Nassim Taleb on Dodd Frank’s OFR: Soviet Style Management

While rapid advancement of technology has been decentralizing or democratizing data and information flows, central planners dream of the opposite: centralizing these in an attempt to control the markets.

A recently enacted financial overhaul law, Dodd Frank has an offspring called the Office of Financial Research.

According to the Wall Street Journal Blog, (bold emphasis mine)

Dodd-Frank created the new semi-autonomous office to support a new council of regulators – the Financial Stability Oversight Council, or FSOC – that is charged with spotting and tamping down emerging risks to financial stability. The OFR has two key components – a data-collection arm that has broad power to request any kind of information from financial firms it deems necessary, and a research and analysis arm that to be focused on monitoring the financial system for risk and producing research to improve regulation.

Celebrity author and Black Swan expositor Nassim Taleb critiqued the framework of this new office. In a prepared testimony Mr. Taleb says that this represents

an attempt to create “an omniscient Soviet-style central risk manager.”

That’s because Mr. Taleb points out that quant models can’t capture real events

According to the same article, (bold emphasis mine)

In his testimony, Mr. Taleb said that “[f]inancial risks, particularly those known as Black Swan events cannot be measured in any possible quantitative and predictive manner; they can only be dealt with [in] nonpredictive ways.” He argued that trying to do what the OFR is designed to do could actually increase risks, in part by increasing “overconfidence” in the information’s ability to predict the next crisis.

Like all quant-econometric based models, they suffer from what the great F. A. Hayek calls as the knowledge problem as embodied by the quote below:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

Most people hardly ever learn

How Global Stock Markets Reacted to the Greece Crisis Resolution

One of my favorite website, Bespoke Invest, has a nice rundown on the performances of 78 world equity benchmarks this week highlighted by the Greece vote on crisis resolution measures.

As expected, most of the benefits accrued to markets that had been most sensitive to the risks of a Euro crisis contagion.

The Philippines have seemingly been indifferent (but not today where the Phisix rose 1.4% to breakout from the massive reverse and shoulder pattern)

But what I find interesting is this comment.

From Bespoke (including chart) [bold emphasis mine]

Looking at year-to-date performance, Bangladesh is down the most with a decline of 26.21%, followed by Peru at -19.20%. Other countries that have really struggled so far in 2011 include Finland, Oman, Malta, Kuwait, Kenya, Vietnam and Brazil. With so much attention being paid to the problems in Greece, you would think that its stock market would be getting absolutely crushed this year, but it's currently down just 9.54%. This obviously isn't a positive number, but it's at least better than ten other countries on the list.

This is true.

I’ve seen many people soooo fixated by the Greece crisis such that they almost see the end of the world take place. This I argued successfully against.

In behavioral science this known as the focusing effect, where people transfix their attention to one event at the expense of the rest.

Black Swan author Nassim Taleb calls this tunneling or “uncertainty of the deluded”

People who tunnel on sources of uncertainty by producing precise sources like the great uncertainty principle or similar, less consequential, matters to real life, worrying about subatomic particles while forgetting that we can’t predict tomorrow’s crises.

Such focusing effect/tunneling vision seems so elaborate on people whom are plagued by political and or economic creeds or those who see the world rigidly in the prism of their (self-righteous) designs and who interprets evolving events that gives much weight on the short term or present oriented actions.

And this is why obsession or getting married to a view/theme can lead to blindspots that can be very fatal.

Aside from the global rally in equities, the Euro-Gold correlations, both have substantially been rallying, have once reaffirmed its relational harmony in defiance of the world according to these ideologues.

Nassim Taleb: US Federal Reserve will Cease to Exist in 25 years

Nassim Taleb celebrated author of the Black Swan theory makes a bold forecast

The Federal Reserve won’t exist in 25 years and the reappointment of Ben Bernanke as head of the central bank was a “management failure,” said Nassim Taleb, author of ‘The Black Swan.’

Allowing Bernanke to stay at the helm of the Fed is equivalent to “letting an unqualified pilot fly a plane,” Taleb, a principal at Universa Investments LP, told a conference in Moscow, Russia today.

From Moneynews.com

Resurgent Gold Equals Resurgent Emerging Market Bourses?

By the way, full employment was one of the main justifications for the Reichsbank's inflationist monetary policies. So nothing has changed. Central bankers still believe that monetary policy can lower the unemployment rate. Patrick Barron The Nightmare of 1923 and Its Cause

Don’t look now, but gold is surging right back! (I have to wait for a successful test of 1,430 before I could blurt out ‘I told you so’[1])

If gold is surging right back, then it is likely that global equity markets will follow gold’s path. And this includes the Philippine Phisix.

Figure 1: Stockcharts.com: Phisix-Gold

We’ve been saying that gold has been a reliable barometer of the equity markets.

