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Musings Report #39 9-27-14 Mutually Exclusive "Solutions"
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For those who are new to the Musings reports: 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. As always, I hope the Musings spark new appraisals and insights. Thank you for supporting the site and for inviting me into your circle of correspondents.
Mutually Exclusive "Solutions"
I'm endlessly fascinated by dynamics that are independent of individuals and specifics of culture, history and ideologies. These tend to be systems dynamics that are scale-invariant, that is, they operate across time and culture in marriages, households, communities, corporations, states, nations and empires.
One such dynamic was described by correspondent Mark G. as mutually exclusive solutions: the solution contains internal contradictions that guarantee failure.
One example is expanding debt to recover "prosperity," i.e. more spending. Debt must be paid into the future, and it accumulates interest, which is a "tax" of sorts for using tomorrow's earnings to buy something on credit today. Interest does not buy any goods or services, and so it actively reduces future income and thus future prosperity.
Borrowing from future income to buy stuff now diverts future income to making the debt payments. Even if the interest is negligible, the payments of principal reduce future earnings.
Since debt reduces future income, it reduces future prosperity, future capital accumulation and future options of what might be done with disposable income. Understood in this way, it's obvious that expanding debt to goose spending today is a mutually exclusive "solution," as debt reduces the very prosperity that is being sought.
The conventional wisdom holds that borrowing from tomorrow to spend more today is perfectly sustainable as long as future income rises faster than debt payments. But with income for the bottom 90% stagnant from 1970 (and actually down from 2000), this necessary offset to exanding debt simply isn't present.
On the surface, mutually exclusive solutions look attractive precisely because they mask the difficult trade-offs the real world requires. Another example illustrates this mechanism: taking on $50,000 more student-loan debt to earn a Masters Degree. The additional degree is seen as a "solution" because it's supposed to permanently boost future income. If the additional degree reaps $10,000 more a year in income, over 20 years it more than pays for the $50,000 in debt (which is of course much higher once interest is added).
But given the oversupply of people with the same degree and the high odds of economic instability in the years ahead, the odds of permanently boosting income by enough to service the new debt and reap a meaningful return on the time and money invested in getting the degree are low.
The "solution" of adding another degree to the resume by taking on an enormous load of debt is a mutually exclusive "solution" for all but a relative few.
What characterizes mutually exclusive solutions? Here are some possibilities:
1. The costs of the solution are predictable and high, but the gains are unpredictable and potentially zero.
2. The "solution" offers little feedback from the real world; it is a conceptual solution rather than a practical solution that can be adjusted at low cost in response to changing conditions.
3. The "solution" crowds out future options, as the high costs generated by the "solution" precludes other potentially lower cost and more effective solutions.
Summary of the Blog This Past Week
Homemade Enchiladas: Flexible, Fun 9/27/14
What the Global Status Quo Optimizes: Protecting Elites and the Clerisy Class That Serve Them 9/26/14
Global Bellwether: Japan's Social Depression 9/25/14
What Metric Are We Optimizing For? 9/24/14
GDP = Waste 9/23/14
The Counter-Intuitive Rise of the U.S. Dollar 9/22/14
"What the Global Status Quo Optimizes" might be one of the more important things I've written in the past 9 years since launching oftwominds.com.
Best Thing That Happened To Me This Week
Recorded an original rocking song with my guitar mentor Coconut Cosmos (CC): Obsession (Song 29) (3:07). The second half of the song is guitar solos: I take the first section, CC takes the second, and we do a tasty call-response in the last section. Have a listen....
Market Musings: Three Narratives: everything's fixed, extremes revert to the Mean, the game is rigged
The Bull market's resilience has a number of sources: vast money-printing by central banks, capital flows from the periphery to the core, and unprecedented U.S. corporate profits and buy-backs.
One key driver is the narrative that everything that was broken in 2008 has been fixed: new housing sales hit a new high in price, household wealth hit a new high, and so naturally, the S&P 500 also hit a new high.
The alternative narrative is that nothing has actually been fixed: what's driving markets higher are extremes in money printing, credit creation, interest rate repression, margin debt, corporate buy-backs and deficit spending that are without historical precedent. In this view, extremes always revert to the mean, regardless of what conditions are deemed supportive of extremes, i.e. "this time it's different."
