If only it were a crisis of confidence

An interesting view that’s bound to stimulate debate (but not the economy) comes from the Daily Reckoning.  I think it offers an opportunity to view the current crisis and attempts by the government to stimulate the economy from a broader perspective.

Firstly, however,  TB pointed out something we’ve both, as well as many others have previously and it relates to the record level of private debt we are carrying coming into this crisis :

Over-borrowing and overspending got us into this fix. It stretches the paradox of Keynesian economics to believe that even more borrowing from a less bountiful future to consume now provides the solution, even if the stimulus comes from the Government on behalf of households, rather than from households directly.

It’s also worth noting history shows that people who save and invest grow and prosper, and the others deteriorate and collapse.

The Final Frontier

The Daily Reckoning Australia

Paris, France – Melbourne, Australia

Tuesday, 10 February 2009

From Dan Denning on the Gold Coast:

–Second thoughts. After the first initial optimism that “doing something” was better than “doing nothing,” you get the sense a lot of people are having second thoughts. Are recessions really caused by a fall in aggregate demand? Or is the previous credit boom that leads to bad investments that makes recessions inevitable?

–The answer to that would matter quite a bit, especially if you were about to commit billions of dollars in money borrowed from the future to test your theory. Isn’t that just high-stakes, high-brow gambling? Have our legislators become speculators? Or are they just providing further evidence that they are morons?

–Over in the States, stocks fell. The Geithner plan-or TARP II as it’s imaginatively named-is facing second thoughts of its own. The banks will get more capital. But no one can figure out how to handle the toxic assets. The big idea is still setting up an “aggregator bank” to act as dumping ground/rehab clinic for the distressed and non-performing loans that securitise so many bank assets.

–And in Australia? Warwick McKibbin told the Senate yesterday that, in his personal view, the stimulus is just too darn big. “Australia is very well placed to withstand the shock which is currently emanating from the world economy,” he said, according to Bloomberg. “This suggests that the scale of the Australian response should be less than the world average.”

— “The current package is too large at this stage of the global economic slowdown. Given the circumstances in Australia, the package should be less than the 2 percent of GDP average stimulus recommended by the International Monetary Fund. Australia does not yet have a domestic financial crisis, but it does face a substantial reduction in exports and substantial decline in the wealth of its citizens. The first job for this package should be to help restore confidence.”

–If only it were a crisis of confidence. The crisis is not what people think about the solvency of the financial sector. The crisis is in the virtual insolvency of many large banks. No amount of cheerleading will change a balance sheet, and changed perceptions do not change the reality.

–Or, as economist Dr. Roger Garrison writes in a chapter on the Austrian theory of the business cycle, “The loss of confidence comes from the realisation that the economy is overextended, asset values cannot be supported, and decisions about how to allocate capital have been based on a false cost of capital and the false level of demand it ‘stimulated.’

–You don’t fix any of that with new stimulus.

-“The core problem for investors is financial instability,” reckons Ashok Shah, the chief investment officer at UK asset managers London & Capital. “If you look at the IMF numbers [forecasting a total $2.2 trillion loss on US bad debts], we are only halfway through the non-performing loan cycle.”

–“Governments are supplying liquidity into the system and unless they sterilize it [by issuing bonds to soak up the excess money creation] they are laying the foundations for much higher inflation for years to come. These are the things gold thrives on,” he told Reuters.

–Of course gold fell over $20 in New York, but his point is well taken.

–And this gives us a chance to make a point we’ve neglected to make it our previous statements about gold: it is the common law version of money. People ask all the time what inherent quality gold has that makes it a superior medium of exchange to salt, pepper, oxen, or bubble gum.

— Gold has at least four physical qualities which make it suitable as money. It’s durable, it’s divisible, it’s convenient, and it’s consistent, not to mention hard to counterfeit. Bars, bullion, coins, even goldsmiths notes…throughout history you could be pretty sure people were going to accept a quantity of gold in exchange for some good or service.

