Friday, June 26, 2009

Faith and Money

The brain is a mysterious organ, capable of incredible functions. We often give it too much credit however, as it is largely run by it’s programming. Bad input produces bad output. Creative independent thought is rare. As such our view of the world is seen through the lens of our teaching, but that is tempered with our experiences. If our experiences mesh with our programming our beliefs are confirmed and strengthened. If our reality does not mesh with our programming, our perception of something is strained. The effect of such a strain can develop in various ways. An absolute denial of the reality gap can occur in which the belief is steadfastly held despite overwhelming evidence to the contrary. Occasionally our experiences are so extreme that the belief cannot hold up and there is a loss of faith. The land in between is a period of reflection, open mindedness, and indecision. Cultural inertia is very powerful but there are moments in time when reality is so at odds with the prevailing belief that it forces people to re-examine the default position, and if enough people do so, and adopt a new perception, a cultural shift will occur, and in time those who maintain the old belief will look foolish.

Currently a strain is developing on our perception of our financial system. Our cultural programming is being tested against a strong flow of evidence that challenges it’s very foundation. Our strongly held belief in the stability of the financial system is weakening. The mass of people are unaware of how dire the situation is, but make no mistake, those who are on the front lines are very worried. The high priests of the economy are squirming because their model, their belief system, is not meshing with reality. They keep pulling on the same old levers but the desired effect is not happening. When a model is failing, distortions reveal themselves such as gyrating stock markets that are unhinged from the fundamentals. Extreme measures are taken to react to the distortion which only serves to exacerbate the condition because they are not addressing the root problem. A crisis brought about by excessive debt and low interest rates cannot be cured by creating more debt and lowering interest rates to zero. Below the headlines, complex manipulations of the markets are ongoing in an effort to disguise the fragility of the old model. When pressed, Greenspan admitted his model was flawed. The only reason we have not had a complete meltdown is because the governments of the world have backstopped the financial system with unlimited guarantees. The underpinnings of the global financial system now rely on the government's ability to keep the faith, except that the math doesn't care how strong our faith is. It is what it is.

The minds of the financial gurus and the legions of followers are going through extraordinary lengths to rationalize the desperate measures that go against their own preaching. Free market capitalism and stock market gains were heralded as the gospel when profits were generated from the risk taking. Now that those risks are not being rewarded, but are instead bankrupting them, everyone who has taken a loss is looking for a government bailout. People forgot what risk is. You can't enjoy the big gains without the associated risk of big losses. The big banks made a series of bad bets and now they have gaping holes in their balance sheets. Few people know how deep these holes are since the truth is shrouded in secrecy. The money pledged thus far may not be enough. Bankers don’t trust bankers anymore. They don’t want to lend to each other because internally they know how dire the situation is and they don’t want to risk their capital with another bank that might be in a similar position. The government was forced to guarantee all loans. The credit freeze is loosening as a result. There is a calm. By that measure there has been an improvement. One thing is for certain, we will not know how bad things truly are until the bitter end, at which point it will be too late. Denial is the name of the game here. The central banks are in full blown damage control. The world is in a crisis brought about by taking on excessive risk and debt at all levels, and now the high priests in their wisdom are transferring that debt load from the banks onto the public. They are unwilling to claim responsibility for the failure of their policies. Instead they talk as though this was an unexpected act of God that could not have been foreseen. Not true. There was a chorus of intelligent, informed, outspoken people who sounded the alarm but they were dismissed as doomsayers. The public are becoming skeptical. For now they are cautiously holding onto their faith but there is a strain.

The economic model that we have been living under for the past few decades has been an experiment in financial engineering. The Central bankers and governments adopted an interventionist economic model. Rather than leaving the money supply stable and paying only for what we can afford, we as a society have bravely steered a course toward the path of least resistance. If there is a recession, stimulate the economy by spending more. If we can't afford something, borrow to get it. If there isn't enough money, print some more. We grew up with an ever improving standard of living or so it seemed. Many of us don't have a memory of hard times. We were led to believe that the modern economy can be managed to avoid significant downturns. A cult of buoyancy has evolved. Markets are not allowed to go down. The government always intervenes. The problem is that every time they intervened to correct an imbalance, it triggered an unintended consequence that required yet another intervention. Intervention after intervention required more and more adjustments to maintain the economic model. The underlying problems were only delayed, manifesting itself in a more extreme way down the road.

Meanwhile the money supply has continued to grow because it's easier to give away money than it is to take it away. The subsequent inflationary pressure has grown as well. Rather than abandon the constant financial meddling that created these imbalances, the government chose to meddle with the statistics that demonstrated the unpleasant effects of their meddling. Inflation and unemployment rates are no longer measured as they were in the past. If the price of beef goes up, that doesn't count because we can still afford chicken. If the price of a car goes up, that doesn't count because we are getting a better quality vehicle. If a worker has been out of a job for over a year, that doesn't count, because he is no longer considered an active job seeker and therefore is not unemployed. The statistics have been massaged to underestimate the reality. That has only served to disguise the failure of their policies, keep the population misinformed, and benefit those in control. For example, if the government is obligated to keep pensions indexed to inflation and the inflation rate is in the double digits, that cuts into their budgets. It's easier to manipulate the statistic down rather than ask the taxpayers to pay more and to receive less. The economy has not performed nearly as well as we have been lead to believe. Most of the perceived gains have been the result of excess credit and creative book keeping. This approach has been systematic for quite awhile now and the strain of the debt burden is at last revealing itself in a catastrophic way.

Our standard of living will deflate back to where it deserves to be. Where that will be, no one really knows. We are in uncharted territory. The day of reckoning will come and we haven't seen it yet. The governments intervened in an unprecedented extreme way. Look around you and ask yourself if your world has changed in an appreciable way. Chances are it hasn't, yet this financial crisis is real. The underlying problem has not been fully reckoned with. As long as the global economy is geared toward feeding a consumptive US that is out of money, there will not be a substantive recovery. A structural rebalancing needs to occur. If I, and the folks I pay attention to are correct, the next leg down will break the faith of the people. A cultural shift is underway and those who continue to invest according to the old gospel will look foolish. Most financial experts and advisers have lost credibility because they failed to see the worst financial crisis in modern history, yet they insist that they can forecast the nuances of a nascent recovery. The culture of credit is being discredited. The holy churches of the financial world are in decay.

No comments: