I was quite taken with this post of our occasional guest blogger Cassandra (who holds forth at Cassandra Does Tokyo). I hope you enjoy it as well.
From Cassandra:
Thumbing through the sell-side research from their multitudes of Strategists, I notice some recurring phrases, small and innocuous as they may be, that trouble me. Time and again, they repeat, in various contexts, the mantras: “when things return to normal”, “when markets return to normal”, and “when x, y or z normalizes” with “normal” implied to be that which has been common over the past decade-or-so in respect of liquidity, leverage, asset prices, equity risk premiums, speculative activity, growth. Mulling this over, I wonder to myself: “is this not just the perfect “recency bias” example, defined by wikipedia as “a cognitive bias that results from disproportionate salience of recent stimuli or observations”? For as I consider what precisely is meant by “normal”, it seems to me that there is a reasonable good chance insofar as this IS “The Big One” (as Bridgewater Associates precsiently termed it nearly a year ago) that all these things – debt, leverage, consumption vs. income, relative asset prices – are ALREADY returning to normal, and the strategists, demonstrating the old poker joke about “if you look around the table and you don’t know who the sucker is, its you….”, simply haven’t yet fathomed the appropriate interval frame of the normality to which things are returning towards.
In Japan, “normal” meant that in 2004 residential real estate prices were roughly 30% of late 1980s or early 1990s prices. In Germany , though nominal prices might be similar in many places to those prevailing two decades ago, the real price destruction would be probably be similar to Japan’s. But what is “normal” for economic growth? Or what is “normal” for aggregate US consumption? Or the amount of debt a typical household can sustain? What is the “normal” leverage for a bank, or the normal return on equity o a listed company? What is a normal share of GDP for corporate profits in an economy experiencing deep recession? What is “normal” for sustainable government budget deficits? What is the normal income multiple of a banker or CEO to a policeman, a professional baseball player to a school-teacher or a doctor to a nurse? What is the normal amount of due diligence a bank should do before extending a loan and what is normal for the amount Honeywell Industries will earn per-share in the coming years?
These may seem disparate and unrelated, but I fear they are not. I fear that the final acceleration towards the denoument of Peak Credit, rooted as it was in poor fiscal policies and lack of regulation & oversight, greased with monetary ease and official foreign mercantile enablement, and driven by parochial and herd-like animal spirits, has distorted what is normal, what should be expected, and of course, what is, and will prove to be reasonably sustainable in the future. But the Strategists, the ones who’ve offended my sense of the normal, seem, in their sanguineness, to be implying that is was normal to extend credit as it was during the last eight years; that gains in asset prices (be they a portrait of Dr Gachet NYC apartments, Chelsea or Notting Hill pied-a-terres ?) are normal at somewhere nearer to the top of their seemingly almost-exponential three-decade rise; that it is normal that US households continue to live with negative rates of savings or consume en masse beyond their means; or cavalierly burn hydrocarbons at the elevated relative per-capita rates that they do presently; that past income-inequality, now rolled-up into massive eddies of wealth discrepancy that approach those which evoke those prevailing during the enclosures in England are normal, and that their sense of normalcy will swiftly return despite the continued pressure to the contrary upon the financial sector, and households to return to a normalcy of a much different mean than those of the recent past, which in their turn directly the impact the corporate sector with body blows from BOTH the cost and availability of their gearing and the ultimate demand for their products.
I do not believe (yet) that we are about to beat each with bones back to the stone-age. But I believe that what we’ve seen in leverage and credit growth during the past 15 years is NOT normal, nor is it sustainable – neither relative to history or in absolute terms. And this return to what is sustainable, and service-able has profound economy-wide, implications, and they are indisputably contractionary: deleveraging, higher savings rates, matching household consumption to income, and government revenues to expenditure. Add to this the impending pull of demographics, the emerging trend towards greater environmental consciousness and sustainability, and “normal” begins to resemble a mean-that is something of a much different magnitude, something still to the south of where we are that – in the big time series – we will continue to revert towards from our presently divergent location rather than – as the Strategists imply – a normal that is something we’ve already overshot.
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My simple mind is confused how a problem created by excess credit can be solved with more excess credit?
I keep reading the fancy theories that in a credit contraction that a highly indebted government should increase its debt even more and paper over the asset deterioration of the financial institutions. How can this work? At some point don’t these assets have to be written down by the Fed that has stashed them on their balance sheet?
Are we trading the Wall Street credit bubble for the Fed engineered Treasury bubble? What are we gaining by that? What happens when the Treasury bubble collapses?