–And that’s really the best reason to explain gold’s historic popularity as a medium of exchange. People have accepted it as such. That makes gold, in our view, a kind of common law money. If people traditionally view gold as money, maybe there’s something to it. Maybe this whole fractional reserve paper money experiment is an historical aberration in the history of money.

–So for the record, yes; there are certain physical properties of gold that make it especially useful as money. And it’s worth nothing people have used it as such for thousands of years. It’s not that there’s any higher mystical principle behind the yellow metal as a medium of exchange. It’s just that it’s what people have accepted as money for a long time. This acceptance is noteworthy if you’re somewhat philosophical. It’s a voluntary exchange without coercion. In a perfect world, that’s the way you draw it up.

–But as we’ve said before, money is not wealth. Neither is gold. You have to trade it for something useful. And it’s better if you receive it for what you produce and then invest in it capital goods, rather than hoard it or worse, squander it. Just ask the Spanish and the Portuguese.

–It is very easy for the people of a nation to mistake money for wealth, or even commodities for wealth. But any useful theory of wealth would probably focus, at least in the material world, on the production of capital goods, and not, say, the consumption of consumer goods. There is no inherent value in anything. It’s what you produce and how useful others find and what they’re willing to exchange for it that determines value.

–The moral of today’s story: Woe to the modern economy that treats paper as wealth and fails to save or invest. We may think we have money on our hands. But paper is not metal and credit is not a substitute for saving. If things keep going the way they’re going, you may have to trade a lot of paper to get anything of substance

Over To You


23 Responses

  1. There is another debt that is being completely overlooked in all this and is as damaging in the long run as all the debts and in some ways more so.

    A successful election campaign was substantially run on it, replete with a large mobile billboard denouncing the folly of it and the damage it would do the country if not curtailed, only to see the announcers of the folly and promised saviours to curtail it change their spots on winning their much wanted power on the back of that campaign to the point of massively increasing to astronomical levels the very folly they said would destroy this country.

    It’s the Foreign Debt Stupid

  2. JMc, the link should be credited to ToSY…he found it in answer to some of my posts…

    It’s also worth noting history shows that people who save and invest grow and prosper, and the others deteriorate and collapse.

    …but people who excessively borrow and spend, end up having the savers and investors paying for their excesses…so everyone loses…

    …I haven’t borrowed money for over 25 years – but now my income as a SFR is being threatened because we have to pay for other peoples excesses…

    …and why are the Boards, CEO’s and Senior Staff of failed and failing banks and companies still running them around the world…

    …because the world is still being run by The Robber Barons (referred to in the last century as The Grey Men of Switzerland). This is just one reference…


    These people “own’ the world and its governments…particularly democratic governments…now we have China ready to leap onto the stage – what a showdown that’s going to be…

    …but guess who pays in the end with their money or their lives…

  3. TB, I also find it interesting that a man who has been at the forefront of financial innovation for 30 years, Richard Bookstaber, would win praise for his forthrightness, honesty and insights about the perils that market fundamentalism (with its love of banking deregulation) has wrought on the global financial system and global economy, by a group of CEOs no less . Great read by the way.

    800 CEO Read.com – Demon of Our Own Design By Richard Bookstaber

    Markets, Hedge Funds, and the Perils of Financial Innovation

    By: Richard Bookstaber

    We chose A Demon of Our Own Design as the best finance & economics book of the year in our first annual 800-CEO-READ Business Book Awards. To see the other winners and finalists, go to our awards website or pick up a copy of In The Books, a magazine devoted to the most notable books of 2007.

    Book Description
    Inside markets, innovation, and risk.

