for individual taxpayers on the first $ X of residential mortgage interest. This immediately lowers the cost of ownership on a dollar for dollar basis. If you really want to be crazy, make the credit refundable.

    3. Reduce the tax on income generated from residential interest payment from new non-conforming loans which have no government insured backstop. Again, boosting the after-tax return would encourage investors to make these loans.


  12. I meant to say, "one-twentieth of the world's population," not "one-fifth." Five percent of world population and some Enlightenment ideas are not enough to perpetuate American hegemony and an Americanized world.

    Clayton Hallmark

  13. Hellasious is quite right, the end of the assumption of abundance that has been the American Dream since about 1900 is at hand.

    What we are seeing is a catharsis. How painful it becomes depends on how much history needs to swept away: Is it just the finance-dominated economy and globalism since about 1990? Does it include the services-imports-debt (US IOUs to other countries) economy since the '70s? American hegemony and military mobilization since the '40s? Consumerism and waste-as-a-goal since the '20s? Corporatism-scientism since about 1900? More and farther back?

    Also, whenever a huge imperial replacement takes place, as when the British Empire was replaced in the early 1900s, there is a huge economic upheaval -- the Great Depression then. Now America is to be replaced by China and Europe at the top. Some Enlightenment ideas and 5 percent of the world's population can only take you so far. And remember, China and India were dominant for millennia, interrupted by only the last 150 years.

    To the Housing Crash, the Credit Crunch, and Asianization, might I add a fourth front of the perfect storm? It's what I call the Great Computer Crash. Real-time online transactions via computer communications, also financial instruments created and managed with supercomputers, have enabled the finance economy. And this important sector, IT (information technology) has in turn benefited hugely from its financial customers.

    The causes of the Great Computer Crash are (1) the commoditization of computers (how are MSFT and Intel going to survive in an era of $100 computers with the Chinese and others able to ignore IT patents?)and (2) the collapse of IT's finance (and other) customers. Trillions of dollars of investments and intellectual property might have to be written down -- worse than the Tech Wreck or dot-com crash.

    From 1995 to about 2000, IT contributed about one third of US GDP growth. Then IT was replaced by housing/debt-inflation as the engine of growth.

    Clayton Hallmark

  14. The efforts currently being undertaken by the authorities are not directed at them.

    I have to disagree with you. Negative real interest rates *are* being directed at everyone with money in their bank accounts. It is a war on savers.

  15. Here is a book that readers may find interesting. I have not read it personally, but the synopsis certainly fits in with the ideas presented on this blog.

    Rogue Economics by Loretta Napoleoni.

    From Amazon:
    Economist and syndicated journalist Loretta Napoleoni argues that the world is undergoing rapid and unexpected great transformations fueled by what she calls rogue economics. Eagerly awaited around the world (translation rights have already been sold throughout Europe, Latin America, and Southeast Asia), Napoleoni's account is based on top-to-bottom primary-source interviews from banking executives in New York to Russian prostitutes to London morgue workers, and grounded in the author's personal experience in international finance. From Eastern Europe's booming sex trade industry to China's "online sweatshops," from al-Qaeda's underwriters to America's subprime mortgage lending scandal, Rogue Economics exposes the paradoxical economic connections of the new global marketplace.

    From Democracy Now!:
    Italian economist, journalist, and author Loretta Napoleoni argues that recent events on Wall Street indicate a much larger upheaval and could “signal the end of the ‘Roaring Nineties,’ nearly two decades of easy money, cheap credit, and soaring global debt.” Its an argument Napoleoni develops in her latest book called “Rogue Economics: Capitalism”s New Reality.”
    Link to Napoleoni's interview on Democracy Now!

  16. Meli-

    Living in the financial blogosphere I sometimes lose perspective and forget that most Americans are still ignoring this mess. Government and Wall St. don't effect their existence directly (yet)so they don't care. Its all related and it WILL make a difference in all our lives. Or our kids lives as they pay for today's bailouts.

    I just read Dith Pran's obituary (his early life was the basis of the movie "The Killing Fields"). What struck me most was how quickly a society went into murderous chaos. Grim.

  17. dink,
    i think you misunderstand me. I am wondering if letting them FAIL will affect us all that much. Bailing them out will do enormous damage to us and our children.

    but as to the day to day...i'm thinking that the hysteria we see in the blogosphere reflects that most of those blogging are in the financial industry. Failure to bail them out affects THEM a lot.

    As to the rest of us, wall street has already damaged our reputation such that it will be harder to borrow for mortgages, cars and credit cards for a long time. That damage is done. I don't think anything being contemplated will help that even a smidgeon.

    i'm with hellasious. let them fall.


