Weekly Musings 23 6/12/11
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For those who are new to the Musings: they are basically a glimpse into my notebook, the unfiltered swamp where I organize future themes, sort through the dozens of stories and links submitted by readers, refine my own research and start connecting dots which appear later in the blog or in my books.
Exciting Times Ahead
As I have noted before, I look forward to writing the Weekly Musings because it is restricted to my most important, steadfast 330 supporters, and thus I can be much freer about what I write, both because I have a more forgiving audience and also because I am not claiming anything in the Musings is "ready for primetime," i.e. public distribution.
An interesting aspect of the blog is that its impact and reach fluctuate in such an unpredictable fashion. Last week I was intereviewed by economist/writer Ty Andros for his new web-audio program, and also by host Ron Smith for WABL in Baltimore. In an unrelated invitation, Douglas McIntyre of 24/7 Wall Street asked me to join their small team of (compensated) contributors. I consider this an honor because 24/7 Wall Street is original content, not just another aggregator taking others' content for zero compensation.
While it easy to focus on how the global Status Quo is falling apart, and it most certainly is, from China to Europe to the U.S., the exciting part is not the creative destruction, it's what is rising from the ashes.
Creative destruction in Capitalism (classic Capitalism, not the cartel-crony variety which dominates the U.S. economy and Central State) acts like a forest fire, that is, as an essential cleansing of accumulated deadwood and suffocating undergrowth. The ashes from the fire then act as fertilizer for the new life which sprouts in the clearings opened by the fire.
Writing a book is form of obsession, at least it is for me, because the task is so vast and horrendously complex that total obsession is required to complete it. I am in that obsessive stage, the last necessary phase of an 18-month long project titled "An Unconventional Guide to Investing in Troubled Times."
I had written over 40,000 words of the book last year, but found myself profoundly dissatisfied with this work in January 2011. When writing projects get this large, then sometimes it's better to set the draft aside and start from scratch, which is what I chose to do. Now I have 43,000 words of the new version, and probably have another 10-13,000 words to go.
Usually I am very early in major trend changes. For example, I wrote about the housing market being a bubble in 2004, three years before it finally popped. I think my timing on this project might be refreshingly contemporary, i.e. as things fall apart there might actually be a market for this book.
While the book does address why the Status Quo is unsustainable, it also focuses on what we can invest in that can take the place of the rotten, tottering Status Quo after the creative destruction has opened up some clearings.
I will of course get each of you a copy, one way or another, and will cover various aspects in the Musings.
Black Swans, and the Inflation/Deflation Question
The key feature of the next decade isn't inflation or deflation, it's unpredictable volatility with outsized consequences, what many call "black swans." I found much insight in "black swan" author Nassim Taleb's recent article in Foreign Affairs magazine:
When policymakers try to suppress economic or political volatility, they only increase the risk of blowups.
One of Taleb's main points is that attributing the "blame" for the global financial crisis on the subprime mortgage fiasco is like blaming the last grain of sand dropped on an unstable pile for the pile's collapse. The real problem is the pile is systemically unstable.
In other words, the primary feature of an unstable system like the financial Status Quo is not deflation or inflation, but unpredictable volatility. This is partly due to the nature of complex (as opposed to linear) systems and to authorities suppressing information in the system, i.e. dissent and low-internsity instability.
Thus we cannot really predict deflationary or inflationary trends with any reliability; as many have noted, we can experience both at the same time (asset deflation and price inflation in essentials).
What we can predict is that no trend will last for a decade or two. That sort of stability is in the rear view mirror. Rather than engage in a fruitless debate over which grain of sand will trigger a collapse of the sand pile, we can be alert to all possibilities and be aware that what makes a "black swan" is not just the "impossibility" (as judged by the Status Quo) of it occurring, but the outsized effects of improbable events when information (dissent and low-intensity instability) have been ruthlessly suppressed.
Here is an excerpt from my book on this topic:
Before deciding what is "impossible," we might recall that the bankruptcies of Enron, General Motors, Bear Stearns and Lehman Brothers were all considered "impossible" before their demise, and the global financial crisis of October 2008 was likewise "impossible" and entirely "unexpected" by conventional economists and advisors.
As Nassim Taleb of “black swan” fame has explained, it is misleading to say the last few grains of sand, for example, subprime mortgages in the housing bubble, are responsible for the entire sand pile collapsing: the masking of risk was systemic, and thus the sand pile was doomed to collapse regardless of the nature of final few grains of sand.
Similarly, it won’t really matter what the final trillion dollars of Federal debt that triggers government default was borrowed for; the default/collapse of the government debt pile is inevitable.
In betting the farm, so to speak, to prop up a façade of financial stability, the Federal Reserve and the Federal government have doomed the entire system to collapse. Taleb explained why in the June 2011 issue of Foreign Affairs: “Complex systems that have artificially suppressed volatility become extremely fragile, while at the same time exhibiting no visible risks.” That describes the global economy in 2007, just before the financial meltdown of 2008 “surprised” conventional economists, pundits and Wall Street apologists.
As Taleb has noted, the very act of suppressing fluctuations renders systems extremely prone to large-scale disruptions which are viewed as low-probability events, the infamous “black swans.” The key to understanding this rising likelihood of supposedly improbable disruptions is to understand the difference between linear and complex systems. Linear systems lend themselves to causal chains (A causes B which causes C) or probability (the odds of drawing two aces in a game of Blackjack) that can be calibrated with a high degree of accuracy.
Complex systems such as financial markets exhibit fractal or chaotic characteristics, and are unpredictable and prone to small changes in conditions leading to outsized effects. When volatility and risk (in political terms, dissent) is suppressed by central authorities, the variations that inform an open market (“variation is information”) are lost.
The misrepresentation (and thus the mispricing) of risk and the suppression of instability (i.e. volatility) by banks and Wall Street is a defect not of individuals or certain institutions but of the entire system, including the Federal Reserve, the Treasury and the regulatory “alphabet soup” agencies (SEC, FDIC, etc.).
The misguided attempts to engineer a false stability by suppressing volatility and visible risk have created an intrinsically fragile system that is doomed to crises of ever greater dimension even as the periods of calm between crises shrink from years to months. Recall that risk is like water in a closed system: it can never be squeezed into nothingness. The more pressure that builds up, the more inevitable it is that the risk will burst out in some part of the financial system that was viewed as “safe” and “stable,” for example, home mortgages.
This is how financial events that are widely viewed by conventional economists and government officials as “impossible” can occur with increasing frequency.
Happiness Results from Abundant Social Capital
Building on last week's reference to Denmark being the "happiest country:"
What may be essential are the supporting networks between people and groups that enhance social capital. Social capital is a major predictor of national happiness, according to new research in the 2011 Journal of Happiness Studies. A 2004 Cambridge University study concluded that mutual support and trust in society leads to well-being in Denmark and elsewhere. The research finds that the citizens of countries that scored highest for happiness also scored highest for trust in their governments, their laws, and each other. Where trust was lacking, "even the well off tended to be unhappy," according to the study.
From Left Field
Here is an example of the informal enterprises which I expect to proliferate as the formal economy devolves:
Photoshopped or real? It's your call.
Thanks for reading--
charles