    Why do markets keep crashing and why are financial crises greater than ever before? As the risk manager to some of the leading firms on Wall Street-from Morgan Stanley to Salomon and Citigroup-and a member of some of the world’s largest hedge funds, from Moore Capital to Ziff Brothers and FrontPoint Partners, Rick Bookstaber has seen the ghost inside the machine and vividly shows us a world that is even riskier than we think. The very things done to make markets safer, have, in fact, created a world that is far more dangerous. From the 1987 crash to Citigroup closing the Salomon Arb unit, from staggering losses at UBS to the demise of Long-Term Capital Management, Bookstaber gives readers a front row seat to the management decisions made by some of the most powerful financial figures in the world that led to catastrophe, and describes the impact of his own activities on markets and market crashes. Much of the innovation of the last 30 years has wreaked havoc on the markets and cost trillions of dollars. “A Demon of Our Own Design” tells the story of attempt to manage market risk and what it has wrought. In the process of showing what we have done, Bookstaber shines a light on what the future holds for a world where capital and power have moved from Wall Street institutions to elite and highly leveraged hedge funds.”

  4. TB

    I tend to view Hyman Minsky’s description of the financial system and its impact on the real economy extremely convincing:

    Minsky defines three financial positions of increasing fragility:

    * Hedge finance: income flows are expected to meet financial obligations in every period.
    * Speculative finance: the firm must roll over debt because income flows are expected to only cover interest costs.
    * Ponzi finance: income flows won’t even cover interest cost, so the firm must borrow more or sell off assets simply to service its debt.

    Over a protracted period of good times, economies tend to move from a financial structure dominated by hedge financing to a structure with increasing speculative and Ponzi financing. The shift toward speculative positions occurs intentionally and more or less inevitably because of the way in which success in a boom enhances expectations. However the shift from speculative toward Ponzi finance is usually unintentional.

    Business cycles are endogenously generated, and are not due to shocks. In large part they are due to the interplay between the two price systems and the way the financial system naturally evolves toward fragility. Exogenous effects can precipitate a crisis, but only when the system has already evolved to a fragile position.

    Conventional wisdom argues that the economy is naturally stable, with the invisible hand guiding the economy to equilibrium. Rather than treating institutions as contributing to stability, orthodoxy views them as barriers to achieving equilibrium. Minsky argues that institutions and interventions thwart the inherent instability of financial capitalism by interrupting the endogenous process and restarting the economy under more favorable conditions.
    System Instability

    As Minsky observed, capitalism is inherently unstable. As each crisis is successfully contained, it encourages greater speculation and risk taking in borrowing and lending. Financial innovation makes it easier to finance various schemes. To a large extent, borrowers and lenders operate on the basis of trial and error. If a behavior is rewarded, it will be repeated. Thus stable periods naturally lead to optimism, to booms, and to increasing fragility.

    A financial crisis can lead to asset price deflation and repudiation of debt. A debt deflation, once started, is very difficult to stop. It may not end until balance sheets are largely purged of bad debts, at great loss in financial wealth to the creditors as well as the economy at large.

    Minsky would not attribute the crisis to irrational exuberance or manias or bubbles. Those who were caught up in the boom behaved rationally, at least according to the model of the model they had developed to guide their behavior. That model included the prospective course of asset prices, future income, behavior of policymakers, and ability to hedge risks or shift them onto others. It is only in retrospect that we can see the boom for what it was: mass delusion propagated in part by policymakers and those with vested interests.

    However, a large part of the blame must be laid on the relative stability experienced over the past couple of decades the tranquility that made the boom possible also created fragility because,according to Minsky, stability is destabilizing.

    The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility.

    It think it is far too simple to attribute the current crisis to a speculative boom in real estate, to excessive monetary -ease, or even to lax supervision. The causes are complex and have developed over a very long period.As such, solutions will also be multifaceted, tentative,and contingent upon continued evolution of the financial system, with an eye to longer-term trends that have made the system much more prone to crisis, in my opinion..

  5. Let us not forget that many Australians having been saving for quite a few years now. It’s called Superannuation. Provided those savings are protected & used effectively there is money available for investment & paying off your houses. But if people are dumb enuff to transfer their Super into the hands of shonky money managers because Neo-Liberals & CONserviles like Howard, Costello & Minchin use financial incentives and SALES TACTICS to promote moving out of more secure & regulated accounts, then they deserve everything they get.


  6. nasking

    There are shonky money managers and there are good money managers who are genuine in their desire for their clients to accumulate wealth.