Common sense would say that income poor, overindebted America should increase savings and investments in productive capacity to generate incomes. That American consumers should reduce their spending to bring consumption in alignment with their incomes. That the US government should not run large deficits but should reduce its overall indebtedness. But what do I know. All the experts and politicians believe in “Keynesianism” or some other fancy theory that says that problems created by excess spending will be solved by even more borrowing or monetizing and spend much more. I didn’t realize that I have no grasp on economics. All I know is that when individuals or a small business lives high on the hog with debt then at some point they go bust, default on that debt, start again with a clean balance sheet and live within their means. But when it is scaled up to nations and governments those classic rules of thumb go out the window,
Nice description of a ponzi scheme….
I keep looking for the (don’t give a F*$K what color) knight(s) that is/are going to lead the charge to sanity in our world.
Yves, got a plan? Your friend have a plan?
I am all about tilting at windmills and think that my life may be that warning to others about not making good with the man. But it is still worth it to be independant, and more importantly, expecting better of humanity than greed, corruption and a ruling world oligarchy.
Yves, I give you a lot of credit for speaking truth to power. What is life for but to live your values.
Thunders applause.
skippy
Interesting. I thought Cassandra was taking this in a different direction.
I don't dispute the point that normal is too often benchmarked against a recent standard (or a standard that is salient for some other improper reason).
For example, for U.S. equities, if one looks at the price earnings ratio since 1936 of the S&P 500, one cannot help but observe that there is a bifed distribution. The very idea of a 'normal' p/e doesn't really work. Instead, it tends to oscillate around a high and a low equilibrium range. We may be moving for a period in the upper tier to a period in the lower one.
But, I thought this blog was going to peel off in a slightly different direction, and take on the very idea of a 'normal' frame of reference. In a phase shift, one can grow old and die waiting for things to settle down and return to 'normal' (whatever it is). Instead we may be feeling our way towards a new normal.
Casandra has hit the nail on the head. The new normal will be much diminished.
Why?
Aggregate demand is crashing and there is no way around it. Our economy needs to be entirely restructured to meet our new paradigm. That new paradigm is that we spent too much over the last 30 years amassing 350% of GDP or $50 trillion in aggregate U.S. debt and that debt bubble has been popped by this banking crisis.
The new paradigm is a lower standard of living for all which is why the well off will have to be asked for much more in the way of taxes. The taxes must be used to build a platform under the public including Medicare for All, longer unemployment benefits and much higher wage cutoffs for food stamps, housing and day care. It may even go so far as a shortened work week from here on out.
The profits from a new public utility banking model will also help address funding new and extended programs as well as set the stage for a sustainable economy.
What is important is that the suffering is shared across the board.
If it was only the “Strategists” thinking this way, the outlook would be much less bleak.
The trouble is that virtually the entire political and media establishment appears to share this thinking. Hence the apparent widespread support for Fed and Treasury policies intended to sustain the unsustainable, at the direct expense of productive enterprise.
Oh, I’m sure they think they are oh so sophisticated and are using their extra-legal powers to help us by transferring our diminishing wealth to extravagantly wealthy bankers, so that they can, in turn, lend it back to us, for a not so modest profit, of course.
This “sophisticated” fraud is as old as fractional reserve lending and fiat money and it always leads to disaster. And then it always seems to start up again. So much for humans being learning creatures. Still, hope springs eternal – maybe some day.
What Cassandra describes with the Analyst is something I call the Martingale Man (yes, it could be construed as sexism, but it just alliterates too nicely :) ), and the underlying thinking MartingaleThink.
In essence, it could be summed up as “tomorrow will be the same as today, or at the worst, as yesterday”.
I believe that a vast majority of humans just cannot use anything else but the current situation as their model of future.
Yes, we have the old saw “those who don’t learn from history are doomed to repeat it” – and the evidence points out that indeed few learn from history despite most professing to do so.
i think with ‘normal’ you are referring to ‘sustanable’.
Good posting.
Incredible to think that Oscar Wilde was wrong when he said,”A cynic is someone who knows the price of everything and the value of nothing.”
It turns out they don’t know prices either.
Perhaps our dilemma should lead us from economics and finance to a broader philosophical question: what has value, and what is wealth? Obviously, wealth is not CDOs, SIVs and CDSs, leveraged by factors of (place insane number here). We’ve seen that the “value” as well as price of many of these vehicles is worth less.