As you can see in figure 1, gold (black line main window) seems highly correlated with the actions of the Phisix (candle chart main window), as well as with the movements of key emerging markets as the BRIC (Brazil, Russia, India and China via BKF) as well as ASEAN equities (via FSEAX).

However such correlation doesn’t imply causation. The link between gold and emerging markets can be traced to concerted monetary inflationism by global central banks most especially by the Fed’s QE programs.

And places which were said to suffer from the risks of deflation, as the US[2], UK[3] or Euro[4], have actually been experiencing the opposite—inflation has begun to seep in and has even been accelerating.

Earlier, mainstream had been telling us that inflation wouldn’t be a factor. How consistently ‘spectacularly’ wrong they have been[5].

Inflation hasn’t just been manifested in the asset markets but has also been spreading throughout the commodity space (see figure 2).

Figure 2: Price Shocks in Food and $100 Brent Crude (sources: Danske Bank[6] and tradingeconomics[7])

Some in mainstream media has pointed to the soaring food and energy prices[8] as representing effects of the unfolding political events in the Middle East and Africa.

However the causation has, in fact, been the opposite—the unintended effects of the cocktail mix of monetary, fiscal and administrative policies of global governments has caused a widespread boom (signs of crack up boom) in commodity prices that has partly added to the public’s political discontent which have led to the spate of unrest in many countries. While rising food and energy prices has functioned as trigger, there are deeper underlying problems from which has caused the public to vent their dissatisfaction.

Concerns of the risks of supply shocks represent as only ‘secondary’ effects or as a feedback mechanism from the main cause—government inflationist policies.

The False Allure Of Negative Knowledge

This reminds me of Nassim Nicolas Taleb’s “Subtractive Prophecy” knowledge theory where the knowledge of the consensus can be characterized as generally “negative”.

Mr. Taleb’s proposition holds that (from his forthcoming “must buy” book-AntiFragility[9]): [bold emphasis mine]

we know a lot more what is wrong than what is right, or, phrased according to the fragile/robust classification, negative knowledge (what is wrong, what does not work) is more robust to error than positive knowledge (what is right, what works). So knowledge grows by subtraction, a lot more than addition —given that what we know today might turn out to be wrong but what we know to be wrong cannot turn out to be right, at least not easily.

Mr. Taleb’s negative knowledge theory melds with my own when I alluded to why many celebrity gurus remain highly popular[10] despite being constantly ‘spectacularly’ wrong on their predictions—the public may not all be concerned with what really works but espouses on what may seem as the traditionally or conventionally accepted wisdom. Peer pressure, or the informational bandwagon, seems to be the single most influential factor in disseminating ‘negative knowledge’.

In addition, a secondary factor could one of projecting the acquisition of ‘positive knowledge’ built around empiricism modelled through scientism or as Professor Russ Roberts writes[11], “the use of the language and tools of science to reach a conclusion that is not merited”.

In short, scientism could signify a form of social signalling aimed at exhibiting one’s intellectual prowess through math based models.

Or simply said, the desire to build self esteem or social capital by projecting themselves as intellectuals. Thus, much of mainstream’s actions have hardly been about the quest to achieve positive knowledge, instead they are focused on sprucing up image or reputation for the intent of social interactions.

As prudent investors our main concern should not be about what is conventionally accepted, but about being right, and importantly, what works. That’s because return of investments depend on ‘positive knowledge’ rather than the false allure or the wishful thinking from a top-down engineered social utopianism.

Soaring Gold Investment ‘Reservation’ Demand

It is important to also point out that as we have been predicting[12], the demand composition for gold has been shifting from a typical commodity to one of money, and this has been represented by the substantial expansion of ‘investment’ demand (figure 3).

Figure 3: US Global Investors[13]: Changing Composition of Gold’s Demand

Investment demand for gold leapt 70% in 2011 with China as a big factor in the demand growth.

According to this Bloomberg report[14],

Investment demand in 2010 jumped 70 percent and consumption by the jewelery sector gained to a record, it said. Investment was 179.9 metric tons, surpassing Germany and the U.S., as buyers sought out gold bars and coins, according the London- based industry group. Demand from the jewelry sector was 400 tons, it said....

Chinese investors have shown great enthusiasm amid lack of other alternative investments,” Wang Lixin, China representative for the council, said today in Beijing. Wang said the forecast was a “conservative estimate.”

As for the supposed reasons for such growth in demand, the same Bloomberg article quotes a report from the World Gold Council...

“The main motivation behind this demand has been concern over domestic inflation pressure and poor performance of alternative investments, combined with expectations of further gold price gains,” the council said in a report released today.

