We're All Speculators Now

When the herd thunders off the cliff, most participants are trapped in the stampede..

One of the most perverse consequences of the central banks "saving the world" (i.e. saving banks and the super-wealthy) is the destruction of low-risk investments: we're all speculators now, whether we know it or acknowledge it.

The problem is very few of us have the expertise and experience to be successful speculators, i.e. successfully manage treacherously high-risk markets. Here's the choice facing money managers of pension funds and individuals alike: either invest in a safe low-risk asset such as Treasury bonds and lose money every year, as the yield doesn't even match inflation, or accept the extraordinarily high risks of boom-bust bubble assets such as junk bonds, stocks, real estate, etc.

The core middle-class asset is the family home. Back in the pre-financialization era (pre-1982), buying a house and paying down the mortgage to build home equity was the equivalent of a savings account, with the added bonus of the potential for modest appreciation if you happened to buy in a desirable region.

In the late 1990s, the stable, boring market for mortgages was fully financialized and globalized, turning a relatively safe investment and debt market into a speculative commodity. We all know the results: with the explosion of easy access to unlimited credit via HELOCs (home equity lines of credit), liar loans (no-document mortgages), re-financing, etc., the hot credit-money pouring into housing inflated a stupendous bubble that subsequently popped, as all credit-asset bubbles eventually do, with devastating consequences for everyone who reckoned their success in a rising market was a permanent feature of the era and / or evidence of their financial genius.

Highly volatile speculative bubbles are notoriously humbling, even for experienced traders. Buy low and sell high sound easy, but when the herd is running and animal spirits are euphoric, only the most disciplined speculators and the lucky few who have to sell exit near the top of the bubble.

The "safety" of investments in housing, commercial real estate, stocks, corporate bonds, emerging markets, etc., is illusory: these are now inherently risky markets, and it's difficult to hedge these risks. (Not many participants knpw how to hedge housing, commercial real estate, etc.)

In an environment in which participants have been richly rewarded for believing that "the Fed has our backs," i.e. central banks will never let risk-assets drop because they understand pension funds, insurers, banks, etc. will implode if the risk-asset bubbles pop, few see the need to bother with hedges, as hedges cost money and reduce yields.

As a result, few participants are fully hedged. Most participants are buck-naked in terms of exposure to risk, and once the tide goes out we'll find out how few are hedged against bubbles popping.

Financial markets are not linear by nature, so predictably rising markets are atypical. Financial markets are intrinsically non-linear, meaning that the dynamics are inter-connected and prone to asymmetric events in which a small input triggers an outsized output such as a crash.

In the fantasy world conjured by central bank stimulus, markets never go down and economies never slide into recession. Financial engineering has eradicated risk. But the dynamics interact in ways that can't be controlled. As inflation heats up globally, central banks are being forced to "normalize" interest rates and yields, and political pressure to stop saving banks and the super-wealthy is mounting.

All speculative markets deflate, slowly or suddenly, depending on the marginal buyers and sellers. The shakier the marginal participants, the greater the likelihood that the speculative bubble will pop with a suddenness that surprises the vast majority of participants.

Take a look at stock valuations as a percentage of GDP, i.e. the real economy: stocks are clearly in a bubble.

The national Case-Shiller housing price index: bubble.

The Seattle Case-Shiller housing price index: super-bubble.

The Dallas Case-Shiller housing price index: super-duper-bubble.

You get the point: virtually every supposedly low-risk asset class is actually a super-risky, super-dangerous bubble. Speculation drives valuations far beyond financial rationality because we're herd animals and unearned gains supercharge our greed, especially when we see all sorts of undeserving people making fortunes for doing nothing but running with the herd.

So when the herd thunders off the cliff, most participants are trapped in the stampede. Very few exited far from the cliff, and even fewer will wait patiently for the dust to settle before moving cash into assets.

Risk has a knack for hiding in plain sight. Few people look for it, and even fewer recognize it. Only a handful act on it.


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Massive Deficit Spending Greenlights Waste, Fraud, Profiteering and Dysfunction

America's problem isn't a lack of deficit spending/consumption. America's problems are profoundly structural.

The nice thing about free to me money from any source is the recipients don't have to change anything. Free money is the ultimate free-pass from consequence and adaptation: instead of having to make difficult trade-offs or suffer the consequences of profligacy, the recipients of free money are saved: they can continue on their merry way, ignoring the monumental dysfunction of their lifestyle.