As a thought experiment, imagine if health care were partly or completely socialized – now, now, calm down free marketeers, it’s only a thought experiment! Were that to happen, a huge source of economic pressure and worry would be removed from the populace, soothing the hurt of unemployment and declining wages.
After all, “Health is Wealth.”
Perhaps we need to begin a discussion of what prosperity really is. Perhaps we might find benefits in social solidarity – or Social Security, in the literal sense – rather than the current vicious S.O.B model of capitalism that we’ve experienced for the past thirty-plus years, where greed, fear and insecurity are the unspoken policy markers.
Oh, foolish, naive heart.
An excellent perspective by Cassandra. Thanks for including it.
What a great breath of fresh air from Cassandra!
The belief that the financial sector could increase from 2% to 40% of the US economy and sustain that level with extreme gearing is NOT normal.
The belief that families with total incomes of $100,000 (or less) incomes can afford homes selling for $500,000 – $1,000,000 + is NOT normal.
The belief that ‘deficits don’t matter’ is NOT normal.
The attempt by the current administration to sustain all of the prior ABNORMAL economic activities is putting the US economy in greater jepordy each day that passes.
The Vice President Elect appeared on tv and stated that the US financial system is in emminent danger of total collapse. Did anyone notice?
Good to see this is the drift the discussion is taking. But there are a couple of bits with which I beg to differ.
Cassandra says:
“And this return to what is sustainable, and service-able has profound economy-wide, implications, and they are indisputably contractionary: deleveraging, higher savings rates, matching household consumption to income, and government revenues to expenditure.”
The intent is all nice and agreeable.
But when and where in history has there ever been a sustainable monetary system? When in history have we ever openly thought or even considered the notion of designing sustainable monetary policies?
Apart from failed and/or marginal attempts, considering only mainstream jurisdictions, the answer is “never!”. Monetary policies have always been giant Ponzi schemes, alternating long periods of irrational exhuberance with credit crises.
I also like the use of the word “service-able” in this context. But I would like to add “solvent” to it. A debt based monetary system is service-able in “normal” times in that interests can be paid at the condition liquidity is continuously injected. But “normalcy” is a meta-stable state because even then there is no solvency. The system is never solvent in aggregate as there is never sufficient money in the system to repay all existing debt and debt is not systematically restructured to follow collateral depreciation or appreciation. It’s precisely a solvency crisis what triggers the final crisis and compromises service-ability no matter how much liquidity one is willing to inject.
But I agree with Cassandra about the rest. What can seriously come out of this crisis is a realization we do need sustainability and a balanced system. Achieving it is certainly not a question of adding a few more volumens of regulations to the already existing ones. One has to go at the very root of the problem and look into the process of money creation and distruction, resource allocation and consumption.
Mankind has been fooled many many times int piramid schemes. Let this be the last.
Tax capital gains (a lot). Remove taxes from the dividends, put some taxes on the interest (to equalise the price of debt and equity).
There cannot be bubbles on the “payable” cash (well, except for madoffs, but those are illegal in the first place, and should be reasonably easy to detect). The bubbless are created when the the future income stream is expected to come from the re-sale of the asset rather than from the value generated by the asset (and independent of the resale). If you cap the gains there (while not removing the gains for real investors), it should help – long term. Of course, since people are taking it as a God-given right that they can re-sell their home and make money, taxing them on the gain would be a hard sell..
Even if you implemented the above, the problem remains that it deals only with the most visible layer of causes. Given a long-enough time of prosperity, the law of unprovable will gain the upper hand (i.e., if a prohibition works, all’s well and it’s extremely hard to show that it works), and change the system. That, of course, will lead to another disaster, and another cycle.
Cultural memory is too short for us to remember indefinitely, and we cannot put the right things into genes (eugenics is frowned upon these days).
Yves, I give you a lot of credit for speaking truth to power. What is life for but to live your values.
I’ll let the sycophants slobber over Yves. In my opinion she publishes a modestly informative blog for purely mercenary purposes. These purposes are to raise her public visibility with Newsweek level journalists and hook a client or three. None of these expert commentary-on-mass- media blogs are excessively unique.
Elitist “populist poseur” strikes me as the most accurate description of what Yves does. This is her chosen role in the gargantuan vaudeville theater that is Manhattan. The New York Times editorial collective often plays this role on a far vaster scale.
Yves’ parallel theme is to apply a toddler’s nerf ball version of the “Culture of Critique” (see evolutionary psychologist Kevin McDonald) to its principle practitioners. She’s self-aware of the sharp limits on this set by her paymasters and she adheres to them.