Again the report only further confirms what we have repeatedly been talking about—a shift of gold’s demand dynamics to one of ‘reservation demand’. As I previously wrote[15],

“money’s “store of value” is increasingly being factored into gold prices (unit of account). Hence, relative to gold pricing, this implies that reservation dynamics or the reservation model (and not consumption model) determines gold valuations or that the exchange ratio or monetary valuations relative to fiat currency applies-- where valuations are determined by the expected changes in relationship between the relative quantity of, and the demand for, gold as money vis-a-vis paper currencies.”

So while jewellery still accounts for as the largest demand for gold, the gist would likely shift towards investments. Nevertheless, statistics can’t assimilate on what people actions represent.

Applied to gold, people can buy jewellery not only for aesthetics or for ornamental purposes, but also as investments.

Official Buying And Monetary Stablization

Figure 4: WGC: Official Purchases First Time in 21 Years

It hasn’t been only the man on streets and the financial markets whom has contributed to a surge in the demand for gold. Governments, perhaps, may have equally been afraid of their own shadows and have begun to stockpile.

In 2010, the official sector, writes the World Gold Council[16], became a net buyer of gold for the first time in 21 years. (see figure 4)

Two factors seem to bear this out, one emerging markets became significant net buyers and secondly, Europe, with significant gold holdings, has greatly reduced their traditional sales activities.

The end in the streak of official selling, should serve as a pellucid and practical example of the error prone predictive value of rigidly relying on statistics and or on the anchoring effect (linear expectations) of past performances. Numbers cannot and will not substitute for people’s actions (this includes the government, who are also comprised of individuals).

As to whether the shift in the attitudes of some governments as reflected by their gold buying patterns would parlay into prospective policies would be another matter.

Yet unless governments act in the way a gold standard is in place (which is to severely downsize on the welfare state and various forms of political economic interventionism), or that government democratizes the banking system to allow for mass competition (by dismantling the banking cartel structure), we are not likely to see governments stabilize the monetary system soon. Adjustments will likely happen at the brink of or during a crisis or what I would call the Mises Moment.

That’s because central banks can always surreptitiously work for the state’s political agenda camouflaged by the esoteric nature of the operations of central banking.

In the fitting and resonant words of Henry Ford,

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

So while the fiscal side of governments may be scrutinized by a vigilant public over the perceived profligacy of a government, central banks actions can and will likely substitute for such a loss.

In the US the Federal Reserve’s recent actions appear to reflect on this.

Fund manager Axel Merk glibly explains[17],

Many of the Fed’s policies since the onset of the financial crisis have not been traditional monetary policies: a central bank usually applies a very broad brush in managing economic growth by controlling levers such as interest rates or money supply. However, when the Fed, for example, bought mortgage-backed securities (MBS), it steered money to a specific sector of the economy. That’s fiscal, not monetary policy, traditionally reserved for elected policy makers in Congress. Just like the MBS program, many of the Fed’s policies continue to appear to be attempts at addressing the “shortcomings” of Congress.

In short, what the Congress cannot do, the central bank can.

So any talk of monetary stability should translate to the reining of the actions of central banks or to a more radical extent—abolishing the central banking platform.

Alternatively this also means that given the absence of popular discontent with central banking, the monetary skulduggery can and will likely go on, in spite of globalization or the internet.

Thus, like all price trends, gold will not go up on a straight line but will sporadically encounter severe headwinds, as seen in the previous months.

Nevertheless, the general trend for gold is that it will continually move higher, and most importantly, increasingly assimilate more of money’s characteristics in the face of the persistent central bank manipulation of the monetary system coupled with competitive debasement for political goals.

Even in the political front we seem to be seeing the evolution of gold as money gain significant ground.

I mentioned earlier the World Bank Chief Robert Zoellig[18] has called for the inclusion of gold in monetary reforms. This seems to be shared too by Kansas Federal Reserve President Thomas Hoenig[19] whereby Mr. Hoenig says gold standard is "legitimate”. And so with 10 US states which had “introduced bills in the past few years to allow state commerce to be conducted with gold and silver.[20]”

Moreover, there has been NO fear factor or fear premium in gold[21] as the vicissitudes (rise and fall) of gold prices has been along with risk assets.

To stubbornly insist on this is to put misplaced belief rather than acting on the basis of evidence required for any serious examination.

Having said so, with the momentum of gold seemingly regaining the upside path, we are likely to see a similar price inflation on equity assets as gold and equity prices have shown strong correlations.

This is most likely to be seen on many emerging market bourses that has started the year on the wrong side of the fence.

The Philippine Phisix included.