  18. Hel,

    The Z.1 dated 3/6/2008 shows that TCMD declined from Q3 to Q4, 2007. This was the first quarterly decline since 2001 when TCMD declined from the start of the year to the end of the year. This decline in TCMD, if it continues, is a very good thing. It means that mark-to-market losses are finally being realized on a national scale.

  19. Dear Alex,

    >>> I'd be interested in hearing
    >>> what you think is the
    >>> metaphorical "higher ground"
    >>> in this situation?
    >>> Personally, I'm not sure there
    >>> is one. ...

    You're going to force me to be philosophical.

    You've posted a number of ideas that will help, and I posted some in an article entitled "Cities and towns need to start helping themselves."

    Those are good ideas, but I think we can learn some lessons from the tsunami / higher ground analogy.

    1) The first lesson from the tsunami analogy is that there's only a limited amount of "higher ground" available, and people who don't reach it will not survive. Also, people who have access to "higher ground" will not want to share it.

    The leftist ideologue will say, "See? You need socialism / communism to allow everyone to survive -- the state should own all the higher ground, and allocate it to individuals on the basis of need."

    But that doesn't work, as history has shown. Communism in Russia or China or Cambodia or whereever it's been tried has resulted in huge, massive slaughters and bloodbaths, almost to the extermination of some groups of people. It's worse than the tsunami.

    So any solution that's going to work is going to have to find a way to allow the sharing of high ground without sacrificing individual freedom. As you say, such a solution may be impossible.

    2) The second lesson from the tsunami analogy is that there's no automatic political solution. President Bush cannot stop a tsunami. Congress cannot stop a tsunami. The tsunami is coming, and nothing can stop it.

    Even within the commenters to various postings on this blog, presumably a sophisticated group of people, we see people saying that Bush or Bernanke or Congress should have done such and such. Even making that statement is delusional. It makes no difference what anyone did. You can't stop a tsunami.

    3) The third lesson from the tsunami analogy is that each individual has to take individual action. The government can't move "higher ground" to you; you have to move to higher ground.

    That means that everyone has to give up their delusions. As I said, even some of the commenters here make delusional statements. Each person has to accept that unless he can get to higher ground on his own, then he's not going to survive, and waiting for the government to move "higher ground" to him is a death sentence.

    And so, Alex, to respond to your original question, you're right that there is no solution. The "higher ground" solution is technically feasible, but politically impossible. Everything else is useless. Each person has to try to survive on his or her own.

    >>> I would submit that accelerating
    >>> the development of a bottom (for
    >>> both the debt and the asset) gets
    >>> participants back into the game
    >>> and liquidity into the market.

    I think I probably agree with you here, but I interpret what you're saying a little differently than perhaps you do. The Fed and the Administration are pulling off little tricks to slow down the financial tsunami heading toward us.

    I interpret what you say as meaning this: Let the financial tsunami hit us as hard and as qhickly as possible, to get it over with. Whoever's going to die will die, but that'll happen anyway, and when it's over we can start building things again.

    I don't think that solution is politically possible.

    John J. Xenakis
    Web site:

  20. Couldn't agree with you more but this is whay it won't happen.

    The efforts currently being undertaken by the authorities are not directed at them. They aim at helping the very top, where most financial wealth resides: those debt instruments (and their issuers) that are owed by the bottom 90% of the people, but owned by the top 10% of them.

  21. Meli-

    I would LOVE for a hedge fund collapse where an isolated group of arrogant Wall St types received sweet justice for not understanding what their math wizards were modeling. But it isn't isolated because they weren't just selling hedge funds to the rich, they were selling them to pension companies and local governments.

    I worry that there are those in politics who think we can make it up to the "innocents" being deceived by the bullies by replacing their stolen goods (bailouts). Their hearts might be in the right place, but their minds aren't. Because America is nearly broke. The politicians might think that they are not broke because they have a credit card (issuing treasury bonds). Except soon no one will accept our credit card anymore; The balance is already over 9 trillion.

    So in summation your parents may have to come live with you because their private pension and gov Social Security have disappeared. Maybe they can home school your kids because the county can't pay the teachers any longer.

    I don't think its a matter of should we or shouldn't we bail them out or fail. I'm pretty much resigned to the idea that we will try to bail them out and they will still fail regardless :(

  22. For some light relief (and dark Russian humor) see
    on what is to come.

  23. JJ Xenakis,
    You (or perhaps someone else) posted a link to an article on your website a few months ago giving possible scenarios for what a financial meltdown might look like (failure of brokerages and loss of access to assets in accounts, inability to transfer funds, etc.) Unfortunately I lost that link and if you remember the article in question I would greatly appreciate if you would post it again, thanks.

