Musings #10 (3/12/11) from oftwominds.com
 
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This week's themes: systemic pressures and thresholds, delegitimization of institutions, thoughts on Japan
 
I look forward to Saturdays now because I get to assemble my most speculative thinking into a Weekly Musings for a small private audience (248 subscribers and major contributors). 
 
I devoted today's blog entry to Japan (Thoughts on Japan), a nation and culture I have studied for almost 40 years, and home to many of our friends. I speculate that the underlying fragilities in Japan's finances which have been masked for over 20 years might be be pushed to a "tipping point" by the staggering costs of rebuilding the damage from the earthquake.
 
I also mention the possibility of a "social earthquake" in which the people's tolerance for a failed Status Quo suddenly snaps in a social action analogous to the release of built-up pressure in tectonic plates and faults. In other words, systemic stress accumulates in social structures just as tectonic forces build up. When a threshold is finally reached, the invisible fault lines give way.
 
Those of you are familiar with Japan will understand what I am about to say here. To others with only a passing understanding of Japanese culture, it may be new.
 
In my personal experience, Japanese culture encourages holding one's feelings inside publicly--especially negative feelings such as frustration and anger.  Should a point be reached in extreme duress where these feelings are unleashed, the results can be volcanic and lasting.  Friendships and connections can be shattered in a moment, changed forever.
 
Most observers see the stability of Japan's economy, government and society.  There are powerful loyalties and feedback loops to reinforce (and enforce) stability, but the past 22 years of financial malaise has frayed the edges of these social norms and loyalties.  This enormous natural disaster thus hits the society at a point of demographic and cultural vulnerability that has been well-masked by the wealth and resilience of Japan's economy, society and people.
 
But if the Status Quo Power Elites fail Japan's people as they have failed them continuously for 22 years, a breaking point may be reached where people no longer accept "continuous failure" by their institutions.  A Rubicon could be crossed, perhaps with great urgency as decades of frustration are suddenly released.
 
Few mention this even as a remote possibility in apparently stable Japan.
 
I discussed humanity's ability to habituate to continuous failure a "the new normal" in my blog post http://www.oftwominds.com/blogmar11/stagnation-innovation3-11.html
The Great Stagnation, and Innovation as Savior   (March 5, 2011).
 
Here in the U.S., income inequality as measured by the gini coefficient is .46, one of the highest in the world. Social scientists have found that .4 acts as a threshold for social unrest.  So far, Americans are complacent, apathetic or resigned to the financial toll of the "new normal," I.e. continuous institutional failure.
 
There may yet be a social earthquake in the U.S. as well, but it will certainly have different characteristics than the one which I am speculating about in Japan.
 
Item #1:  catastrophic system failure
"It 92s axiomatic that failing systems work the best just before they fail catastrophically."
 
I discussed that axiom last week. Correspondent/blogger Kevin M. made the following insightful comment:
 
"It's only an apparent contradiction. The reason the system works the best just before failing is that both faith-- and participation-- in the system are at their peak to the degree that the system isn't even questioned.  It's that same combination of unquestioned faith and unrestrained participation that causes too many people and resources to lean in the same direction.  At that point, objectivity, balance and counterforce no longer exist, the system is over-extended, then POOF!  It makes perfect sense!"
 
Excellent point, Kevin, thank you.
 
I see this mechanism in various markets.  For example, mutual funds have very little cash right now--the melt-up in stocks has sucked in most the available cash, as managers who stayed out of the market underperformed. Now that the institutional investors are all participating (also reflected in the low "short interest", that is, bets by professionals that the market will decline), that sets up the potential for a cascading decline in stocks and bonds.
 
I am long QID, a 2X inverse ETF of the Nasdaq 100.  This is not financial advice, it is only disclosure so you know what I'm doing myself.
 
Item #2: mortgage market about to feel a new stress; housing market phase shifts
 
One of my correspondents recently reported on the regulatory changes being imposed on the mortgage market. In effect, the fees earned by mortgage brokers will be limited, so difficult mortgage applications that require a lot of time to process will be paid at the same rate as those which breeze through because the applicants are overqualified. This change was designed to keep mortgage brokers from shoving through dodgy mortgages just to earn large fees, but the unintended consequence is that brokers now have no incentive to work with time-consuming marginal borrowers. They will choose to work with only over-qualified borrowers. This will effectively limit the market for mortgages and also limit the number of buyers who qualify to buy houses.
 