---

[1] See Gold Fundamentals Remain Positive, January 31, 2011

[2] Wall Street Journal, Deja Deflation Fear, February 18, 2011

[3] bbc.co.uk UK inflation rate rises ‘hitting savers’, February 15, 2011

[4] Bloomberg.com Trichet Says ECB Doesn’t Exclude Possibility of Inflation Risks, February 19, 2011

[5] See Inflation Expectations: The Widening Chasm Between Households And Experts, February 12, 2011

[6] Danske Bank, Inflation so far not a risk to growth February 17, 2011

[7] Tradingeconomics.com, Brent Crude

[8] Bloomberg.com Brent Crude Trades Near Two-Year High on Mideast Supply Concern, February 17, 2010

[9] Taleb Nassim Nicolas Anti Fragility, How To Live In A World We Don’t Understand, Chapter 5, How (NOT) To Be A Prophet fooledbyrandomenss.com

[10] See Explaining Popularity In Terms of Predictions: Dr. Nouriel Roubini’s Case, February 17, 2011

[11] Roberts Russ Scientism, Cafe Hayek, January 10, 2011

[12] See Is Gold In A Bubble?, November 22, 2009

[13] US Global Investors, Investor Alert - February 18, 2011

[14] Bloomberg.com China 2011 Gold Investment May Jump 50%, Council Says, February 17, 2010

[15] See What Gold’s Latest Record Prices Mean, June 21, 2011

[16] World Gold Council, Gold Demand Trends Full year 2010

[17] Merk Axel, Politics of Inflation, safehaven.com February 16, 2011

[18] See World Bank Chief Robert Zoellig: Bring Gold Back As Part Of The New Monetary Order, November 9, 2010

[19] Reuters.com Fed's Hoenig says gold standard "legitimate", January 5, 2011

[20] TPMDC, At Least 10 States Have Introduced Gold Coins-As-Currency Bills, January 5, 2011

[21] See Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy, April 26, 2009

Nassim Taleb: Government Deficits As The Next Black Swan

Speaking of political incentives Nassim Taleb has one great example, in an interview he says

The massive one is government deficits. As an analogy: You often have planes landing two hours late. In some cases, when you have volcanos, you can land two or three weeks late. How often have you landed two hours early? Never. It's the same with deficits. The errors tend to go one way rather than the other. When I wrote The Black Swan, I realized there was a huge bias in the way people estimate deficits and make forecasts. Typically things costs more, which is chronic. Governments that try to shoot for a surplus hardly ever reach it.

The problem is getting runaway. It's becoming a pure Ponzi scheme. It's very nonlinear: You need more and more debt just to stay where you are. And what broke [convicted financier Bernard] Madoff is going to break governments. They need to find new suckers all the time. And unfortunately the world has run out of suckers.

In other words, the incentive for politicians has been to run up unsustainable deficits through lavish spending.

And he thinks that definancialization should be the way to go

I think we should not need financial reform. What we need is definancialization. What we need to do is break the financial community's grip on society. And you can do it very easily by transformation of debt into equity. Banks have an interest in building debt, but equity in society is vastly more stable than debt.

But in my view, we can’t definancialize without overhauling the political system which has been tied to Central Banking. Therefore, definancialization should mean the end of central banking.

Nassim Taleb: Waking Up One Day To Perceptional Hyperinflation

Here is Bloomberg's recent interview of Black Swan author Nassim Taleb.

Great stuff from Mr. Taleb...




Some notes:

-If you look at governments they typically underestimate deficits
-No government wants solution to apply on themselves
-I think we are going to have, at some point, a failed auction that’s gonna cause severe worries...here in Greece in US, something that’s gonna contage...
-We don’t have enough buyers for treasury bonds so the government may have to print them, and you know can what can happen when you start printing money
-Nothing happens early on and then suddenly you wake up one day and you have something called hyperinflation without having inflation-perceptional hyperinflation.
-Worried about government debt and rising interest rates
-Perceptional hyperinflation is going to penalize real estate in real terms, stock market and companies
-The problem was debt, you don’t cure debt with debt.
-I am going to give what I call as negative advise-what investors should not be doing
-I don’t recommend...treasury bonds as a repository of value...go very short term
-Euro and the US dollar will have the same ills
-If you have perceptional hyperinflation you should have hard assets...a good collection of metals would work or agricultural land
-I’d recommend not thinking about the stock market...
-If you go to business school today they teach you the wrong stuff, so I suggest not to go to business schools
-Don’t take any class that has equations in it. Learn accounting, computer science but not what they teach you...it’s all bogus

Nassim Taleb: We Are Probably Worst Off Than Before

Interesting discussion between Nassim Taleb and Nouriel Roubini on Ben Bernanke at the CNBC.

Mr. Taleb avoids directly confronting Mr. Roubini, but runs an argument against policies undertaken by Bernanke from which Mr. Roubini supports. Nevertheless, Mr. Taleb in pun notes that Mr. Roubini's weakness is that "he likes Bernanke too much".