  24. dink, i get it. what i am not as sure of (as you are) is how deep the rest of us in this quaqmire. i don't have time to do a ton of research but this piece seems to suggest that maybe our pension investments are not as deep as one might think.

    if pensions have some 10-15% exposure to hedge funds, i would think they could weather that.

    obviously, there would be tons of number crunching to figure it out, but i'm wondering whether we are all assuming that the interconnectedness is so complete without questioning our assumption.

    pension funds are slow-moving creatures and the big growth in hedge funds is very recent.


  25. I think this is your best essay to date. One of the hardest things for finance guys to do is to be objective. By that I mean not so anthropocentric that they can't see we live on a sphere. Thanks.

  26. dink,
    i wish i could delve into this, but a couple of things are bothering me:
    1) the explosion in subprime is very recent
    2) the explosion in hedge funds is very recent
    3) the multi-trillion dollar GAIN in housing that we are all losing is also very recent (in the last couple of years.

    theoretically, hubby and i will 'lose' about 300 grand on our modest home if housing falls 50%. we bought it almost 30 years ago. It was only worth 250 about 8 years ago. we didn't borrow against it.

    'losing' 300 grand doesn't change our life one iota. 'making' it didn't either.


  27. Meli-

    I am definitely biased towards being a "tin foil hat". So I take that innate skeptical predisposition and add incomplete data to come up with some appalling philosophies. I'm practically becoming a Gen-X Xenakis (are you puking, JXX?)

    For all our sake, I hope your analysis and extrapolation turns out to be more accurate than mine.

  28. Dear yoyomo,

    >>> You (or perhaps someone else)
    >>> posted a link to an article on
    >>> your website a few months ago
    >>> giving possible scenarios for what
    >>> a financial meltdown might look
    >>> like (failure of brokerages and
    >>> loss of access to assets in
    >>> accounts, inability to transfer
    >>> funds, etc.) Unfortunately I lost
    >>> that link and if you remember the
    >>> article in question I would
    >>> greatly appreciate if you would
    >>> post it again, thanks.

    I've mentioned the following two articles here. The third one is a new article on auction-rate securities that everyone ought to be aware of:

    Questions and answers about the 'credit crunch'

    How to compute the 'real value' of the stock market.

    Investment bank UBS is now 'writing down' clients' auction rate securities

    Feel free to send me a private e-mail message if those articles aren't what you're looking for, or if I can answer any questions.

    John J. Xenakis
    Web site:

  29. Ignorance: Galbraith wrote the Affluent Society back in the late 50's which is also a good read:
    a review below:

    Galbraith asserts that the conventional wisdom of economic thinking in the United States is based in nineteenth-century European economic theory and is no longer suited to the unprecedented phenomenon of mass affluence achieved by American society in the twentieth century. He criticizes the overemphasis on high rates of production as a measure of economic prosperity, suggesting that other factors may be of greater importance. He further asserts that economic theory must take into account the importance of advertising in artificially creating high rates of consumption to support high rates of production.

    Galbraith’s central concerns in reassessing the American economy include: the nature of American affluence; the relationship between production, consumption, and advertising; the abiding issue of poverty and economic inequality; and changing factors in such economic concerns as employment, inflation, and consumer debt. He ultimately advocates a greater emphasis on sales tax over property tax; greater government expenditure on such public services as education and health care; and a national goal of expanding the ‘‘new class’’ of citizens able to pursue work they find inherently enjoyable.

  30. I think there is only one thing we can do: work more and save more.

    People say the war saved us in 1941-- personally I think the war was just a reason to really work hard and save everything we earned. When it all ended, we had a whole lot of capital accumulated to put to good ends.

    What other way out is there?

  31. This comment has been removed by the author.

  32. Dear Thai,

    I think that you've said something that's extremely important in just a few words. You've really captured something here, and you expressed it very well. I can't imagine how it could be said any better or any more clearly than you have.



  33. i agree wholeheartedly, that Thai has hit the nail on the head.

    and that is the REAL reason the investment bankers and the hedge fund guys are sweating. Everyone i know has sworn that they would rather wear shoes with holes in them than deal with these credit card companies anymore. The rape and pillage of america, combined with no small amount of fear, is going to make them pull back, and pull back hard.

    If the bankers really understood their own self-interest, they would be focused on consumer legislation that would make the consumer feel like he could step in the game again.

    But i think it's too late. this debacle will change the way americans think about debt for generations, just the way the depression did.


  34. Thai said:

    "I think there is only one thing we can do: work more and save more."


    But..The US economy is now entirely dependent on over-consumption, both of goods and services. And this kind of economy creates the kinds of jobs that go along with it.

    How are you supposed to work hard and save, if by doing so you are very likely to lose your job?

    The economy must be overhauled from the foundations up.

  35. Hellasious,

    A lot of people will lose their jobs. A lot of people won't survive. The point is that "work more and save more" is your only chance to survive, even if it may not be enough.

    Returning to the tsunami analogy, you've got to try to run for higher ground. A lot of people won't reach higher ground, and they'll drown. But running for higher ground is your only chance to survive, even if it may not be enough.

