Our metastable Empire, built on a foundation of clay

More thoughts on the “dreamland” described by Wolfgang Schivelbusch in The Culture of Defeat.   In the concluding chapter he says…

The West’s victory in the Cold War was, however, the first to be achieved explicitly by the economy in its own name.  Perhaps it is for this reason that the economy received a new nom de guerre:  globalization. 

… The growth in the economy’s power and prestige after 1990 was not confined to its functional efficiency but came to touch areas of society previously monopolized by religion and nationalism.  If people looked toward anything in the hope of salvation or in fear of damnation, it was increasingly the economy.  Having lost faith in God, the nation, and utopian politics, they credited the economy with the power to both create paradise on earth and to destroy life as they knew it.  In the West, the threat of collective extinction attached no longer to war — which had in any case become a long-distance media event — but rather to the economy, with its doubt threat of devastating the environment and wiping out jobs

Like Minerva’s owl, our faith in Mammon may have come too late.  A grim future of geopolitical and economic problems presses on our imaginations as we see the end of our hegemonic delusions, founded as they were on unlimited borrowing at low interest rates.  In response we retreat into comfortable dreams.  We can elect leaders with vast ambitions (foreign for McCain, domestic for Obama), but can no longer afford them.  

The reason is simple:  our imperial economy is metastable.  Apparently stable (a pseudo-equilibrium), but vulnerable to a sudden and radical change resulting in a truly stable condition (such as I described here and here).  It is like a “hanging rock” — a small push can move it to a firmer foundation.  In addition to geopolitical instability, the result of decades of unsound grand strategy, the economic foundation of the American hegemony has large cracks.  The cracks might be opening NOW.

  1. At any time we might see currency flight from the US dollar.  Not only could this happen at any time, afterwards we must endure economists explaining how inevitable and obvious it was.  Every tick down in the dollar’s value makes our foreign bases and adventures more expensive for us.
  2. The rising stress on our financial system (deleveraging in extremis) continues to break links in our economy’s fabric.  As each link breaks, the stress rises on the remaining links.  If this ripping continues, it will certainly cause serious damage.  Consider what we have seen during the past year:  collapse of the asset-backed commercial paper market, defaults on subprime mortgages, collapse of the mortgage brokers, alt-A mortgage defaults, collapse of the auction-rate securities market, near-collapse of the monoline insurance companies, rising incidence of voluntary defaults on prime mortgages, rising rates of default on commercial mortgages-auto loans-credit card loans, and today warnings about another cycle of bank failures.  What is the next weak link to break?  What will stop the tearing?
  3. We have begun a downturn which, due to our high level of household debt, might lead to a long and deep recession (i.e., like that of 1973-75 or 1980-82 — nothing we have not survived before).  Our economic stabilizers — fiscal, monetary, and fx policies — are exhausted from decades of foolish overuse.  Our leaders have no plans to deal with this, and are doing none of the analytical research that can lead to sound plans.  Hence the most likely outcome if things deteriorate is desperate and foolish boldness.
  4. The economy has become globalized.  The path taken will depend not just on global economic factors (e.g., selling of the US dollar by private European investors), but also the political decisions of the world’s great powers — both our our friends and enemies.

Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more information about this subject

  1. A brief note on the US Dollar. Is this like August 1914?  (8 November 2007) — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
  2. The post-WWII geopolitical regime is dying. Chapter One   (21 November 2007) — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  3. We have been warned. Death of the post-WWII geopolitical regime, Chapter II  (28 November 2007) — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
  4. Death of the post-WWII geopolitical regime, III – death by debt  (8 January 2008) – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  5. Geopolitical implications of the current economic downturn  (24 January 2008) – How will this recession end?  With re-balancing of the global economy, so that the US goods and services are again competitive.  No more trade deficit, and we can pay out debts.
  6. A happy ending to the current economic recession (12 February 2008) – The political actions which might end this downturn, and their long-term implications.
  7. What will America look like after this recession?  (18 March 208)  — More forecasts.  The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
  8. The most important story in this week’s newspapers   (22 May 2008) — How solvent is the US government? They report the facts to us every year.

To see the all posts on this subject, go to the archive for The End of the Post-WWII Geopolitical Regime.

13 thoughts on “Our metastable Empire, built on a foundation of clay

  1. TulsaTime

    dear fm- I have often thought that the US and the USSR went bankrupt at the same time. The US just had the advantage of better credit to mask the system insolvency. I would say we have burned through that cushion now. The rabid pursuit of ‘alpha’ by those lights of the street (Citi/GoldmanSachs/Merril/JPMorgan/etc.) has led to a not so happy place indeed. The great financial boom of the 21st century could evaporate more wealth than we have created since FDR. For those that may think this impossible, I have two words for you: Leverage, and Derivatives. The last numbers I saw being batted around were 4 times the annual GDP for the US.
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    Fabius Maximus replies: We all know that another Depression is impossible, despite their frequent occurrence in the 1800’s (this is part of the Catechism of Orthodox economists). The 1930’s wiped out a large fraction of the wealth accumulated since the Civil War (It reduced the value of publicly traded stocks back to that of aprox 1880, from memory).