Here is Henry Blodget's summary of the interview:

-We're all in denial
-We're replacing private debt with public debt.
-We're not dealing with the cancer in our banking system.
-We're not making the structural changes we need to make.
-We're not being aggressive enough about restructuring debt (debt for equity swaps).
-Bernanke is a wimpy Greenspan sycophant
-Obama's rewarding the fools who got us here (Summers, Bernanke, Geithner)
The banksters are taking over again

Nassim Taleb: Monetary Policy Is Out of Control

Monetary Policy is out of control says Black Swan author Nassim Taleb in an interview at CNBC.

Some noteworthy quotes

-Don’t be fooled by complex system, you can have a positive number, but that doesn’t mean anything. System is very fragile, your talking about something that is deleveraging

-You may have a temporary relief but you still are in a world that is breaking, and that world should break…gonna break.

-Whatever is fragile in complex system breaks, in other words, you took at nature, nature breaks anything that is too big, not to create interdependency just to reach equilibrium.

-We’re in a middle of a crash

-If I am going to forecast something I know its going to get worst not better.

-If things start breaking as you can see it, they break much harder than they build themselves

-Monkey on our back is debt.

-Instead of deflating debt they are thinking of inflating assets, actually they even don’t know what they are doing. They’re doing lot of contradictory things.

-Hyperinflation is a mechanism that’s very vicious. Because all you need is for people to think there’s gonna be inflation to start hoarding. So it’s a perceptional mechanism and TIPS won’t save you from that. If you have TIPS, TIPs pays you nominal inflation but expectations can go wild.

-My statement is not that we are going to have hyperinflation, my statement is that Monetary policy is out of control.

-What makes me very pessimistic in not seeing any leadership or awareness on parts of government on what has to be done, which is deleverage $40-to-$70 trillion

-Those who basing themselves on past history, don’t know anything about history, because we are in an environment that doesn’t resemble the past at all.

Nassim Taleb at CNBC: Understanding Risks From Complex Systems

CNBC's interesting interview with Black Swan author Nassim Taleb...

Nassim Taleb: Banking System is Designed to Blow Up

From Bloomberg:

Banking with Ponzi characteristics...
People can invest in real thing...
You can't trust bankers
Hat tip infectious greed

What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis

``The most popular method of deprecating capitalism is to make it responsible for every condition which is considered unsatisfactory. Tuberculosis and, until a few years ago, syphilis, were called diseases of capitalism. The destitution of scores of millions in countries like India, which did not adopt capitalism, is blamed on capitalism. It is a sad fact that people become debilitated in old age and finally die. But this happens not only to salesmen but also to employers, and it was no less tragic in the precapitalistic ages than it is under capitalism. Prostitution, dipsomania, and drug addiction are all called capitalist vices. Ludwig von Mises Economic Teaching at the Universities

Lessons from Nassim Taleb

There are two important things I’ve learned from my favorite iconoclast Nassim Taleb, the chief proponent of the Black Swan Theory.

One is that he cautions the public to indulge in the study of markets or economies centered upon highly flawed but popular econometric models which are nothing but algorithms designed to operate on sterilized environments similar to classroom or laboratory conditions.

Since these computer models unrealistically operate on the assumption that every factor can be anticipated, examined and evaluated, risks are therefore assumed to be under control. Yet, the complex nature of our world can lead to manifold variables which can’t be read, evaluated or anticipated. The impact of which is known as randomness or the BLACK SWAN, a low probability but HIGH impact event, and is the nemesis of these ‘quant’ models. For instance the humongous losses in today’s financial crisis have been be partially blamed on the failure of quant models to anticipate risks from statistical fat tails.

Second, the other lesson taught by our unorthodox savant is to avoid getting trapped with cognitive biases such as projecting past connections and outcomes into the future.

The Sanctity of Delusion

Today we are told that the world is going to the sewer.

That is because the US, which has functioned as the only major ‘aggregate demand’ of the world, can’t live up to its role as it is undergoing a deep recession. In corollary, these experts further assert that the world won’t be able won’t replace the US as the provider of demand because of its sheer size. In other words, past performance guarantees tomorrow’s outcome.

Based on their economic premise, where supply exists only as a function of demand, then with today’s imploding private sector credit bubble, which has deeply dented the demand equation, must be replaced and absorbed by the government. Therefore, the government’s role MUST be to create artificial demand by printing up as much money in order to sustain the bursting bubble structure.

Tersely said, from the private sector, the credit bubble now is being reconfigured to one known as a government credit bubble. And this seems to be what we are seeing all around the world. From nationalization, “bad bank” or other means of government interventions, the idea is to transfer the leverage and the attendant losses to the government.