    Overhauling the economy will come only after it's too late for a lot of people.


  36. People. While you've great arguments about how big the booger is, the stock markets are saying otherwise.

    Yes, there's a correction but where's the recession - considering that the markets run ahead by about 6 months?

    It is quite hard to see any correlationship in your understanding and reality.

  37. What about "work LESS, spend LESS, save MORE"?

    If, for resource and economic reasons, consuption is going down, then the amount of work need done goes down also (although energy resources might end up being replaced by more labour).

    If there is less work to do then what about sharing the work (ie, working less, earning less - or maybe earning even the same if "trickle down economics" is stopped).

    That means more free time, less consuption. Do people still remember the time where we derived pleasure from spending time with our families and community? Or are big f*ckin' cars/houses/TVs/travel so entrenched that we don't remember anymore about socialization as a main source of pleasure?

  38. "People. While you've great arguments about how big the booger is, the stock markets are saying otherwise."

    Contrary to popular opinion and Conference Board inclusion in the Leading Indicators, the stock market has become THE absolute worst predictor of economic activity.

    Simple example: S&P 500 peaked in 2000 at 1.550 points. What was it predicting? Tech/telecom/dotcom earnings as far as the eye could see. Horribly wrong.

    Don't fall for the "market up, everything must be OK" claptrap. Believe you me, I have seen up close and personal how it is done. And along with sausages and politics, simple citizens should never witness how markets are manufactured.

  39. >>> People. While you've great
    >>> arguments about how big the booger
    >>> is, the stock markets are saying
    >>> otherwise.

    Q1 was the worst quarter for the stock market since 2002.

    Also, check out the value of the dollar.


  40. Allen Sloan (Fortune online 3/31/08
    "On The Brink of Disaster" towards end of article) speculating that soon foreign creditors will refuse to extend dollar denominated loans, bye-bye reserve currency status. No need to invade any more oil exporters that want to trade in Euros.

    Thank you John for the above links.

  41. Tiago,
    I read an article on a couple of years ago (sorry can't remember link) by a former engineer in the oil industry that calculated that the energy provided by fossil fuels replaces the labor of 300 laborers per capita. In other words each one of us would have to hire 300 people to provide the same life-style that energy provides us with (assuming an upper-middle class life-style).

    If energy supply dwindles (highly likely) only kings and queens will have any leisure time on their hands, the rest of us will be toiling like serfs.

  42. H said:

    "Believe you me, I have seen up close and personal how it is done. And along with sausages and politics, simple citizens should never witness how markets are manufactured."

    So then tell us how the markets are manufactured.

  43. Good idea. I suggest you call this the "no lube" program.

  44. Thai and Hell:

    "Work hard and save more". That'll address the "paddle hard" component, but it doesn't address the navigation component.

    "Work hard" at what?

    Hell, occasionally you posit that the end of the expanding GDP/Consumer-driven economy has arrived. Maybe, maybe not. What's arrived is the end of the way we do it now (no re-use, extraction mentality, etc.).

    In my own thinking, I keep returning to this question: what do we invest ourselves into? What are the standards we apply when we select the industry, the activity, the culture that we buy into tomorrow?

    Hard work is certainly part of the equation, but my view of Americans is not that we're lazy. We are all in a great, big hurry, and we are not bashful about allocating resources to something (esp. when it's borrowed!). We have simply not allocated resources to the right things, and the Piper's arrived with the check.

    No surprise there.

    The question remains unanswered: Where should sentient beings be allocating their effort?

  45. You quote Treas Sec mellon and I am unlcear of on your point about being backward looking. Are you arguing that the governement got it wrong in trying to forestall the amrket clearing (which would be an endoreseent of the curent actios?) The context of the quote was that he was fully advocating letting the market take its course so a more healthy economic footing was found and healthy growth could start. I don;t read his quote as a liquify rather than liquidate the farmer. Anyway, great post. Just curious on the context of the quote. History and theory seem to validate exactly what mellon was saying: let markets work. it is governement inertia that got in the way.

  46. Re: Mellon's quote

    At the time (1930's) there was no safety net: no FDIC, no Social Security, no Medicare.. none of the basic social programs we now take for granted. Mellon made the mistake of thinking the Great Depression was a part of regular boom/bust cycles that had operated in the US since the middle of the 19th century. "Liquidation", though painful, took care of excess relatively quickly and thus the economy also got back on track quickly.

    But the 1930's were very different as we now know - a different type of war.

    Bernanke and Co. are making the same mistake, but from the Keynesian side: they think this is a run of the mill - or a bit more - economic contraction that can be solved by providing massive monetary policy relief.

    In fact, I think, we would be better off taking Mellon's advice right now and liquidate debt ASAP.