    I have a Financial Planner and intend to stick with him as I trust him to have my financial well being at heart. It is not his fault we have an economic melt down.

    Over 70% of Super is inveted outside cash holdings be it by planners or employer funds it is still exposed to the current economic climate.

    I think we need to ensure we don’t have an Spanish Inquisition and label all people within a certain profession as shonky or dishonest.

  7. shaneinqld, the system is about to crash big time again, primarily because too many people w/ certain careers & mindsets that prioritise “wealth accumulation” over substantially paying off existing debt have been promoted as the geese that lay the golden eggs…primarily because governments of a certain political persuasion leant far too much in the direction of trusting financial advisors & bankers & manufacturers & farmers & & energy suppliers etc. to do the right thing.

    I went to a party of stockbrokers and financial planners back in 2003…most were loathsome, egotistical, callous, greedy fools…or just plain ignorant. Interestingly, many had been employed in other sectors previously & were half-decent characters before the money lust got a hold of them.

    When I told them that by the end of the decade we would see a re-emergence of Social Democratic policies & even a temporary re-nationalisation & part-nationalisation of banks, utilities & other sectors most laughed in my face and spouted on about their “accumulating wealth”…all bar one fella who looked concerned, gave me his card and said he’d like to hear more.

    As far as I’m concerned, the problem lies in the myopia & lack of social, environmental, historical grounding of many in the financial industry. Or their education has been too slanted towards certain ideological perspectives. And during the rampaging of the BULL even the most wide thinking theorist &/or employee can have their ideas trampled in the RUN.

    Sure, I’m sure there are plenty of rational, cautious financial planners out there…even imaginative, who have the clients good fortune in mind…but how do we define “good fortune”?

    As for Super, I’d like to see workers be able to redirect some of their deductions into eating off their debt burden. Hard times call for practical measures. I’m not sure the interest rate decreases are going to do the trick…nor how far they can go w/out putting the country & banks into a really wobbly state.

    “I think we need to ensure we don’t have an Spanish Inquisition and label all people within a certain profession as shonky or dishonest.”

    Indeed, weed out the bad apples…and focus by way of a DIVERSE media on the good ones who have assisted the TORTOISES in their journey…:) And EDUCATE….wider. And governments need to set a more COMPASSIONATE, less consumerist agenda…

    Business does not need to be toxic. Or sell unrealisable dreams. Or dreams that come at the expense of our children, environment & working populations overseas that are kept in abject poverty in order to supply the goods for those toxic dreams.


  8. nasking

    The problem with redirecting superannuation to paying off debt or other obligations means that it is not being saved for the true reason, providing an income at retirement to save the country the crippling pensions in the future.

    In addition how do you control paying off genuine debt and recklessly accumulated debt that you speak of now. All very well to start using super for what it was not intended but very hard to apply the brakes and also to stop rorting of the funds.

    At the moment there is massive loss of super funds by people running their own super and then blatantly taking the funds out for personal use to pay for badly accumulated debt.

    Tinkering too far will destroy the whole purpose of superannuation in the first place.

  9. “Tinkering too far will destroy the whole purpose of superannuation in the first place.”

    shaneinqld, I understand your concerns, but it’s going to be difficult to explain to those who are losing their jobs & finding it hard to service their house debt in the future why they can’t access a small portion of their compulsory savings in order to keep a ROOF over their kids heads. I’m talking about redirecting a certain percentage of Super payments into someones home loan for a few years until we begin to climb out of this mess…

    that future Super payout/pension will be absolutely useless to depressed home owners who have done the right thing for years and due to their health &/or diminishing jobs circumstances are under so much pressure that they die early or kill themselves…or end up on the streets…or in jail…when a small amount redirected from their compulsory payments could’ve made the difference.

    just trying to think ahead. Thnx for the response.


  10. N’

    “that future Super payout/pension will be absolutely useless to depressed home owners who have done the right thing for years and due to their health &/or diminishing jobs circumstances are under so much pressure that they die early or kill themselves…or end up on the streets…or in jail…when a small amount redirected from their compulsory payments could’ve made the difference.”