This explains the appeal of Modern Monetary Theory (MMT), which holds that deficit spending is the "solution" to all our problems because governments can't go broke--they can always emit whatever currency they need via printing or borrowing.

The problem with government deficit spending is it's free money to the recipients: there are no feedback mechanisms to enforce any consequences for spending that's wasteful, fraudulent or inefficient/ineffective.

Deficit spending simply enables the wasteful, corrupt, rewarding-insiders profiteering state-cartel kleptocracy to continue gorging on public spending.So what desperately needed efficiencies and improvements are imposed on the higher education cartel by handing the cartel another trillion dollars of public spending? None.

What desperately needed efficiencies and improvements are imposed on the healthcare cartel by handing the cartel trillions of dollars in publicly funded "Medicare for all"? None.

What desperately needed efficiencies and improvements are imposed on the national defense cartel by handing the cartel additional trillions of public spending? None.

What kind of sense does it make to encourage wasteful consumption on a finite planet with limited resources? The entire rationale of Modern Monetary Theory (MMT) is that the productive capacity of the economy isn't being maxed out because we're not consuming enough.

This is the insane ideology of endless growth on a finite planet. Consumption funded by free to me deficit spending has no mechanisms to recognize the wasteful, dysfunctional insanity of planned obsolescence and growth-for-growth's-sake wasteful consumption.

Everybody supports spending trillions on infrastructure but has anyone noticed that the system for building infrastructure is completely broken in the U.S.? It takes a decade or two to rebuild a bridge (for example, the Bay Bridge connecting Oakland and San Francisco) and every project that is budgeted to cost $1 billion ends up costing $4 billion.

China would have cleared the political/permit process in weeks and rebuilt the Bay Bridge in six months. In the politically dysfunctional, over-regulated, insider-oligarchy of the U.S., the process takes 17 years, and costs quadruple. That is the acme of dysfunction on all levels.

Increasing deficit spending in this system simply rewards insiders and elites.Look, the U.S. has already borrowed and blown $16 trillion in federal deficit spending and trillions more in state and local deficit spending, i.e. the sale of bonds to repave streets, reroof schools, build affordable housing, etc.

Somebody benefits from all the deficit spending on cartels and all the financing of the debt: the top .1%. And why are you surprised? This is the only possible output of a state-cartel kleptocracy/oligarchy.

Deficit spending isn't just public. Corporations and households have been deficit-spending as well. Total credit outstanding in the U.S. has far outpaced the expansion of GDP, the real economy. We're borrowing more and getting less, overwhelming evidence that printing/borrowing money is generating less output.

Here's federal debt. The government doesn't "print" currency in our system, it borrows it into existence. The central state issues bonds and the central bank buys the bonds with newly created currency. Or pension funds, insurers, etc. buy the bonds, so "we owe it to ourselves." Regardless, debt accrues interest and eventually this generates consequences.

But not everyone owns debt, which is of course an asset. The benefits of deficit spending are as asymmetrical as all other spending/debt in our system.

Deficit spending is simply doing more of what's failed. We have two examples to study: Venezuela, which has supported its free to me public welfare spending and its corrupt ruling elites by printing currency with abandon.

It's simply not true that "governments can't go broke because they can print money": they can print currency but the currency has no purchasing power. I've read all sorts of excuses for Venezuela's debasement of its currency, but the reality is: they printed as much as they needed to keep the status quo afloat and this profligate issuance of currency destroyed the purchasing power of their currency.

Then there's Japan, which has been deficit spending on a colossal scale for almost 30 years. They've played the game of "we owe it to ourselves" and the wink-wink cycle of the central bank buying government bonds (to fund deficit spending) with newly created currency.

Japan's problem isn't a lack of government spending. Its problem is a dysfunctional, sclerotic state-cartel structure of self-serving corrupt insiders. Beneath the glossy surface of the trains running on time, Japan's social order has been hollowed out by the dysfunction, a dysfunction that's been propped up by deficit spending on bridges to nowhere and other redundant or even pointless infrastructure.

Japan's younger generations have stopped getting married and stopped having children because they can no longer afford such luxuries. The elites are still immensely wealthy and politically powerful but the economy and society have been hollowed out. Nobody will speak freely about it because it reflects poorly on Japan.

In a similar fashion, we cling to the fantasy that a few trillion more in wasteful consumption will save our dysfunctional, sclerotic state-cartel system from well-earned collapse.