The same logic says that if Bernard Madoff was a fraud, and had operated on an unsustainable platform which didn’t last, the government’s insistence of operating on the same an unsustainable platform, but charged to the taxpayers and meant for the “good of the citizenry”, MUST SUCCEED. The difference was that Madoff was a felon, while governments sustaining bubbles for chimerical prosperity, are deemed as legitimate and for a good cause.

Unfortunately for Madoff, he was an individual and not privileged to conduct the same scheme which is equally being thrown to the public by governments. But the underlying principle of both Madoff and the governments is the same: to get something from nothing!

In other words, you resolve the problem of drug addiction by providing more drugs. If you are Madoff you get charged with drug pushing. But if you are the government, you receive plaudits for a fighting for a good cause.

In a reality check, unsustainable trends which can’t last, won’t! NO amount of the printing press nostrums will make illusions a reality.

Reality has finally landed in Zimbabwe. The Mugabe-Gono government finally capitulated to the marketplace realities by allowing the depressed African economy to trade in foreign currencies which in effect jettisoned the local currency, the Zimbabwe dollar. This also means the Mugabe-Gono government will fall soon. And in the same vein, all nationalizations or government guarantees are only as good as the real capital standing behind these.

Does the words of Karl Marx in Das Kapita in 1867…``Owners of capital will stimulate the working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism"…ring a bell?

Fairy Tales Cures and Self Righteousness

Yet popular opinion believes in fairytale cures.

To call for market forces to rectify the situation, one risks being labeled as insane, inhuman or bloodless.

Nevertheless just look at level of desperation policymakers are into so as to consider ridiculous ideas to restore an unsustainable structure of economic growth:

-In déjà vu to the hog reduction program of the Great Depression of the 1930s, US policy makers are considering to boosts car sales via a program known as "cash for clunkers". (CNNmoney) Yes, the US government plans to buy and junk old cars so as to motivate its populace to buy new ones. If the policy gets enacted, this is going to be a waste of productive resources.

-Moreover, they are considering “to renegotiate mortgages it owns that might otherwise enter foreclosure” (Washington Post) or allow “bankruptcy judges to modify the mortgages of troubled homeowners” (Washington Post) all at the expense of the property rights of American people.

To add, not content with plans to impose tons of regulations on the national level, the statists have been contemplating on to expand impositions abroad. Signs of protectionism, which had greatly contributed to the Great Depression of the 1929, are surfacing in the political arena. At the confirmation hearing, Treasury Secretary Tim Geither unleashed what he “believes that China is manipulating its currency” (Wall Street Journal). In addition, the stimulus bill which was recently passed by Congress contained a “Buy America” rider (Washington Post).

All these actions seem to agitate for a mutually devastating global trade war.

And why would authorities engage in such potentially calamitous actions? We understand 3 possible things: economic ignorance, messianic complexity or plain political rhetoric.

Realities say that the US doesn’t produce enough, that’s why it incurs trade deficit. And a trade war would mean massive catastrophic shortages. Think oil. The US imports 60% of its oil requirements (CNNmoney). If world trade shuts, the economic implication would be a collapse in the US economy with a geopolitical implication of a possible World War 3.

And also considering that the US is the largest debtor nation in the world, it wouldn’t be far where a trade war would also extrapolate to an equally internecine debt default. And what’s to stop these interventionists fools from inciting a war economy or the misguided belief that only war, after everything else fails, can stimulate the economy?

Now we turn the tables and wonder who is insane, inhuman or bloodless? Does provoking a trade war which has dire consequences similar or worst in scale than the Great Depression a humane and charitable option? How altruistic is it, if the world goes into war out of the desire to stimulate the economy? How does hyperinflation as in the case of Zimbabwe lead to progress? How charitable can it be to live a world of self delusion?

Does the 2008 Global Trade and Production Collapse Signify Posttraumatic Stress Disorder?

If a bubble structure can be characterized by unrestrained credit creation, speculative excess seen in asset inflation and unparalleled concentration of financial wealth and power, then in as much as the massive wage or income disparities or “Shameful bonuses” in Wall Street relative to the average Americans had been a function of a bubble structure, the world’s production-supply chain structure have also been partly been built around the same bubble environment.

And today’s bursting bubble which has prompted for “demand destruction” has been met by more “supply destruction”.

Yet what seems to be remarkable has been the sharp collapse in global production and trade.

Figure 3: IMF World Economic Outlook: Collapse of Global Industrial Production and Merchandise Trade

The chart IMF’s World Economic Outlook demonstrates the seeming peculiarity of the last quarter’s world trade and production activities.