    This must be a real dilemma for many people who now they have super accumulating and are unable to access even the voluntary portion yet struggle to meet their debt demands now.

    And how do so many people also feel about the destruction of their super brought about by the current crisis?

    Sadly, this crisis isn’t over by a long shot and just how bad it can get is unknown.

    As TB also said

    “… people who excessively borrow and spend, end up having the savers and investors paying for their excesses…so everyone loses…

    …I haven’t borrowed money for over 25 years – but now my income as a SFR is being threatened because we have to pay for other peoples excesses”

  11. Shane

    “At the moment there is massive loss of super funds by people running their own super and then blatantly taking the funds out for personal use to pay for badly accumulated debt.

    Tinkering too far will destroy the whole purpose of superannuation in the first place.”

    It shows just how complex and dangerous this crisis has really been. Sadly, many of us lost respect for the concept of risk and loss.

  12. Shane and N’

    And here we are:
    Minsky’s theory of financial crises is set within the context of an expanding economy. As the expansion develops, optimism increases, and conventions about the proper level of debt and risk begin to change. Prices of financial assets rise and the general level of speculation increases. Speculation is taken to be the attempt to bet on the future direction and psychology of the market (Keynes 1936, ), and also the more general process of financing assets whose value depends on future developments (Minsky 1975, ).

    As attitudes about risk and proper liability structures change, the financial system becomes increasingly fragile. Minsky’s view is that fragility grows as debt levels increase.

  13. “Sadly, many of us lost respect for the concept of risk and loss.”

    John, that’s what we get when our media is dominated by talking heads, editors, moguls & radio jocks who prioritise profiteering & obscene competitiveness over a more holistic approach to work & environmental/social issues. And when governments allow corporate access to public media & allow boards to slash skiiled jobs in order to save bucks & in turn dilute creativity & diversity of message/information. Think the ABC news department.

    When the public is exhausted, work-worn, anxious, desperate for pleasure, desiring security, on the verge of being addicted to fulfilling wants and desires to overcome fear & that sense of doom that comes w/ recognising the mortality…and they’re plugged in & the voices continually say BUY BUY BUY…INVEST HERE INVEST HERE INVEST HERE…WATCH THIS WATCH THIS WATCH THIS…TRUST THIS PERSON TRUST THIS PERSON TRUST THIS PERSON…well, it’s a strong INDIVIDUAL that can resist THE WAVE of PROPAGANDA.


  14. Funnily enough N’ I understand what you’re saying and completely agree.

  15. Now Russia’s in danger of defaulting on its debt obligations, again.

    Russian debt woes report stuns euro
    Russia will request negotiations with European and other foreign banks to postpone repayment on up to $US400 billion ($600 billion) of its private sector debt, Japan’s Nikkei business daily said today.

    The euro fell sharply on the the report, with the single European currency sliding more than 1% against both the dollar and the yen.

    The newspaper quoted a Russian banking industry official as saying up to $US400 billion in debt was at stake.

    A proposal for postponing repayment had been submitted to the government and some foreign banks have already agreed to start negotiations, the Nikkei said.

    “As was the case last week when Fitch downgraded Russia, bad news about Russia basically becomes a factor for the euro to fall,” said Takahide Nagasaki, chief foreign exchange strategist for Daiwa Securities SMBC.

    This is because of the euro zone’s economic ties with Russia, and also since banks in the euro zone probably have large lending exposure to Russia, Nagasaki said.

    Fitch Ratings downgraded Russia’s sovereign rating to ‘BBB’ last Wednesday and said further cuts were possible due to low commodity prices, high capital outflows, melting reserves and corporate debt problems.

    Fitch’s downgrade followed one from Standard & Poor’s in December, making it the second ratings cut for Russia since the end of its last major financial crisis in 1998, when Russia devalued the rouble and defaulted on $US40 billion of its debt.

  16. Hyman Minsky eh? I’ll try to get around to reading that. Thnx for the link John. Must go spend some time w/ my wife. Later.

    The Russian news is worrying. There are some real hardliners waiting in the wings to pounce from what I hear.

    You might find this interesting reading:


    (The Washington Morons:
    Driving Over the Cliff
    February 9, 2009)

  17. They all knew that it would all the lending boom would end badly, but were surprised by just how badly. It’s got to make you wonder just how narrow minded and greedy some of these bankers really are.

    Ex-bank chiefs sorry for crisis

    THE former heads of two of Britain’s biggest banks have offered their “profound” apologies for their role in the nation’s financial crisis.

    The four bankers who used to run Royal Bank of Scotland (RBS) and HBOS – both of which have needed to be bailed out by the British Government – also conceded the industry’s controversial practice of paying out massive bonuses to executives needed urgent changes.

  18. nasking

    You ask about those losing their homes. I see your point but there needs to be safeguards. if they are going to lose their home then the payments are to be made directly from super funds to the Bank. Why you ask.?

    My sister who is older than I is an alcoholic and gambler who was so destitiute she requested under harship rules for access to her super as her home was being repossessed by the Bank.

    Under the harship rules all of her super was released, over $57,000 which was gone in 3 months, her house was sold and the $40,000 she made gone in 6 months and back to beggin me for money.

    She now has no home no super and no future. She reamins a gambler with no assets.

    That is why I am against what you propose.

  19. “She now has no home no super and no future. She reamins a gambler with no assets.”

    A sad situation…occurs to many. I can empathise we your concerns. This is why I get so sh*tty when I see so many TV shows promoting Las Vegas, betting & other forms of gambling. But, if governments aren’t going to fund more shows & greedy actors & such are going to keep demanding lunatic amounts of dosh for often mediocre performances that often rely on superb crew work (lighting, editing, camerawork, digital manipulation etc.) to make them palatable, then we’re going to see more of this kind of funding…& entertainment gradually transform into glorified ads…pretty well there as it is. Be interesting to see the economic downturn effects.

    Same goes for the news…someone should start a count on how many times they spot Coke & other corporate signs in ABC news footage. And how many times they promote &/or refer to News Ltd. product.

    “if they are going to lose their home then the payments are to be made directly from super funds to the Bank.”

    shaneinqld, exactly what I was thinking. I’m hoping the government is thinking all this thru. Minister for Superannuation Nick Sherry looked rather dazed & confused this morning on ABC 2 morning news.

    And Virginnia Triolli’s “conservationist & Green groups browbeating authorities regarding clearing of forests” comment (or something similar) seemed to come right out of the Sean Hannity & Michelle Malkin playbook…gimme a break!

  20. nasking

    If I was the minister for Superannuation I would be looking a bit dazed as well, and probaly spooked too. You would have man and his dog bashing down your door with an opinion on how to spend the saved super and rescue people, without having any regard to the actual reason we have super.

    Super at the moment is protected even from bankruptcy, so those who go bankrupt will have their super at least at retirement. Spending of super for any reason other than retirement or assistance in purchase a first home should be avoided at all costs.

    In the end there would be absolutely nothing left and all the hard work in creating an independent living at retirement destroyed.

  21. “In the end there would be absolutely nothing left and all the hard work in creating an independent living at retirement destroyed.”

    Tell that to the many thousands in the future who won’t have anything but dependence on government &/or charity when the lines for jobs extend from one city block to the other…or from one town to an inner-city suburb…& independent living at retirement is about as meaningless as continuing to live for some.

    We’ll agree to disagree shaneinqld.

    Anyway, let’s hope it doesn’t get that bad. Passing a stimulus package might help…:)

  22. With apologies..just scan reading but I recall reading something about loading up future generations with debt.

    Such as HECS and unaffordable housing?

  23. nasking

    We will have to agree to disagree as I see it as follows 🙂

    We have had unemployment before and we will have it again yet we are still here and the country has not sunk into oblivion or fallen off the face of the earth

    The difference is that due to the superannuation guarantee levy at least those retiring will have some funds, other than the government pension. Unlike those who retired a number of years ago before it was intorduced.

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