America's problem isn't a lack of deficit spending/consumption: America's problem isn't a lack of free to me money. America's problems are profoundly structural: a sclerotic, toxic political system of self-serving oligarchic elites propped up by a class of self-serving professional technocrats, and an insiders-take-most economy in which virtually all the income gains (and 85% of the wealth gains) flow to the very top and the 5% technocrat class that owns enough of the assets that have been inflated to bubble heights to enjoy the illusion of security and wealth.

There is no such thing as free to me money: the cost is simply being hidden in the deep, pervasive structural rot of our economy, politics and society.


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The Next Financial Crisis Is Right on Schedule (2019)

Neither small business nor the bottom 90% of households can afford this "best economy ever."

After 10 years of unprecedented goosing, some of the real economy is finally overheating: costs are heating up, unemployment is at historic lows, small business optimism is high, and so on--all classic indicators that the top of this cycle is in.

Financial assets have been goosed to record highs in the everything bubble.Buy the dip has worked in stocks, bonds and real estate--what's not to like?

Beneath the surface, the frantic goosing has planted seeds of financial crisis which have sprouted and are about to blossom with devastating effect. There are two related systems-level concepts which illuminate the coming crisis: the S-Curve and non-linear effects.

The S-Curve (illustrated below) is visible in both natural and human systems.The boost phase of rapid growth/adoption is followed by a linear phase of maturity in which growth/adoption slows as the dynamic has reached into the far corners of the audience / market: everybody already caught the cold, bought Apple stock, etc.

The linear stage of maturity is followed by a decline phase that's non-linear.Linear means 1 unit of input yields 1 unit of output. Non-linear means 1 unit of input yields 100 unit of output. In the first case, moving 1 unit of snow clears a modest path. In the second case, moving 1 unit of snow unleashes an avalanche.

The previous two bubbles that topped/popped in 2000-01 and 2008-09 both exhibited non-linear dynamics that scared the bejabbers out of the central bank/state authorities accustomed to linear systems.

In a panic, former Fed chair Alan Greenspan pushed interest rates to historic lows to inflate another bubble, thus insuring the next bubble would manifest even greater non-linear devastation.

Ten years after the 2008-09 Global Financial Meltdown, analysts are still trying to understand what happened. For example, the new book Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze is an attempt to autopsy the meltdown and investigate the mindset and assumptions that led to the panicky bailouts and frantic goosing of a third credit/asset bubble--the bubble which is about to pop with even greater non-linear effects.

This is the nature of non-linear dynamics: everything is tightly tied to everything else. Tightly bound/connected systems are hyper-coherent, i.e. every component is tightly bound /correlated to other components.

This is how the relatively modest-sized subprime mortgage market ($500 billion) almost toppled the entire $200 trillion global financial market.

The vast imbalances created by 10 years of unceasing goosing will unleash a non-linear avalanche of reversions to the mean and rapid unwinding of extremes. Consider the impact on hedges, a necessary function of the financial system. With yields so low, the cost of hedging negatively impacts returns, so hedging has been abandoned, trimmed or distilled down to magical-thinking (shorting volatility as the "can't lose" hedge for all circumstances).

With shorting volatility being the one-size-fits-all hedge, the signaling value of volatility has been distorted. The same can be said of other measures: the information value of traditional financial signals have been lost due to manipulation and/or goosing.

The interconnectedness of global markets means a small blaze in a distant market can quickly become a conflagration. Put these two together and you get a perfect setup for crisis and crash: nobody really knows anything because the signals have been distorted, but everyone thinks they know everything-- sell volatility and buy the dip. It works great until it doesn't.

Meanwhile, beneath the "best economy ever" the rot is accelerating. This article on the empty storefronts proliferating throughout New York City's neighborhoods, This Space Available, mentions one dynamic in passing that is an example of the distortions that will be unwound in the next financial crisis.

Desperate for yield in the near-zero yield world engineered by central banks, investors have piled into commercial real estate and overpaid for buildings as the bubbles in rents and valuations expanded in tandem.

These owners are now trapped: their lenders demand long-term leases that lock in nosebleed rents, but back in the real world, no business can survive paying nosebleed rents, and agreeing to long-term leases in this environment is akin to committing financial suicide.

If you actually want to make a profit, it's impossible to do so paying current commercial rent rates. And if you want to retain the absolutely critical flexibility you'll need to adjust as conditions change, you can't sign a long-term lease. Everyone signing a long-term lease today will be declaring bankruptcy in 2019 when the recession trims sales but leaves expenses unchanged.

