For All We Know, “There Be Dragons”

FinancialCollapse2by Cato   4/27/15
Ron Paul, John Hussman, David Stockman, and many other doomsday forecasters have one thing in common.  They are all focused on the financial architecture of the world in 2015.  They believe the financial structure cannot endure in its present form and that the future contains a catastrophic reset that will, in Biblical terms, result in financial brimstone and fire.  They each describe their doomsday scenario and their fears differently, of course; they don’t agree on what the reset world would look like nor even on what would cause that reset to occur.

Paul thinks the risks are in fiat currency:  Despite rising stock prices and a falling unemployment rate, the United States is on the brink of a catastrophic “financial crisis,” according to former U.S. presidential candidate Ron Paul. And the culprit could be the dollar. “There’s a huge bubble with the dollar,” Paul told CNBC recently.

Hussman believes that the markets will lead the way: “…the lesson to be drawn from our own challenges during the recent half-cycle is not that the Iron Law of Valuation can be abandoned, but that the Iron Law of Speculation makes the near-term outcome of severe overvaluation conditional on the risk-preferences of investors.

Stockman opines that debt will be the trigger: Financial engineering is one of the worst ills perpetuated by the Fed’s regime of cheap debt and money market subsidies for speculation. And these deformations are turbo-charged by the tax code which creates a powerful bias toward loading capital structures with tax deductible debt…”

Paul, Hussman, and Stockman do agree on one thing: that the root cause of all three triggers is quantitative easing (QE).  Too much printed money, allowing government to borrow free of market discipline; money with nowhere to go but into financial assets … all have QE at the base.

The question one should reasonably ask is: based on experience and history are any of these men wrong in the details, or more broadly are they all just wrong?  Does history and experience give us any reason to think this ‘end of days’ tooth-gnashing and hair-pulling is just nonsense?

The answer is no.  It’s not nonsense because the financial architecture of the world has sailed, metaphorically, into the region of a map that a few hundred years ago would have been notated “there be dragons”.  Ancient European mariner’s maps, drawn before the world was completely explored, would indicate the edge of the known world with that phrase.  It’s not that the ancients believed mythical beasts actually lived out there in the darkness.  It was just a warning that whatever was out there harbored unknown risks.  And that perfectly describes the state of affairs today in the financial architecture of the world.  We have experience with only part of the central bank-created quantitative easing (QE) map, and beyond that part “there be dragons”.

Paul, Hussman, Stockman and others are just stating what those dragons might look like. And they may be right.

The truth is we simply don’t know what will ultimately result when dozens of large and mid-sized central banks print money in a competitive race to weaken their currencies or intervene in a crisis; that is, engage in some form or iteration of QE, repeatedly and regularly.  We are gradually gaining some insight into the limits of the effectiveness of this dark magic.

We know, for instance, that as a tool to block a runaway collapse of the financial structure in the very short term, say one year or less QE can be effective and that it can be used successfully.  Think of the horrendous potential of the 2008 mess had it gone unchecked.  We are learning that in the intermediate term, say 1 to 4 years, there is a negative feedback loop that surfaces in important trade and commercial marketplaces, a loop that arguably does more damage than QE does good.  I described that damage in this answer I wrote to a comment by Country+Boy in a previous AT post on QE:

Michael Booth (Cato) replying to “it will work until it doesn’t.” The damage I refer to in my essay, the damage that caused the US Fed to cease their last QE, was the drying up of what the finance world calls “good collateral”, defined as AAA sovereign debt. While a QE buy-up is in process the ONLY source of sovereign T-bills, notes and bonds comes from new debt issued by the Treasury. Because rates fall at least initially in a QE program, and because falling rates mean capital gains for holders of existing bonds, no one sells. “Good collateral” is essential for the operation of trade, bank and other commercial markets, and a lack of “good collateral” causes those markets to seize up. Trade slows. Commerce is inhibited. This negative feedback is what the US Fed saw and the reason they ceased QE buying. For similar reasons QE causes capital investment to slow or be delayed. Europe’s QE program has had the expected initial bloom of good news, but as the ECB sucks “good collateral”, especially German bonds, out of the system these negative feedback loops will kick in. I would be very surprised if the ECB doesn’t declare victory and cease their QE efforts long before their stated Sept 2016 end date.

We have no idea what the long term effects, say 5 or 10 or 20 years out, of constant use of QE might be.  We simply don’t know what integrating this method of financial central planning and market interference into the basic, long term central bank tool kit would do.  We don’t know what unintended consequences it would create.