Like every other Ivy League paper flipper in lower Manhattan she wants to be paid vast sums of money for nothing more than the sound of her voice and a ream or two of laser-printed 20 lb paper. The populist pose has limits defined by the transition zone to reality.
You do not find virgins lying naked in bordello bedrooms and you do not find genuine populists in lower Manhattan. Nor will you ever make any progress preaching chastity and virtue from such a position.
Yves wants to be the token populist flying on the executive jet to Davos. If such is your goal then I’m sure Yves is probably a worthy teacher.
If any form of real populism is your objective, then I commend to you a close study of the corporate history of Steel Dynamics of Northern Indiana. It’s a genuine (as opposed to NYC phony) Horatio Alger story. You’ll learn how a cow paddy Catholic community college graduate and some Midwest engineers took Wall Street bankrupted and disused steel mills, a smidgeon of local investment and created the most efficient steel company in the world.
As for “New York”, who in the future would ever stake their future on it? Only the same kind of poor moron who’d walk into a casino after reading a billboard announcement stating: “we play with marked cards, loaded dice and electro-magnetic wheels”.
Yves’ wet finger in the wind sees this too. The conclusion is that “consulting” at six figures for government bodies may be the next growth sector for her business. As noted earlier, this business is talking in elite-sounding jargon and operating a laser-printer.
After all the ‘experts’ first asking for government stimulus packages, I am glad to see that here (and on other websites) the idea starts to sink in that stimulus packages is not the solution. But we are only halfway in changing our dogmas. Most people still see free trade as part of the solution. The idea that in the 1930s a trade tariff war made things worse confirms this. But than the USA depended on manufacturing and exports, now it has too much imports. So trade tariffs could actually help the USA in solving the trade deficit and rebuilding industry. But that requires a complete shift from free market thinking to protecting domestic industry thinking. But I think we will eventually get there, the Reagan/Thather era is ending, we are in the process of a paragdigm shift.
After all the ‘experts’ first asking for government stimulus packages
They define "stimulus" as a golden river of 6 & 7 figure goivernment consulting contracts and academic grants to themselves.
Anon of 10:09 AM,
You are way off base as far as my motivations and eeconomics are concerned. I have made less than minimum wage working on this blog. If making money were my objective, I’d do better delivering groceries. With tips, I’d come out ahead.
As for the synergies between this blog and my (or any) consulting, again you are about as far from the mark as you can get. Writing this blog puts me in the camp of a journalist, in most potential clients’ minds. Do you ever see journalists hired as consultants? The last thing an organization or executive group wants to have in is someone who they fear might use them as grist for future publication.
I suggest you become better informed about the pay scales in journalism and blogging versus management consulting, my day job, before you draw inferences.
The system is never solvent in aggregate as there is never sufficient money in the system to repay all existing debt and debt is not systematically restructured to follow collateral depreciation or appreciation.
All money is debt. Money is something that’s valuable because other people will give you something for it and no other reason – which is to say debt. Money can’t be anything else, because it’s used to represent and account for two people making an exchange with a timing difference. During the gap the person who gave up his stuff first has the money – representing the debt the other owes him. When 7 billion people get involved it gets a lot more complicated but the underlying equivalence remains: money = debt. There’s no point in getting upset about it.
Apart from failed and/or marginal attempts, considering only mainstream jurisdictions, the answer is “never!”. Monetary policies have always been giant Ponzi schemes, alternating long periods of irrational exhuberance with credit crises.
Also, while Ponzi schemes are prone to abuse and fraud, human society is at its base a *sustainable* Ponzi scheme. We get taken care of by the previous generation as children and then as adults take care of the next generation. Money is a Ponzi, in the sense that a gets something later from b who gets something even later from c etc., but it can be a sustainable Ponzi, just like families are.
CASSANDRA SAYS:
READ THE PROTOCOLS OF ZION.
Then, and ONLY THEN, can one understand ECONOMICS of this 20th and 21st Century.
Yours truly,
CASSANDRA
Anonymous of 10:09 –
Trashing the hostess is truly bad form, old boy. If you don’t like the free canapes here, better to move along to another shindig that caters to your anger, no?
This forum helps lots of us discern some clarity in this economic mess, for which I’m very grateful.
Yves, thanks, and Happy Holidays.
@ Anon 10;09
“As for “New York”, who in the future would ever stake their future on it? Only the same kind of poor moron who’d walk into a casino after reading a billboard announcement stating: “we play with marked cards, loaded dice and electro-magnetic wheels”.