There's been precious little evidence that extremes are poised to revert to the mean, and so holding the second perspective has been lonely, unrewarding work: anyone who doesn't publicly support the confident complacency is ridiculed as a permabear who's been wrong for 6 straight years, etc.
As a result of the ceaseless expansion of extremes to even more outlandish extremes, a third narrative has emerged: the markets have been so thoroughly captured by central banks and their proxies that they can remain at permanently high plateaus essentially forever.
Those of us who look at systems as working regardless of specifics see narrative 2 (reversion to the mean) as the only historically sound option. But trying to pick the point in time where mean reversion finally kicks in is frustrating for systemic reasons: the grains of risk can continue trickling onto the pile of systemic risk without triggering collapse for quite some time--especially since central states and banks have dampened the pile to make the grains less prone to collapse.
Many of those who construct technical cycles see a window for a mini-crash in equities between now and October 10-17. If the market skates through this seasonally vulnerable window without harm, it will not negate the reversion to the mean narrative, but it will certainly negate attempts to time that reversion.
Those who hold the third narrative were unsurprised by Wednesday's manic rally; such a sudden skyrocket to blow off short positions' stops is precisely what we'd expect in a manipulated and centrally managed market. Those holding the 2nd narrative were unsurprised by Thursday's meldown, which looked suspiciously like the start of mean reversion.
Those holding the 1st narrative were reassured by Friday's recovery, which looked just like dozens of other "buy the dip" rallies over the past 5.5 years.
All three narratives can't be right in the month ahead; one will be correct and two will be incorrect. Beyond that, the narratives may shift as the global economy downshifts into financial and geopolitical instability.
From Left Field
Portland Will Still Be Cool, but Anchorage May Be the Place to Be (via Joel M.) On a Warmer Planet, Which Cities Will Be Safest? -- the latest parlor guessing game; tell me about snowfall on the Sierra Nevada and I'll tell you whether California will be livable....
Germany's Ukip political party threatens to paralyse eurozone rescue efforts (via U. Doran) -- looks like a potential Black Swan in the EU...
“Until recently, no openly Eurosceptic party in Germany has been able to galvanise opponents of European 'bail-outs’. But this comfortable position now appears to have come to an end.”
Larry Ellison Bought an Island in Hawaii. Now What? (via Girija D.) -- long but interesting on several levels--especially for me, having lived there in the plantation era (1969-70). I picked pineapple with one of the local guys mentioned (Butch Gima) and my brother and I are friends with the Matsumoto brothers. Ellison has the capital and vision, but he also has to communicate his vision clearly and consistently.
Lessons From My Mother (Yian Mui) -- anyone seeking to understand why so many Asian immigrants build wealth in one generation: start with extreme, consistent frugality....
BJORN LOMBORG IS STILL THINKING ABOUT “EVIL ECONOMICS” (via John S.P.) -- how $75 billion could fix global hunger, cure malaria and HIV....
After Surgery, Surprise $117,000 Medical Bill From Doctor He Didn’t Know (via Joel M.) -- Exhibit 1 in why sickcare is hopeless and doomed to self-destruct, taking the entire nation with it....
Suspicions Run Deep in Iraq That C.I.A. and the Islamic State Are United (via U. Doran) -- they're not alone in thinking this....
China Clamps Down on Web, Pinching Companies Like Google (via Maoxian) "A lot of companies are asking whether they really need to be in China." Short answer: no.
How Gary Hart’s Downfall Forever Changed American Politics -- worth reading, if you haven't used up your NYT.com free articles for the month. NYT is still doing journalism from time to time, which is why I subscribe to the online edition for $15/month....
Virtually everything: How the physical world is being consumed by software services
Low Oil Prices: Sign of a Debt Bubble Collapse, Leading to the End of Oil Supply? -- highly recommended....
When Albums Ruled the World (via Jim E.) a fascinating BBC documentary (1:28 hours)
"I think and think for months and years. Ninety-nine times, the conclusion is false. The hundredth time I am right." Albert Einstein
Thanks for reading--
charles |
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