Would QE be seen as a ‘fail-safe’ device in the minds of financial operatives, such that they felt emboldened to take on unhealthy levels of risk, secure in the knowledge that central banks would print money at the first sign of market or commercial failure?  Would QE spawn financial ‘moral hazard’?  We don’t know.

Would the permanent, potential use of QE result in periodic flooding of the fiat money system, as one nation or another made competitive attempts to gain an advantage, called ‘currency wars’?  Would it be the least disciplined central bank, the loosest one most prone to print, that set the standard, a standard all other central banks had to follow or risk being economically burdened by an “expensive” currency?  We don’t know.

We’ve never sailed the seas our global financial system is sailing right now.  We’ve never had the massive universal levels of debt, the global level of trade and commerce, the intricate web of interconnections technologically and economically we have today.  We’ve never had government so totally, universally in regulatory control of the financial, banking, and currency systems, either.  We’ve never had so much money printed so quickly by so many fiat currency issuers.  This is a complex stew of firsts, is it not?

For all we know, “there be dragons” out there.  For all we know, there may be paradise over the horizon, too, if in the future this stew creates its own universal resistance, as it does among StubbornThings readers now, and normality is demanded and restored.

Paul, Hussman, Stockman and their kin have opinions and forecasts, and any one of them … or all of them … may be right.  They may also just be panic-stricken Cassandra’s.  What’s important as the future unfolds is for all of us to keep a clear, skeptical mind, both to the propaganda coming from the governments and central banks … all is not well, official data is unreliable, and the happy talk does contain a large dose of nonsense … and from the doomsday fraternity, as well.

Michael Booth, often posting and commenting as Cato, lectured in finance and economics at the Univ. of Texas, and worked for 20 years as an independent contractor and managerial trainer on financial topics in the technology industry.
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3 Responses to For All We Know, “There Be Dragons”

  1. Timothy Lane says:

    There’s reason to believe that the 2008 collapse was at least partly the bursting of a financial bubble. Financial policies since then have been about the same as those leading up to the collapse, so it’s easy to suspect that another bubble could burst at any moment. This is what happens when people choose not to learn from their mistakes.

    • Cato says:

      Well said. And while the trigger of the next mess will undoubtedly be different, as it was sub-prime mortgages in 2008 and won’t be that again, the constant of soft money (QE) and irrationally low interest rates (ZIRP) remains. QE and ZIRP are the fuel and it continues to be pumped. The question is from whence comes the spark.


    We’ve never had the massive universal levels of debt, the global level of trade and commerce, the intricate web of interconnections technologically and economically we have today. We’ve never had government so totally, universally in regulatory control of the financial, banking, and currency systems, either. We’ve never had so much money printed so quickly by so many fiat currency issuers. This is a complex stew of firsts, is it not?

    This is true, and I certainly agree with Cato that it is impossible to predict the results in terms of precise dates and times, I think it is possible to predict a collapse of some kind at an indeterminate future date if we do no change direction.

    I say that because we have had government debt, inflation of the money supply, and government regulation and control of business, and we know where each one leads individually.

    1. Government debt, if unchecked, leads first to problems as more money is spent to service the debt (interest payments). We are currently spending something like $1 billion per day on the U.S. debt (enough to fund the budgets of, say, five good-sized individual states) at a time of very low interest rates. As this amount increases, the pressure to cut defense spending (which buys no Democratic votes) will increase irresistibly, much as it has in Europe. It becomes worse as the the amount of debt, the rate of interest, or both increase. Of course the government is controlling interest rates (one cause of our current economic problems), but like other price controls the market pressures could become unbearable and force the Fed to raise rates. The end result is either open default or else some kind of disguised default (as we saw in Greece) such as printing yet more money (see #2 next).

    2. Inflation of the money supply – leads inevitably to inflation as more dollars chase fewer goods. This is what socialist countries do in a desperate attempt to avoid facing the consequences of their prior actions. Inflation is basically a vicious form of taxation and goes hand-in-hand with the welfare state.

    3. Regulation of business – eventually, it becomes impossible to produce under the terms demanded by the regulators and one business after another goes under (or in today’s global economy, flees the country). Businesses are already running away from California and, to some extent, from the U.S. The eventual result was depicted in Atlas Shrugged.

    So while we can’t predict exactly when, we can say that collapse is coming unless we change direction. That is why it is not sufficient to vote for Republican Establishment-men as “the lesser of two evils”. Either we change direction, which requires truly Conservative governance (massive welfare spending cuts, massive regulatory cuts) or we collapse – it’s as simple as that.

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