  47. Re:"So then tell us how the markets are manufactured."

    I think that:

    (a) If you ever visited a meat processing facility you would seriously consider turning vegetarian.

    (b) If you ever spoke candidly with most party flunkies and/or elected politicians you would seriously consider turning Anarchist (capital A, as in Proudhon and Bakunin theories).

    (c) If you ever witnessed how securities are sold to investors and speculators (they are 90% sold, 10% bought) you would consider sticking to saving bonds. If you are good friends with an honest broker (NOT a customer), ask him/her.

    I have done all three for a long time and I still eat bacon, vote and BUY securities. But I have my eyes open...

  48. Outerbeltway said...

    1. "My view of Americans is not that we're lazy..."

    Yes and no. We don't like deprivation-- I remember my nightly walks home from the Library at Med School (where I was the only 'white' face amongst a sea of recent immigrants) past the fraternities and sororities (a sea of white). Every night it was a new 'wild rager'. I know this point can be overstated, but it has a kernel of truth to it.

    2. "Where should sentient beings be allocating their effort?"

    There has only ever been one way to grow economically-- knowledge creation and social cooperation.

    I remember once reading how developing the A-bomb required 25% of America's entire copper supply. Imagine Americans or Europeans making that kind of sacrifice today. I just returned from a trip to Colorado the other day—you should see the gluttonous homes some of these Masters of the Universe are building on mountain tops. These kinds of activities are terribly destructive to social cooperation. Yet on the other hand, all day long, all I read in the Washington Post (my local rag) is that some Liberal politician is saying ‘the poor are suffering and we need to get someone else (e.g. the rich) to pay for it’-- even to the extent their math is correct, the social disintegration they preach is horrifying. Only war (or fear of extreme threat) seems to catalyze social cooperation… “Let’s cooperate against a common enemy”. WWII ended the socialist’s destructive language of rich vs. poor in this country once and for all and everyone could cooperate towards a final goal. Everyone sacrificed (at least more than they had). That was when we became rich again, when everyone cooperated--- that has always been the Scandinavian/Nordic secret for success.

    Basic research is our ONLY way out of the mess (and it needn't be in energy alone), yet it is shrinking almost daily as a % GDP. That needs to change immediately (something NO politician is talking about).

    Think of the world’s MASSIVE needs to reduce dementias, infirmity, illness, trauma, etc... Making significant improvements in any of these areas would have tremendous improvements on social productivity and wealth (assuming it didn’t mean the elderly used the gift to spend more time on the golf course).

    A new energy regime is necessary, but if we don’t find it right away, that’s OK; its discovery is not the only way out of our current predicament.

    My thoughts:

    1. Pass a constitutional amendment dedicating 10% GDP to basic research FOREVER. There is PLENTY of government/personal spending we can do without—even amongst the poor. Increase researcher’s salaries until it starts looking attractive to return as a career again.

    2. Get rid of the social idea of ‘golden years of retirement’. What a myth paid for by the young in this country. As we live longer it makes things worse and worse.
    3. Bring back a regressive flat tax at the same rate for EVERYTHING: income (same for every income level, rich or poor), capital gains, etc... It is a myth to think our current ‘progressive’ system does not destroy social cooperation (people who pay a lot more in taxes start looking at those they see as ‘freeloaders’ on the system… the poor/welfare/chronically infirm, etc… and this destroys social cooperation from their end.
    4. Start paying down our debts.

  49. Hmmm, when McCain advocates this, Obama calls it a "do-nothing" plan. I'm not sure it's going to resonate with voters this round.

    And secondly, when is someone going to get around to advocating that we get rid of every planning board in the country? They surely hold some of the blame for the oversupply of housing and strip malls we currently see. High time we stopped wasting any money on a group of people who will basically approve any application that crosses their desk.

  50. "It is quite hard to see any correlationship in your understanding and reality."

    The Dow is your gauge of reality? You're putting a lot of trust into people who have a lot to gain by being dishonest.

    "Where should sentient beings be allocating their effort?"

    Airline safety drills always tell you to put on your own oxygen mask before helping others with their masks. Its a a great principle outside the plane, too. Become as responsible, healthy, and self-sufficient as possible. This will minimize your liability to a group. Learn math, science, and practical skills derived from them. This will maximize your value to a group. Being part of a viable group will greatly increase your chances of 1) happiness if society is stable, or 2)survival if society is not stable.

    Thai- I'm glad someone is brave enough to go after the retirement myth.

  51. H:

    Let me add one to your list:

    d) If the working class people in this country truly understood how they are being taken advantage of, there would probably be a general strike across the country.

    This kind of ties into your point "b."


    Do you not see the conflict in your beliefs? Let me show you. You said:

    " should see the gluttonous homes some of these Masters of the Universe are building on mountain tops."

    You do know that progressive income taxes are one good way to discourage such gluttony, right?