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  2. Duncan Kinder

    TulsaTime:

    An altogether excellent post. The crucial asset the United States had in the 80’s was its superior credit. That credit is now lacking. ( One doesn’t have to agree with – or even understand – everything Fabius Maximus has written. It is impossible to read him without feeling nervous. That is the point. )

    Your point about the derivatives is also sound. The United States essentially has been exporting derivatives since 1980 – that is why we have been able to borrow and to borrow and to borrow the way we have. The various collapses cited by Fabius Maximus evidence that these financial instruments have become substantially less marketable.

    There is a direct link between this derivative collapse and the so-called War on Terror. Derivatives essentially are techniques to manage risk while terror essentially is a technique to make risk unmanageable. Many of these derivatives have been used to manage – and to depress – the cost of commodities – oil and gold being the bellwether commodities. Societies that depend upon commodity production therefore have an interest in disrupting risk management, thereby weakening controls on their commodities. It is no coincidence that terrorism has been coming from commodity dependent societies.

    The “War on Terror” would be better understood if it were to be renamed “The War to Sustain Derivatives,” “The Revolt of the Commodities,” or something like that.

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  3. Mikyo

    Revenge of the alienated? Hmmmmm.

    Tyler Durden: “…We cook your meals, we haul your trash, we connect your calls, we drive your ambulances. We guard you while you sleep. Do not f**k with us…”

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  4. Fabius Maximus Post author

    Not to be too technical, the US has not been “exporting derivatives” in the sense you mean. Real derivatives are a seperate and as yet unexploded problem. The current turmoil results from complex products that turned junk debt into high-rated debt (straw into gold). As Brad Setser (expert on global capital flows with the Council on Foreign Relations) says in “Worth less, not worthless” (2 March 2008):

    “For much of this decade, financial engineering was to the US what automotive engineering was to Germany. Mortgage-backed securities were the United States leading export — by a large margin. Those securities no longer command a premium in the global market. Indeed, they can only find buyers if they carry an Agency guarantee.

    “That has consequences.

    “1. The collapse in demand for complex securities has reduced overall foreign demand for US financial assets. There was a time when serious observers – including observers at places like the IMF — argued that the United States comparative advantage at creating complex financial “products” would assure demand for US dollars and the financing of the US current account. That forecast hasn’t been born out. Foreign demand for US equities has emerged, but that demand hinges on getting those assets at a sale price.

    “”… Just as the market for housing finance has been “effectively nationalized,” so too has the financing of the US current account deficit. The Agencies are now big buyers of US mortgages. Central banks are big buyers of Agency securities. Treasuries too.”

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  5. Duncan Kinder

    Insofar as “complex ‘financial products'” differ from “derivatives,” I stand corrected. So far as I know, futures for pork bellies are still ok. (However, if our Peak Oil friends are correct, given the dependence of agricultural output upon petroleum input, then perhaps we ought to start keeping an eye on pork bellies.)
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    Fabius Maximus replies: The Great Peak Oil scare of 2007 — that global liquid fuels production peaked in 2006 or even 2005 — has proven false. Not only is production slowly rising, but it is clear that the key OPEC members are comfortable with the current price. They are talking about *cutting* production, not raising it. Lots of things to worry about in the near future, but PO does not seem to be one of them. Of course, to avoid a crisis in the future, we should start preparing now. Responding, like a dog, only to what is front of our noses is certain doom — now, then, eventually.

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  6. Duncan Kinder

    Mikyo:

    You might be interested in the Commedia del arte. The Commedia, which began during the Italian Renaissance, essentially featured who variously prevail at the expense of their masters. ( The opera, the Marriage of Figaro, derives from the Commedia. Napoleon stated that, in order to understand the French Revolution, you should study the Marriage of Figaro. ) Rather than relying upon fixed plots, Commedia performances were improvised. This improvisation can serve as a metaphor for 4th Generation warfare.

    I’m sure we all want a soft landing from the current situation. We could do worse than the Commedia’s happy endings.

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  7. Greg Lehmann

    I have …
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    {Editor’s note: My apologies for snipping this, but this is a site focused on geopolitics. History is relevant, a bit of philosophy or literature adds some tone. Investment discussions are a topic drift too far. There are thousands of sites for that.}

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  8. Duncan Kinder

    According to the New York Times, US corporations are piling up cash:

    The increase over the last decade in the amount of cash, as a percent of total assets, for the companies in the Standard & Poor’s 500-stock index has been steep. One study shows that the average cash ratio doubled from 1998 to 2004 and the median ratio more than tripled, while debt levels fell. According to S.& P., the total cash held by companies in its industrial index exceeded $600 billion in February, up from about $203 billion in 1998.

    The Times cites potential problems with complex risk management financial instruments (aka “derivatives”) as one factor in this cash hoarding:

    In the last 25 years there has been an explosion in financial products intended to help companies manage risk — from currency devaluations to commodity shortages. “We would expect improvements in financial technology to reduce cash holdings,” the researchers noted. And yet, corporations have continued to cope with risk the old-fashioned way: by saving for a rainy day. That suggests that either corporations are not making sufficient use of risk-management tools, or that the tools themselves — while helpful — are inadequate to cope with the increased levels of risk that companies now confront, Professor Stulz said.