Sorry Charlie. As a born and bred Philly guy who was indoctrinated at a young age with a hatred for the Yanks, Giants, Mets and Jets(probably due to things they put in the “wooder”) I really enjoy NYC itself when I visit. Further, I’ve always been amazed at how she comes back whenever everyone else thinks she’s finished(Think the 70’s, early 90’s, 9/11, etc.)She’ll be back again at some point, hopefully a little more wise for the wear.
To you New Yorkers. Don’t get the wrong idea. I’ll still be screaming expletives at my flat screen the next time I see Eli.(Some things never change).
BTW Anon @ 10:09- A big difference between Yves and You and I. She signs her name.
I agree with Anon @ 11:54.
10:09, your merdivorous jabber reflects an obvious competing interest with Yves’ enterprise – of course, i’m giving you the benefit of the doubt that you’re not completely psychotic. But what cowardice to make such an eggregious personal attack without revealing yourself or your true intentions. if your true intention is to make such a miserable opinion known, its best to just keep that to yourself. your parents should have taught you that.
(btw…it boggles the mind that 10:09 has to come to the blogsphere to learn manners)
I agree with Cassandra’s analysis, but the frustrating thing is, reversion to the mean can take many different paths. And the appropriate response for investors or citizens planning ahead can be very different for each case.
Inflated asset prices, for instance, can fall in nominal terms. Or they can be ratified by letting inflation surge. It has become absolutely clear now that the US government has crossed the Rubicon and is furiously working to make the latter scenario unfold.
So, for instance, should we be buying shares at this point? A simple answer seems to be no, asset prices are still inflated and there is more reversion to the mean ahead. But on the other hand, common shares represent a claim on very long-term cash flows, and those in general keep pace with inflation (and certain Zimbabwean stock prices bear this out).
The worst thing, I think, would be to get the description right but the prescription wrong…
Here’s kinda of a random question. What if all of the policy decisisions made to bring us to the financial point of no return were part of an orchestrated plan? Greenspan, Paulson, etc. Have alway appeared to be of the bent that prefered the Rand-ian approacht that called for no governmental intervention. A truly free market. The only way that was ever really going to happen was if the issue was forced. If a massive credit bubble was created – one which the US government simply had to deal with – the cost would be so prohibitive that the entire social safety net would have to dismantled or the country would become a third world banana republic in a decade or less. Could this all be a grand game of chicken to see if the beast can finally be starved to death (to paraphrase Grover Norquist)?
The Normal Conquest will be bad for the Anglo-Saxons.
Clever, Dearie Me !! I concur!
anon@3:30
I’ve been chewing on this for the last 3 years.
It certainly feels orchestrated. And I’m sure many would prefer to feel like it wasn’t just the ultimate shipwreck resulting from rudderless policy.
I thought about your angle a little, but rejected it because I thought that the new depression would necessitate huge social reforms and big tax increases — all of which *seems* antithetical to the neocon idealogy. As we’ve learned, though, our junta is not is not the small government self reliance thing we were sold.
So who knows.
I had two other orchestration scenarios:
a) The bad guys went to college and figured out how to scam the entire world very efficiently and elegantly, and using all the tricks of modern psychology and pr. Good job, bad guys. You are really smart if this is what happened. Right up until the guy who lost his job and house shoots you in the head and takes your car.
b) Legitimately concerned council of academics (I picture them as Oxford Dons) games out a way, using our greed and fear, to knock down all the capitalist garbage that allows millions to starve and kill each other, and then build up a society that can respect itself.
“It is demonstrable,” said he, “that things cannot be otherwise than as they are; for as all things have been created for some end, they must necessarily be created for the best end. Observe, for instance, the nose is formed for spectacles, therefore we wear spectacles. The legs are visibly designed for stockings, accordingly we wear stockings. Stones were made to be hewn and to construct castles, therefore My Lord has a magnificent castle; for the greatest baron in the province ought to be the best lodged. Swine were intended to be eaten, therefore we eat pork all the year round: and they, who assert that everything is right, do not express themselves correctly; they should say that everything is best.”
Wise words form ‘fair economist’.
It is not difficult for economists like me to describe ‘normal’ in economic and financial terms.
The BIG problem is how to stop sustained and ultimately unsustainable divergences from normal. To quote Roubini today in the FT ” markets are not self regulating each other”.
In other words, the invisible had needs some help…. especially in the finance sector.
Graham Cox
Yves is a male name
Cassandra rocks
Normalcy is overrated
This is the big one all right
But not how most think
More pain will come