If you are to compare with the dot.com days or the previous bubble bust and its ensuing recession, you’d notice that the same trends went into a steady decline over a period of time (years). But this hasn’t been the case last year. The outright collapse in just ONE MONTH by both economic variables suggests that world suddenly stopped doing anything and merely watched in shock and awe!

And why would the world do that? The obvious answer is the shock emanating from the near meltdown of the US banking system subsequent to the Lehman debacle. This has been prompted for by the institutional bank run in the US banking system as discussed in last October’s Has The Global Banking Stress Been a Manifestation of Declining Confidence In The Paper Money System?

So contrary to mainstream views which ANCHORS upon this collapse as their basis for prediction, we suggest instead that this could be a function of a Posttraumatic stress disorder (PTSD) where according to Wikipedia.org, ``is an anxiety disorder that can develop after exposure to one or more terrifying events that threatened or caused grave physical harm.”

As an example, the 9/11 terrorist attack on the World Trade Center was graphically captured in living color by media. The repeated airing of the deplorable terrorist event heightened the fear of air travel which thereby caused a shift or substitution in some of the public’s traveling patterns.

And the shift emanating from the fear, resulted to more casualties from the higher risk land transportation.

According to a study The Impact of 9/11 on Driving Fatalities: The Other Lives Lost to Terrorism by Garrick Blalock, Vrinda Kadiyali, Daniel H. Simon, ``We find that driving fatalities increased significantly following the terrorist attacks of September 11, 2001, an event which prompted many travelers to substitute less-safe surface transportation for safer air transportation. After controlling for time trends, weather, road conditions, and other factors, we attribute an increase of 242 driving fatalities per month to additional road travel undertaken in response to 9/11. In total, our results suggest that about 1,200 driving deaths are attributable to the effect of 9/11. We also provide evidence that is consistent with the 9/11 effect on driving fatalities weakening over time as drivers return to flying. Our results show that the public response to terrorist threats can create unintended consequences that rival the attacks themselves in severity.”

Why is this so? According to Trevor Butterworth, ``Because fear strengthens memory, catastrophes such as earthquakes, plane crashes, and terrorist incidents completely capture our attention. As a result, we overestimate the odds of dreadful but infrequent events and underestimate how risky ordinary events are. The drama and excitement of improbable events make them appear to be more common.”

So given Mr. Butterworth’s tread, could we be “overestimating the odds of dreadful but infrequent events and underestimating how risky ordinary events are”?

Evidences of PTSD

Some evidences show we are.

One, global barter trade has been picking up. [see Does Growing World Barter Trade Suggests Of Bigger Cracks In Today's Monetary Order?]

According to the Financial Times, ``Officials estimated that they ranged from $5m for smaller contracts to more than $500m for the biggest.” It could be more. There have been accounts of barter since this episode has unraveled.

And the reported cause? ``Failure to secure trade financing as bank lending has dried up.”

The fact that governments have traded OUTSIDE the financial system, means demand and supply seems intact for basic necessities for them to conduct trade. The fundamental problem lies within the traditional means of facilitating payment and settlement via the banking system.

Two possible reasons why governments have been undertaking barter, which is a primitive method of trade:

One, the banking system remains dysfunctional despite the heavy interventions by global governments and

Two, there is a growing distrust for the present medium of exchange. The second finds a voice in Russian Prime Minister Vladimir Putin’s speech in Davos, ``Excessive dependence on a single reserve currency is dangerous for the global economy. Consequently, it would be sensible to encourage the objective process of creating several strong reserve currencies in the future. It is high time we launched a detailed discussion of methods to facilitate a smooth and irreversible switchover to the new model.”

The next evidence could be seen via the surging Baltic Dry Index see figure 4.

Figure 4: stockcharts.com: Rising Baltic Index=Rising Oil and Copper?

The Baltic Dry index according to the wikipedia.org is ``a number issued daily by the London-based Baltic Exchange. The index provides "an assessment of the price of moving the major raw materials by sea. Taking in 26 shipping routes measured on a timecharter and voyage basis, the index covers Handymax, Panamax, and Capesize dry bulk carriers carrying a range of commodities including coal, iron ore and grain.”

Plainly put, the Baltic Index is the cost of freight to move raw materials or basic commodities. It could be seen as a leading indicator.

So far the Baltic Index has risen by 60%, whereas oil and copper appears to be consolidating or “bottoming” even as the US dollar index has been going up. To recall, during the October-November collapse, the US dollar has inversely accompanied the rapid declines of the Baltic index as with the oil and copper.

The seeming divergence could be added signs of the diminishing influences of debt deflation.

Furthermore, even in the US, there are signs that production and inventory or supply destruction have been catching up with its counterpart demand destruction see figure 5.

Figure 5: Danske Bank: Is the US Manufacturing Sector Beginning to Recover?