"When a threshold is finally reached, the invisible fault lines give way." That may be true of the housing market as well. Years ago I speculated that the housing market might suffer a stair-step series of phase shift declines--apparent stability would give way and prices would suddenly drop to a new level of apparent stability.  I suspect we are about to witness just such a phase shift downward as FHA has to cut back (it's over-extended due to defaults) and Fannie and Freddie are effectively removed as "guarantors" of mortgages.
 
I discuss the Stick/Slip hypothesis in "Survival+"--another physical analogy for this sort of pressure building below the surface and then being released "unexpectedly."
 
Item #3: delegitimization of institutions
 
The way in which institutions are slowly delegitimized is one of my focuses this year. I have two examples to share.
Via my old friend Ian Lind, here is a link on FDIC secrecy:
 
This is a perfect example of a Central State-cartel fiefdom which engages in '"full spectrum defense of the Status Quo" (in my terminology) to the disadvantage of transparency and thus governance.  Federal and State governments are largely opaque; the FDIC is simply a standout in its failure to be more discreet about its fiefdom mentality.
 
The average debt-serf/tax donkey (I raise my hand to both) feels powerless in the face of this sort of institutional fortress mentality/arrogance of power for the very good reason *we are powerless*.
 
In a similar example, it was revealed that 47% of the workers in the local subway system (BART) tasked to clean and replace the filthy, disgusting seat covers in BART trains (I would say the Bay Area trains are Third World, except the trains in Bangkok and Shanghai etc. are marvelously clean and new) don't show up for work.  This has been the case for years. The workers claim to be "taking care of sick relatives" which enables them to get paid while not showing up for work.
 
Now in a system with competition, commuters would choose another alternative. But with BART being an effective government-proxy monopoly, customer complaints have no weight whatsoever. 
 
In a situation where customers could desert incompetence and failure in droves and thus drive the enterprise out of business, then the public unions which represent the workers might feel some pressure to respond to their customers. Instead, the union defends the 50% absentees/no-shows as being "burned out" and needing their rest.
 
How many people would choose to work 50% of the time for 100% of the pay if that was an easy, no-penalty option? Talk about perverse incentives.
 
My larger point is that the public employee unions are delegitimizing themselves via their rabid defense of these abuses.
 
Politically liberal people know it's un-PC to publicly state their disgust, so they keep quiet.  Yet in private, it's a different story. One of my most liberal friends surprised me a few months ago by suggesting that all public workers should be fired and the system re-set.  If unions fail to grasp the way in which they have delegitimized themselves with audiences who were once sympathetic, then their demise will only be quickened.
 
Item #4: self-regulating organizations
 
One consequence of social media: new opportunities for self-regulating organizations to step up and fill the vacuum of official oversight and monitoring.
 

"After months of dithering and backstage bickering about who should regulate the nation's roughly 26,000 investment-advisory firms, this week there was movement. Two students at the University of Mississippi law school held a news conference to announce that if no one else was ready to oversee independent financial advisers, they would do it.

Timothy Collins, a 25-year-old second-year student, and Tyler Roberts, 26, who is in his third year, launched the Self-Regulatory Organization for Independent Investment Advisers to "provide investors with the best protection we can," Mr. Collins says. A self-regulatory organization, or SRO, is an industry group authorized by Congress to enforce rules approved by the Securities and Exchange Commission."

It's easy to imagine an entirely unsanctioned social media site which is a "Yelp!" equivalent for financial advisors.  Such social media sites are able to build self-organizing trust and transparency which is simply unavailable to fiefdom regulatory agencies.
 
Item #5: Could this be the apex of global corporations?
 
This is a highly speculative musing, but I have been wondering if the apparently unstoppable power of global corporations (both financially and politically) might be reaching an apex that will trigger a sudden phase shift or decline.
 
The entire union movement was, after all, based on corporations being tied to a physical locale on the planet. That's why public unions have taken hold--governments are fixed to specific locations.  But global capital has no such boundaries, and plants can be built in Ireland one year to take advantage of low taxes and closed a few years later and moved elsewhere as the need arises. Labor has no leverage in a global economy, except where resource extraction is localized: oil wells, diamond and gold mines, etc.
 
It's not employees who have leverage over global corporations--it's consumers of their products and services. If perceptions of corporation's value shifted dramatically, "lowest costs, always" might not be enough to keep citizens shackled to the "consumerist" theology that low prices are the highest good. Such a shift would lead to a relative decline in global corporate power as people chose not to give their money to these global giants.
 
Right now, such a shift in perception seems "impossible." Perhaps, but then everyone said the housing bubble wasn't a bubble in 2005, 2006 and 2007, and the financial meltdown was "impossible" in 2008--right up until it happened.
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Thanks for reading--
charles hugh smith
 
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