    Theses risk management tools are related to those which have failed in the mortgage context and to those which I have suggested the terrorists are attempting to sabotage.
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    Fabius Maximus replies: These kinds of failures are commonplace in financial history, esp. following periods of rapid innovation. Look at the late 1800’s, following evolution of the modern corporation. No need to assume sabatoge. Note that the Times description of corp cash holdings is misleading (simple aggregates cannot accurately describe a population). A small fraction of corporations, esp some giants, have little or no debt and piles of cash. The majority of corps have considerable debt; a large fraction have so much debt that a severe recession (e.g., like 1973-75 or 1980-82) might destroy them. The average bond rating in the US is low investment grade — not “AAA” as one might expect after reading this article.

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  9. OldSkeptic

    Ford and GM for example, running around the ‘junk’ level on their bonds. Which one will go under in the next few years? The best that can happen in the US is that it has a very severe recession with high inflation(stagflation). The worst doesn’t even bare thinking about. Odds are about 50/50 at the moment.

    From a great site called the Daily Reckoning:

    “The costs of the credit crunch are mounting up. Each estimate is bigger than the one than before it. The latest estimate from the Union Bank of Switzerland is $600 billion. Economist Nouriel Roubini goes even higher – at $1 trillion. Of course, those are just the direct losses…the disappearing cash. There are also losses in implied wealth (and subsequent changes in spending and retirement plans) from falling house prices themselves. The residential housing market is worth some $20 trillion. If it goes down 30% from top to bottom, as expected, that’s a loss of more than $6 trillion.”

    And:

    The Federal Reserve’s Rescue Has Failed,” announces a headline in the English paper, the Telegraph. Ambrose Evans-Pritchard, the paper’s business editor, says, “The verdict is in. The Fed’s emergency rate cuts in January have failed to halt the downward spiral towards a full-blown debt deflation. Much more drastic action will be needed.

    “Yields on two-year U.S. Treasuries plummeted to 1.63pc on Friday in a flight to safety, foretelling financial winter. The debt markets are freezing ever deeper, a full eight months into the crunch. Contagion is spreading into the safest pockets of the US credit universe.”

    One thing that is very different now and 1929 was that the US was physically in a good position. Large, trained workforce, plenty of new (albeit idle) plant, oil and many other resources. When the financial taps were turned on in WW2 the economy bounced back as all the spare capacity was taken up. None of those things apply now, so a recovery will be a very long and painful process, if possible at all. The contrast to now is like comparing a strong, fit youth to a fat, wheezing geriatric on drugs with a walking frame and an oxygen bottle.

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  10. Fabius Maximus Post author

    1. The best we can hope for is a short and mild slowdown, during which the economy can recover.

    2. There is no art or science today that allows us to accurate give odds. Specific economic predictions are wastepaper.

    3. The Daily Reckoning is fun to read, but not too useful. Somewhat like relying on the Sunday comics when we need the Financial Times.

    4. We have to keep a sense of proportion about this. We have not had a substantial recession in a quarter-century. That does not mean that a typical post-WWII recession would mean the end of life as we know it. The post-WWII average is a recession every 5 years (20% of quarters). People just buckled down, like ships in a storm. Even a severe recession would be bad, but survivable — just as we survived 1973-75 and 1980-82.

    4. What made the Depression was a series of public policy mistakes. They had not read Keynes, who published his great work in 1936. I doubt we are in much worse shape than 1929. Our economic command and control machinery is far superior to that of 1929. We will imo be OK if we hang together and our leaders do nothing too stupid.

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  11. Mikyo

    Thanks for the he Commedia link. This kind of improvisation also seems to be the way that most people entertain themselves in chatrooms and ‘virtual worlds.’

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  12. dckinder

    Speaking of our more mundane commodities, the Oil Drum ( which, concededly, Fabius Maximus has criticized ), has posted a article about how the United States now stands as the world’s foremost grain exporter. Agricultural production depends upon fossil fuel inputs and also upon climatic conditions, hence would be vulnerable to Global Warming. The are well-chewed-over topics. Interestingly the article states In 1988 three countries accounted for 80 percent of all traded cereals (USA, Canada and France), This suggests that the 80 / 20 rule could be a useful tool for approaching this topic.
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    Fabius Maximus replies: The dependence of ag on petroleum is true, but to a far less extent than usually described. Electrical energy can substitute for liquid fuels to a very large extent in both production of fertilizers and (eventually) to drive ag vehicles (they often do not travel far from a base, hence are suitable for battery power). Peak Oil Debunked has several good articles about this.

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  13. Barry

    Economics is over my head, however if the US is the keystone of the world economy a lot of states will see no alternative to propping it up or lying about it’s health no matter what the cost. Anyone disagreeing might still play ball fearing US economic retaliation.
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    Fabius Maximus replies: I do not agree with this metaphor.

    We are the largest brick in the global economic structure. But the structure is not so vulnerable as an arch — perhaps it is a pile. And being the largest brick does not mean that we are the keystone.

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