    You then said:

    "Yet on the other hand, all day long, all I read in the Washington Post (my local rag) is that some Liberal politician is saying ‘the poor are suffering and we need to get someone else (e.g. the rich) to pay for it’-- even to the extent their math is correct, the social disintegration they preach is horrifying."

    Can you not see that the "social disintegration" that you refer to has already happened? The Washington Post didn't create it; they are proposing a way to mitigate it.

    "Only war (or fear of extreme threat) seems to catalyze social cooperation…"

    I think it is high time that we become patriotic about something other than war.

    Actually, I think Naomi Klein has gotten closer to it.

  52. Dear Thai,

    >>> I remember once reading how
    >>> developing the A-bomb required 25%
    >>> of America's entire copper supply.
    >>> Imagine Americans or Europeans
    >>> making that kind of sacrifice
    >>> today. I just returned from a trip
    >>> to Colorado the other day—you
    >>> should see the gluttonous homes
    >>> some of these Masters of the
    >>> Universe are building on mountain
    >>> tops. These kinds of activities
    >>> are terribly destructive to social
    >>> cooperation.

    What you're describing here is going to change drastically and dramatically.

    In generational theory, what we're waiting for is a specific event call the "regeneracy," something that will end the political bickering and regenerate civic unity for the first time since the end of WW II.

    William Strauss and Neil Howe, the founding fathers of generational theory, described the regeneracy in their book, The Fourth Turning:

    >>> "Private life also transforms beyond prior recognition. Now less important than the team, individuals are expected to comply with the new Fourth Turning standards of virtue. Family order strengthens, and personal violence and behavior now face implacable public stigma, even punishment. Winner-take-all arrangements give way to enforceable new mechanisms of social sharing. Questions about who does what are settled on grounds of survival, not fairness. This leads to a renewed social division of labor by age and sex. In the realm of public activity, elders are expected to step aside for the young, women for men. When danger looms, children are expected to be protected before parents, mothers before fathers. All social arrangements are evaluated anew; pre-Crisis promises and expectations count for little. Where the Unraveling had been an era of fast-paced personal lives against a background of public gridlock, in the Crisis the pace of daily life will seem to slow down just as political and social change accelerates."

    Things like "social sharing" and "survival" are not part of society today, but they will be. This is the American and European society that you can expect to see before long.

    In the American Civil War, the event triggering the regeneracy was the Battle of Bull Run; in WW II it was Pearl Harbor and the Bataan death march. What will it be this time? It might be a terrorist attack on American soil, or it might be a significant military defeat of some kind. Whatever it is, it will regenerate civic unity and change society in a way that can barely be imagined today.

    John J. Xenakis
    Web site:

  53. Hey Okie!! :)

    I apologize this is a little long but I hope to bury our differences once and for all!

    Perhaps I should have added '(sadly) only war...'
    Please do not ever think I am a fan of war. I do not believe 'we need a good war now and then to clean things out’-- if that is what you are getting at. If it is you really have the wrong view of me. But as John just said, society does need some kind of ‘regeneracy’ to restore cooperation.

    As for what you see as a conflict in my beliefs-- I ‘THINK’ (?) I see how YOU may see a conflict in my beliefs, but to me they are completely compatible. Did you read my frame of reference essay? Please remember econophysics and evolutionary psychology form the basis of how I look at the world.

    Okie, to answer your question-- 'yes', I think progressive income tax would reduce this gluttony. However, the problem with the seemingly obvious social benefit of a progressive tax system is that it comes at a cost I find completely unacceptable-- the rich resent the poor as 'freeloaders'. And try as the poor might to shame or guilt the rich into understanding they need the money more than the rich (because they are poor); still the rich will never see the poor as their equal in their eyes. And Okie, if you try to telling me this is not true in our society (really every society in the world); I hope you are VERY eloquent; I have NEVER encountered this to not be the case when I scratch the surface. Read the chapter on online dating in if you don't believe me.

    Okie, as I see things-- life/people/wealth/(you name it) do not really look at how much they make in any kind of absolute sense over the long term. People really only care what their rate of return is (over the long term) and what their social standing is within their group. So if you visit a home/town more than 100 years old, you will quickly realize even most of today’s poor live like the very rich compared to yesteryear. But still this is not enough because people really don’t care what their absolute wealth is; they really only care where they stand within a group. Just look at the fundamentalist Islamic nuts trying to maintain the world they once knew; they don’t mind one bit if their countries regress economically, as long as they remain on top of their social pyramid.