In other words, neither small business nor the bottom 90% of households can afford this "best economy ever." The financial markets have completely disconnected from reality, and the process of reconnection will unravel all the imbalances and extremes and deflate every interconnected bubble.

The current fantasy is that bubbles will never pop and recessions are a thing of the past; financial engineering can maintain bubbles and "growth" forever.Everything is distorted to the point that those wandering the hall of mirrors believe they know everything they need to know to continue reaping fat returns on capital.

Conventional thinking that performs well in linear eras is disastrously ill-prepared to navigate non-linear eras like the one we'll be entering in 2019--right on schedule.


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How Things Fall Apart: Extremes Aren't Stable

A funny thing happens on the way to stabilizing things by doing more of what's failed: the system becomes even more unstable, brittle and fragile.

A peculiar faith in pushing extremes to new heights has taken hold in official circles over the past decade: when past extremes push the system to the breaking point and everything starts unraveling, the trendy solution in official circles is to double-down, pushing even greater extremes. If this fails, then the solution is to double-down again. And so on.

So when uncreditworthy borrowers default on stupendous loans they were never qualified to receive, the solution is to extend even more stupendous sums of new credit so the borrower can roll over the old debt and make a few interest payments for appearance's sake (also known as "saving face.")

A funny thing happens on the way to stabilizing things by doing more of what's failed: the system becomes even more unstable, brittle and fragile.

Central banks and states have latched onto a solution akin to a perpetual-motion machine: the solution to all problems is simple: print or borrow another trillion. If the problem persists, repeat the print/borrow another trillion until it goes away.

Consider China, a nation (like many others) dependent on a vast, never-ending expansion of credit. So what happens when defaults start piling up in the shadow banking system? The central bank/state authorities conjure up a couple trillion yuan (a.k.a. liquidity) so defaults go away: here, Mr. Bad-Risk-Default, is government-issued credit so you can pay off your defaulted private-sector loan. Everybody saves face, private losses have been transferred to the public sector/state, problem solved.

Small banks over-extended and technically insolvent? Solution: print or borrow another trillion and give the insolvent bank the dough. Problem solved!

Here in the U.S., the solution to student loan debt hitting an astronomical $750 billion was to double the student loan debt to $1.5 trillion. When faced with an extreme that's blowing up, double-down and do more of what's failing.

Once $1 trillion of that soaring student loan debt is in default, the solution will be for the Federal Reserve/Treasury to print or borrow another trillion dollars and hand it to the debtors so they can pay off their private-sector student loans. Problem solved!

There is literally no extreme that can't be doubled down. Tens of millions of disenfranchized folks getting restless and voting for the wrong candidates? Solution: print or borrow another trillion and distribute it as Universal Basic Income: problem solved. Repeat annually, and if it's still not enough to quell revolt, double-down: print or borrow $2 trillion more every year to double everyone's UBI bribe, oops, I mean entitlement.

In terms of system structure, extremes are not stable. They beg for a reversion to the mean. Extremes in finance, credit and debt are akin to monoculture crops: flood the fields with fertilizers, herbicides and insecticides, and the apparent stability of the monoculture is preserved (at great expense, but who cares? Just print or borrow another trillion.)

But the system isn't stable. It's brittle and fragile. Eventually some non-linear dynamic manifests: a blight that's resistant to the herbicide destroys the crop, an insect that's resistant explodes out of nowhere and eats the crop, etc. Pushing the system to an extreme only made it more vulnerable to an increasingly broad range of disruptors.

Systems made to appear stable by brute-force application of extremes will never be stable. Stability arises from all the features erased by brute-force application of extremes.

Debt at an extreme? Double-down. (Student loan version)

Debt at an extreme? Double-down. (China version)

Debt at an extreme? Double-down. (U.S. version)

Extremes beget extremes. Extremes of financialization lead to extremes of wealth which lead to extremes of class disparity which lead to extremes of political polarization which lead to destabilization and collapse.

By all means, double down again in the next crisis, Leadership Elites. That should destabilize the status quo for good and your privileges will go the way of all the other extremes: into the dustbin of history.


My new mystery The Adventures of the Consulting Philosopher: The Disappearance of Drake is a ridiculously affordable $1.29 (Kindle) or $8.95 (print); read the first chapters for free in PDF format.

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Read the first section for free in PDF format.


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