These observations from the Danske Team (bold emphasis mine),

``First, prior to the recession the US manufacturing industry ran very lean inventories. Second, the liquidity squeeze from the credit crisis has led to an unusually fast alignment of production to demand fundamentals.

``Consequently, the pace of production is now undershooting the slowdown in demand. Hence, it will merely take stabilisation in demand growth to spark an industrial recovery.

The Danske team suggests that the first signs of recovery will be manifested over the ISM index which may stabilize and recover over the coming 3-6 months. In addition, a recovery in the ISM index will most likely add pressure to long US bond yields and signal stabilization in corporate earnings.

While I don’t necessarily share the optimism of the Danske team, the point is that the recent collapse have meaningfully adjusted both the demand and supply equation possibly enough to generate some market based (and not government instituted) revival.

So from growing world barter activities, buttressed by the rising Baltic Dry index, and a potential run down of inventories and similar downside adjustments in the supply side production could mean a semblance of restoration of global trade.

And if indeed the Danske Team is right about their forecast about the manufacturing recovery in the US, then this could signal a potential trough or nearing close of the US recession.

But then again, as a reminder, the cardinal sins in policymaking that could lead to prolonged bear markets: protectionism (nationalism, high tariffs, capital controls), regulatory overkill (high cost from added bureaucracy), monetary policy mistakes (bubble forming policies as negative real rates), excess taxation or war (political instability). Except for the last threat, the 4 seems likely a clear and present danger.

Will An Easing PTSD Lead To A Resurgent Asia?

Nonetheless, if the US supply side has adjusted to counterbalance the sharp fall in demand, then it is likely that the spate of sharp declines in the economic activities in most of Asia can be construed as the same degree of supply/production side adjustments.

Figure 6: DBS Bank: Asia’s Industrial Production Recovered earlier during the .com recession

Like in 2001, Asia’s heavy exposure to the technology sector hit exporters. Today, the sharp decline in US consumer spending has equally affected Asia’s exports as much as it also affected production. However, the sharp drop late last year could likely be explained by the Posttraumatic stress disorder (PTSD) emanating from the distress in the banking system.

But unlike in 2001, which saw Asia as floundering from the nasty side effects of the Asian Crisis, where there essentially had been no domestic demand, this isn’t the case today. Asia has simply grown bigger and more dynamic and with ample shield from its high savings enough to potentially generate its own demand.

The recent DBS bank outlook says it best, ``Asia now generates almost as much new demand every year as the US- and it is that fresh demand that’s the very definition of global growth. The US is still a key driver and will remain so for a long time. But it is not the driver it used to be.” (bold emphasis mine)

And the Economist seems to agree, ``The question is, might domestic demand now take up some of the slack? There are reasons to think so. Falling commodity prices are boosting consumers’ purchasing power, just as they squeezed it last year. More important is the impact of monetary and fiscal expansion…(bold emphasis mine)

And the Economist sings to be singing a tune similar to ours, ``Asia has never before deployed its monetary and fiscal weapons with such force. Every country across the region has cut interest rates and announced a fiscal stimulus. In previous downturns, Asian governments were often constrained by dire public finances or the need to support currencies. But most countries entered this downturn with small budget deficits or even surpluses. All the main Asian emerging economies apart from India have relatively low ratios of public debt to GDP.” (bold emphasis mine)

In our Will “Divergences” Be A Theme for 2009?, we brought up the Austrian economics explanation that ``market rate of interest means different things to different segments of the structure of production.”

In essence we believe that convergent actions by global central banks will ultimately lead to divergent responses based on the capital and production structure of every economy.

Where the same amount of rain is applied to a desert land, forest land or grass land, the output will obviously be different. And to complement the DBS and Economist outlook, we recently said ``this crisis should serve as Asia’s window of opportunity to amass economic, financial and geopolitical clout amidst its staggering competitors. But this will probably come gradually and develop overtime and possibly be manifested initially in the activities of the marketplace.”

So to refrain from overestimating the odds of dreadful but infrequent events and underestimate how risky ordinary events are, we revert to the study of Garrick Blalock, Vrinda Kadiyali, Daniel H. Simon who concludes, ``Although we are unable to identify precisely reasons for either the 9/11 effect or its weakening, the existence of the effect is consistent with theoretical models in behavioral economics and psychology of inaccurate assessment of risks by consumers and exaggerated adjustments to risk assessments. The fortunate weakening of the 9/11 effect may be attributable to consumer learning over time in response to environmental changes. For example, the perceived risk of flying may have declined with the absence of any further terrorist incidents since 9/11, or travelers may have become accustomed to the increased inconvenience of flying.”

No we don’t just read past data and project them to the future like most of the experts. Instead, we try to understand that human action, to quote Ludwig von Mises, is a purposeful behavior!