    To quote Hell ‘the generals keep trying to fight the last war’-- so too our mind’s evolution is trying to make us behave as if we still existed in the small bands of the savannah where 99.99999% of our evolution occurred. But this is not the case anymore; today we live in a vast world with billions of people becoming more and more connected by the hour. And wealth inequality is simply a mathematical fundamental of social networks: wealth distributions follow fractal scalability. There is nothing you can do to change this fact. It is a fundamental, like the sun comes up in the morning. And the larger groups become, the more scalable and disparate wealth distributions becomes… I REPEAT THERE IS NOTHING YOU CAN DO ABOUT THIS, NOTHING, IT IS WHAT IT IS!

    So I am faced with a dilemma: cooperate or defect. I can defect because my moral biology tells me to disagree with the math/science that says this is so (believe me, I am sure my genes don’t like wealth inequality any more than yours—I did go to Berkeley, I did vote for Obama). But how? By destroying the status quo and making the group smaller? I find such action totally reprehensible. Or I can cooperate with the system I live under—I choose cooperation.

    In a world with billions of people all connected by the web, old notions of social standing and material wealth are absurd. I could care less whether you are rich or poor. To paraphrase Dr Martin Luther King “I judge on the basis of character”. If I don’t trust you (something you may have misunderstood from one of my other postings), I don’t trust you, period. I agree, trust is earned.

    Perhaps this will help you better understand me: I could (truthfully) live in a system where I gave 90% of my earnings to the collective; my only issue is I would demand absolutely the same from every other member of the collective. Anything less would destroy my trust/faith in the system. I am neither an extreme 'free market' capitalist, nor a 'big government' socialist, nor even a 'split the difference' type of democrat (third way?). I could easily live under all three systems—but the devil is in the details. I see all systems as expressions of something much more fundamental: collectives of people ‘cooperating’ or ‘defecting’. I choose cooperation because I see its advantages, but I understand the cost of cooperation comes at the risks that those I cooperate with will not produce results-- leaving me worse off than if I never cooperated with them at all (in evolutionary psychology this is called 1+1>2 vs. 1+1 < 2). With such risks, I will abandon system ‘cheats’.

    So my views are kind of a populism, but they do not include things like race, nationality or wealth (if that helps). Most populists I know view society thru the lens of social class/wealth-- which I reject.

    Anyway, I hope this helps.
    And by the way, to say society is disintegrating seems a little melodramatic to me (who knows?); in fact if anything, I think it is getting better all the time (remember the TED video I shared on the fractal improvement of violence over the millennium?)

    Can the wealthy be shamed a little more? Absolutely!!!

    But the thing about cooperation is that everyone needs to give a little.
    And it is sad that war (or common external threat) seem to be the only way social cooperation happens-- if you have other suggestions on how to get society to cooperate (John, do you?), I am all ears!

  54. Sorry, I know it's hard to read. It seems I forgot to close a tag for an html link to Freakonomics and I don't know how to fix the problem.

  55. Some good points, but a lot of junk here.

    Resource depletion? Give me a break. Remember Julian Simon versus Paul Ehrlich. More left wing talk to try to control people.

    "Now America is to be replaced by China and Europe at the top."

    China will (eventually) rise to the top, but Europe? HA HA HA HA HA! They have much worse structural (and demographic) problems than the United States does.

  56. Wealth distribution by type of asset, 2001
    Investment Assets
    Top 1 percent Next 9 percent Bottom 90 percent
    Business equity 57.3% 32.3% 10.4%
    Financial securities 58.0% 30.6% 11.3%
    Trusts 46.3% 40.4% 13.3%
    Stocks and mutual funds 44.1% 40.4% 15.5%
    Non-home real estate 34.9% 43.6% 21.5%
    TOTAL 47.8% 37.7% 14.5%
    (Edward N. Wolff, 2004)

    My point? Simply that the upper 10% constitute a rentier class, i.e. what can be thought of a group who depends on its ownership of claims to what is ultimately other peoples labor.

    Further, that any relative insufficiencies of labor value realized as economic profit is compensated for through a substituting of debt-based subsidies via, as we've been seeing, State and quasi-state channels and that, while this has been ongoing, it has become progressively more consequential and evident.

    The politicos may constitute a ruling class but this is a 'class' meant and willing to do the bidding of and safeguard the dominant even though in doing so it virtually guarantees severe problems for all.

    In short, a ruling class unfit to rule and a dominant class perfectly unfit to dominate.


  57. To Anonymous who said:

    "Resource depletion? Give me a break."

    A three word answer: Iraq. Oil. War.

    In my experience, actions constitute 99% of proof. As in: "watch what I do, not what I say".


  58. Thai:

    I did read/watch your and I wanted to e-mail you some thoughts on it, but you don't provide an e-mail link.

    I don't think you can "bury the hatchet" with me (not that there's any hatchet that needs to be buried), because I think your ideas are simply Social Darwinism and Pareto principle combined with "flat tax" ideas. I have to go to work now; I will have to expand on it more later. The ideas do kind of have a synthesis, but that doesn't change my criticism of them.

