Musings Report #18 5-2-15 What Black Swan Could Disrupt our Financial System?
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What Black Swan Could Disrupt our Financial System?
Adam Taggart of PeakProsperity.com recently posed a question to me that ended up fueling an hour-long conversation: what event or dynamic could become the black swan that disrupts our central-bank dominated financial system?
It's relatively easy to imagine a number of potential black swans, but as the past six years have shown, the central banks have effectively defused a great many potential disruptions simply by creating money and buying assets in unprecedented quantities.
My starting point is this: any problem that can be solved by creating $1 trillion out of thin air and using that new money to buy assets cannot disrupt the system.
Mortgage sector going south? Solution: Create $1 trillion and use that to buy $1 trillion of troubled mortgages, effectively burying the debt in the balance sheet of the Federal Reserve. (All central banks play this same basic trick to solve any problem that arises in their economy: print money and use it to buy assets.)
Government needs to borrow a lot more money, but there aren't enough private investors willing to buy sovereign bonds paying almost no yield? Solution: print $1 trillion and buy up all the sovereign bonds being issued by the government. (This is called monetizing debt.)
Stock market looking shaky? Solution: Create $1 trillion and use that to buy $1 trillion of stock indices.
Local government bonds about to default? Solution: Create $1 trillion and use the money to buy up the iffy local-government bonds.
We can anticipate this will be the ultimate solution to student loan debt defaults: the Fed will print another $1 trillion and use it to buy up all the student loan debt. Once this debt is buried in the Fed balance sheet, it will be forgotten.
So if a problem can be solved by printing another $1 trillion and using it to buy assets (i.e. safely bury the troublesome debt in the central bank balance sheet), then the problem cannot destabilize the financial system.
Any future black swan must not be solvable by printing money and buying assets.
Adam and I boiled down the list of problems that cannot be solved by creating money and buying assets to two classes of problems:
1. real-world resources
2. social/financial inequality
Declining oil production (as a result of geopolitical turmoil, Land Model reduction of exports, marginal producers shutting down production, bankruptcies shelving development and expansion plans, etc.) is currently being matched by softening global demand as the global economy weakens.
But eventually these declines in production will set up a massive price spike as supply falls well below demand. Once existing stocks of cheap oil are consumed, production must rise quickjly to meet demand. But raising production globally is not like turning on a light switch--it takes years and tens of billions of dollars to increase oil production on a global scale.
Should oil drop to $30/barrel as many expect (most analysts see the rise from $43 to $59/barrel as driven by speculation rather than fundamentals), a secular decline in production will trigger a sharp rise back to the level needed to support marginal production, i.e. $90-$100/barrel.
Central banks can print another $1 trillion, but this won't magically increase production of oil. Price spikes in energy reliably cause recessions, and since interest rates are already near-zero and every asset class is already in a bubble, central banks will be powerless to solve a recession by printing money and buying more assets.
Adam posited that the social pressures generated by rising wealth inequality--the direct consequence of central-bank money-printing and asset-purchase policies--are another potential black swan that the Fed and other central banks cannot resolve by printing more money and using it to buy more assets.
As Adam mentioned, the Fed could resolve rising inequality by following Steve Keen's plan for reducing household debt: send every household $50,000, which would have to be applied first to debt. Those households with no debt would be free to spend the $50K at their discretion.
But central banks have no mechanisms in place to create trillions of dollars and distribute the money directly to households. Central banks exist to insure private banks have the means to continue reaping outsized profits from speculation and lending money. It would take a massive political shift for central banks to be politically empowered to "gift" households with newly issued money. It would take a crisis of immense proportions to trigger such a radical political and financial shift.
Another candidate for a black swan that is beyond the control of central banks is a crisis in a major currency. This has the potential to disrupt the global financial system because printing $1 trillion isn't enough to move the global currency markets if the herd is running. It could take $5 trillion or more--larger than the entire Fed balance sheet of $4.5 trillion--to control the global foreign exchange markets. And money creation on that scale might well generate fierce political resistance and unintended consequences.
