Monday, May 18, 2009

The Yellowstone Analogy and The Crisis of Neoliberal Capitalism

Just as forestry management's attempt to suppress forest fires enabled ever larger conflagrations, so governments' attempts to suppress global neoliberal capitalism's crisis will fail.

The first task of those at the levers of neoliberal global capitalism is to deny that global capitalism is in crisis.

"Neoliberal" refers to a model of State-managed capitalism which has been in vogue since the Great Depression and the Keynesian revolution: when capitalism's business cycle veers into discomfort (unemployment, slowing sales and borrowing, etc.) then the State (government) suppresses recession with monetary policy (making money cheap and abundant) and fiscal policy (quantitative easing, injections of liquidity, stimulus programs, etc.)

Sounds good, but the Yellowstone Analogy reveals the flaw in this suppression strategy. "Free market private sector capitalism's" normal business cycle of over-investment and excessive risk-taking is naturally followed by a reduction in debt, the liquidation of bad loans and excess inventory, a trend to reduced risk, etc.--in other words, a fast-burning forest fire which incinerates all the dead wood, clearing space for the next generation of growth.

For decades, the operative theory of forestry management was that limited controlled burns-- mild reductions of dead underbrush and debris--would essentially reduce the possibility of a major fire to near-zero.

But the practice actually allowed a buildup of dead wood which then fueled the devastating forest fire which swept Yellowstone National Park in 1988. Various revisionist views sprouted up later, claiming the fire was not the result of misguided attempts to limit natural forces: Vast Yellowstone Fire Now Seen as Unstoppable Natural Cataclysm (NT Times, 1989)

The forest fires that swept vast areas of Yellowstone National Park in 1988 constituted a largely uncontrollable natural event that occurs once every 200 to 300 years, say two biologists who have spent more than a decade studying the ecology of the park.

They said the fires would have been about as extensive and destructive no matter what fire management policies had been followed.

In the aftermath of the blazes, politicians, foresters and environmentalists argued over the National Park Service's policy of allowing fires started by lightning to burn out within prescribed areas. The Park Service and environmentalists said this was necessary so wild areas could regenerate properly. But critics said the policy was misguided and was responsible for the destruction of about 1 million acres in and around Yellowstone.

Now we're in a financial conflagration which is widely considered the result of failed risk-suppression policies. All the derivatives originated and sold were supposed to, along with "self-regulating markets" (smirk), limit the risks in the financial systems to near-zero.

In other words, even as dead branches piled ever higher, various complex hedges would insure no fire in the FIRE economy would ever spread.

Meanwhile, Mr. Greenspan and other officials made sure the slightest whiff of debt reduction or other signs of recession were instantly snuffed with superlow interest rates and abundant government stimulus.

But this private and public risk suppression not only failed to eradicate risk--it enabled risk to grow to unprecedented levels.

Globally, the State has responded to this failure to suppress risk by creating gigantic new risks and transferring them to taxpayers and buyers of government-issued debt.

The suppression technique being pursued by governments everywhere are simple: borrow and print staggering sums of money to bail out the private-sector banks which sparked the crisis, and then borrow and print even more money and throw it into the economy in an attempt to match the fiscal stimulus of World War Two spending.

Unfortunately, all this stimulus is essentially adding more dead wood to an already vast pile which is already choking what's left of the economy's living forest. Rather than close down failed banks and businesses, various games are being played to negate the fires of creative destruction which real capitalism needs to thrive; without a write-off of bad debts and risky failed gambles and a closure of overcapacity then the new business cycle cannot take root.

Isn't it obvious that by trying to make forest fires a thing of the past then you're actually killing the forest? The same mechanism is at work in the multi-trillion dollar attempts to make financial cycles of over-indebtedness and excessive risk a thing of the past.

The financial firestorm of 2008 burned off some of the dead wood, but it left no clearing. Thus the smouldering embers will light all the new bad debt and deadwood blanketing the floor of our moribund, choked economy and a new round of monetary easing and fiscal stimulus will be attempted.

But policy makers will find the willingness of capital to flow into more low-yield government debt will be near-zero. The zombie banks and businesses--the equivalent of dead but still-standing trees--will finally start toppling over.

You can't make people who are already over-indebted take on more debt, and you can't make people whose collateral is falling creditworthy. To shove more debt into the system is to pile more deadwood onto the already-dense pile of dry debris littering every inch of the economy.

The big conceit here is that borrowing trillions of dollars is risk-free as long as the government is doing the borrowing. That is an illusion--there is always risk when you borrow or print or "backstop"/guarantee trillions of dollars of risky debt; the risk has simply been transferred to taxpayers, who will soon suffer the consequences.

For the crisis in capitalism is not just debt-based--it's also resource and demographic-based. Here in the U.S., the Social Security system will reverse its long trend of generating a surplus in 2016 (or sooner as the Depression cuts tax revenues) and as a result it will start drawing upon the general fund--y'know, the Federal budget that's already running a $2 trillion/year deficit.

Medicare is even more fragile, and thus we can easily foresee a fiscal crisis looming in which the Federal government can no longer borrow enough trillions to fund these entitlements. And despite all the repeated soothing official assurances, the crisis is not in 2035 or even 2025--it will hit in 2015 or perhaps even earlier.

It's the old "extend present trends" fallacy. Back when the Social Security system was designed, it was assumed there would always be 10 workers to "pay as you go" to support 1 retiree. The Baby Boom in the 1950s made that projection reassuringly long-term--or so it seemed.

Now that we're approaching a worker-retiree ratio of 2.5-to-1, the system cannot possibly pay the benefits promised without borrowing trillions of dollars each and every year--and from whom?

Meanwhile, oil has plummeted in a long-anticipated head-fake in which global recession cuts demand, masking the arrival of Peak Oil. Will there be enough oil to fuel 100 million new Tata minicars in India plus run the 600 million existing vehicles currently burning oil? And exactly where will the electricity come from to charge up 100 million plug-in hybrid cars made by China's BYD? (Not to mention the lithium-ion batteries.) As for all the aternative fuels, well, maybe maybe maybe, but right now all alternative energy sources provide only a few percentage points of global energy.

Ramping up alt. energy from 2% to 20% of global energy production will be stupendously costly--and um, aren't governments vacuuming up much of the world's capital to squander it on their financial sectors and local governemnt pork-barrel projects?

Neoliberal capitalism is in crisis for one fundamental reason: the State has played "the fixer" with monetary and fiscal policy in the belief that risk could be suppressed or mitigated or even massaged away by spreading it over the entire taxpaying populace.

But the excesses of credit, risk, bubbles and overcapacity are now gutting the very middle class which the State relies on to pay most of the taxes. And as tax revenues dry up, entitlement spending ramps ever higher and borrowing is no longer cheap or even possible, then the State and the "private sector capitalism" which depended on passing off its risks and gambles-gone-awry to the State will find the firestorm was not suppressed-- it was only delayed--and not for long.

The best explanation of systemic financial risk and why it cannot be "disappeared" is The (Mis)behavior of Markets: A Fractal View of Risk, Ruin, and Reward by Benoit Mandelbrot.

The demographics trends which are about to overwhelm entitlements programs are described in Fewer: How the New Demography of Depopulation Will Shape Our Future 

The Coming Generational Storm: What You Need to Know about America's Economic Future 

Our previous list of hot reading (check them out at your local library if you don't want to own a copy) can be found at Books and Films

Thank you, Rebecca H. ($30), for your astonishingly generous contribution to this site. I am greatly honored by your support and readership.

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