  59. Okie, I look forward to your reply! :)

    And 'yes', I absolutely believe in Pareto (the constancy of wealth scalability according to 'power law' distributions).

    But as I said before, I strongly reject the Social Darwinism label-- something VERY different than Pareto and something I find quite offensive.

    I can see how people who do not understand evolution well might confuse the two and thereby link Social Darwnism and Pareto, but to evolutionists, they are VERY VERY different.

    So again, I am interested to read your reply, but one comment: are you sure you are not a Social Darwinist without even realizing it? Or perhaps 'religious' without realizing it? (no insult intended if you are either)

    Remember, I read a lot on evolution so please think about your response.

    Perhaps this might help?

    I really recommend you read the page 221 to 239 (if you have time, which I know is short for all of us).



  60. Thai:

    My main concern regarding evolutionary psychology and the Pareto principle is that it attempts to explain wealth distributions in societies by claiming that is somehow mathematical -- even scientific -- which I reject. No concern seems to be given as to whether such a distribution is a just one. It assumes (as you have said before many times, I believe) that such distributions are unchangeable in any political or economic system.

    I'm am not saying that the Pareto principle does not have some application. I just think you are taking too far.

    You said you went to Berkeley and voted for Obama. Good for you. I have written diaries on DailyKos urging former John Edwards supporters to support Obama now that Edwards has suspended his campaign. But I can assure you that Obama does not support a flat-rate income tax.

    The problem with the flat tax is that it is unfair because the lower income earners in society have to expend more of their resources for basic necessities such as food, shelter, energy and transportation. This tax burden then can be a barrier to entry to social advancement. I make the same point about student loans, but that is another discussion entirely.

    There is also a point where such costs to wealthy citizens become de minimis. As more of the wealth becomes concentrated, three problems occur:

    1) Wealth gets hoarded and needed capital for business formation is unavailable for new, innovative and improving technologies, which prevents products that would improve everyone's quality of life from reaching the market.

    2) Even if such capital is invested, the person with the concentrated wealth has a finite and limited understanding of the world. As such, the capital gets misallocated to endeavors which are less productive...or even useless. Therefore the wealth becomes wasted. Even if we extend this to the person's family, the amount of knowledge garnered is still quite finite.

    3) To the extent that such wealth is invested in new technologies that are invented by new players, the contracts are often bought for far less than their "market value" due to the disparity of bargaining power of the wealthy participant and the non-wealthy participant.

    OK, enough about that. If you want to know more about my philosophy, you can see two of my posts:

    The Orphans of God; and my most recent post:

    The Greatest Happiness Principle.

    Like all humans I am more complex than these two posts show. But that ought to give you a start.

  61. For a long time they continue to build and expand New Orleans, knowing full well it is below sea level and right in the path of great hurricanes. 5 days before Katrina, all can see the giant swirling clouds honing for New Orleans. Then it hit. Natural physical laws in control of everything, dictating the outcome.

    Much warnings were sounded as far back as 1998, when the Asia Financial Crisis hit, that the US is asking for similar trouble and need to change things.

    So new we are talking about changing things, after the financial Katrina. So unfortunate because again, natural physical laws are in control post par tum. I say again, natural laws, NOT those made in DC and Wall Street. Deal with it.

  62. Thai:

    Another point that I just realized that I forgot to make: the implication, as I see it, is that somehow the disparity of wealth is a natural state and no attempt should be made to change it. I also disagree with this idea.

  63. Okie, Thanks! Actually, I just left a posting on your blog responding to all your thoughts to spare everyone else on this blog.

    Actually, I did infer this point from your last posting, even though you never directly mentioned it.

    If you want to fight the system, go ahead! I still am not sure you see my point, but that is probably my own fault/lack of eloquence.


  64. One last (small) point

    evolutionary psychology does not try to explain wealth distributions as we see them, it tries to explain human behavior.

    Pareto (the way most people I know think of it) is noting more than an observation, . Pareto does not try to explain 'why' the distribution exists, nor 'whether' it should exist or be changed... Though Pareto himself did note the apparant ubiquity/constancy of the wealth distributions when he loked at them across geography and history.

    It is the study of complexity economics and the study of complex adaptive systems which tries to look at things like whether Pareto is 'natural' or 'changeable'.

    Remember, the constancy of hierarchy within a social network does not mean the players within a network remain constant.

    Dinosaurs were once the 'wealthiest' members of a social network/ecosystem (really the same thing) of bygone eras. Within that dinosaur network, there were further dinosaur subspecies networks-- meat eater vs. plant eater or meat eater vs. meat eater for example); except for their remaining avian grandchildren, we know what happened to their 'supremacy'.

    While ecosystem network heirarchys remains intact, player supremacy often changes with the network.

    Think on your own life and you will clearly see this is true.