The last possibility Adam suggested is systemic complexity: the more complex the system, the greater the uncertainties and thus the risks of apparently minor events that "appear out of nowhere" triggering disruptions that quickly spread to the entire financial system.
Right now the system is being stabilized by two very simple mechanisms: zero interest rates and central banks buying assets in astounding quantities. These brute-force methods have worked for six years, but the complexity of the global financial system opens the possibility that something somewhere will not be controllable by these simple brute-force tools.
Summary of the Blog This Past Week
The Cash Value of Home Gardens 5/2/15
Escaping the Deadly Financial Rip-Tide of Debt and Speculation 4/1/15
When the Herd Turns 4/30/15
The Financial Markets Now Control Everything 4/29/15
How Much of our Work Is Compliance, Enforcement and Menial Servitude to the New Aristocracy? 4/28/15
Is This a Blow-Off Top? Four Ways to Tell 4/27/15
Best Thing That Happened To Me This Week
I saw (with my sister) The Firebird by Stravinsky performed in San Francisco (my first listen to this classic of modern music). A wonderful performance led by Finnish composer/conductor Esa-Pekka Salonen, who also led the orchestra in a performance of one of his original pieces.
Market Musings: Oil and the Dollar
One of the fundamental principles of technical analysis is the retrace--what drops down will bounce back up, and what climbs rapidly will drop back. This is the structure of the classic A-B-C (or A-B-C-D) pattern of one move up/down, a retrace that is roughly a third, half or two-thirds of the first leg, and then a third major move in the original direction.
Oil has retraced from $43 to $59/barrel, and this raises the question of whether this is a sustainable rally or simply the B leg in a pattern than will see oil fall in a C leg well below $43/barrel.
The U.S. dollar is currently retracing some of its remarkable move higher from last year.
There are various targets for both moves based on moving averages and Fibonacci numbers. I won't hazard a guess where these retraces end, but the fundamentals have not changed, and so I expect oil to resume its slide and the dollar to resume its ascent once the global recession can no longer be masked.
From Left Field
Can Bitcoin Conquer Argentina? (via Lew G.) With its volatile currency and dysfunctional banks, the country is the perfect place to experiment with a new digital currency.
We Just Broke 2008's Record For The Fastest Economic Unraveling -- charts worth a look--if your dare...
Nate Hagens - Turning 21 in the Anthropocene (via B.C.) (56 min) -- one of the former editors of the Oil Drum website catalogs our current situation...
The End of California? (via Joel M.) -- growing low-value alfalfa uses as much water as 38 million residents... something's not being priced correctly...
Will Minecraft and Makerbot Usher in the Post-Scarcity Economy? (via Lew G.) (6 minutes)
Retired Japanese Fighter Pilot Sees an Old Danger on the Horizon (via Joel M.) -- 98-year old with a message from veterans that is being lost in global saber-rattling...
How Old Do I Look: another way to feel bad about yourself online -- haha, as if we need another one...
How Old Do I Look? -- I tried it, it said I look 65 (real age 61), close enough... I found that using a photo that was taken at some distance yields a lower age because the wrinkles are not clearly visible...like everything else, this can be gamed to your advantage...
Tesla expands into batteries for homes -- manufacturing affordable batteries at scale was always the challenge. Are Lithium-ion batteries sustainable?
The Nature of Poverty -- throwing money around helps but doesn't actually solve it...
In ‘Look Who’s Back,’ Hitler Returns and He’s Amusing (book review)
The age of drone vandalism begins with an epic billboard tag -- rogue art leads the way again...
The Difference Between Living in New York and San Francisco -- cutesy/snarky comparisons are getting tiresome but this has the advantage of brevity....
"If you aren't in over your head, how do you know how tall you are?" T.S. Eliot
Thanks for reading--
charles |
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