A world in which nearly everything is overvalued cannot be sustained
At Zero Hedge this morning, Rick Ackerman (a bloke whose observations I find pretty sharp on the whole) posted a typically outspoken piece that included this extract:
‘…hundreds of billions of dollars – trillions of dollars, if you keep a running total – are floating in the financial ether, unable to find their way into the world of real goods and services. Only a liar or a dolt could assert that this all-too-transparent, economically valueless shell game will continue to provide “breathing space” to the banking system for much longer….’
He was referring to the various packaged investment derivatives sold to idiots by private banking firms, and the QEs or other financial system liquidity schemes mounted by central banks in general, and most recently by Mario Draghi at the ECB. But in a broader sense, the point Rick raises is one that’s been pestering me for five years: when is money ‘real’ money, when is it notional money, and is it safe to have traffic moving from one to the other?
To answer the last part first, the simple response is ‘don’t be silly, how could it be?’. Banker denial of this reality has been easily the most absurd form of Elmer Gantry con anywhere on the roller-coaster of fantasy that began after Greenspan ignored all the obvious signals of growing insanity during 2004. Money created by the buying and selling of paper derivatives has nothing at all to do with real wealth, because after a certain point – not very far into the mission – the whole thing is based on the value of paper. Which is near to zero.
So really, this answers the first part too: wealth is only real when it is directly related to a known-value item or currency.
A thing is produced. It is manufactured or grown. It is sold into market. It gains a tangible value. This can last for centuries – until it becomes an antique. Instead of barter – and then precious metal purchase – people buy it with currency of a valued guaranteed by the Sovereign State. If I want some money upfront from my crop or factory production, I can sell a certain derivative value of it to a third party.
All the above is real. But seventeen purchases later – and later still, after it and a hundred other things have been salami-chopped into a meaninglessly packaged cacophony – that derivative is worth what somebody might pay for it on a good day. On a bad day, it is worthless. It is, simply, a piece of paper.
The trouble starts when, somewhere along the chain, somebody needs some real money: to buy a house, or a company, or 450 pcs following a competitor’s bankruptcy. That somebody – probably thought of as a nobody by the MoUs – sells his or her counterfeit derivative note….and in exchange gets the real thing: real money guaranteed by a Federal something or other, or a Crown Treasury, or a European Central Bank. Now that person has received money in return for something that represents nothing of a final, produced, grown or indeed physical nature at all. In doing so, the seller of paper must, by definition, reduce the value of the currency received in return…for the currency has been used to buy something that doesn’t exist.
In theory of course, what can happen is that – via a notional value bestowed upon it by users of the real currency – the counterfeit version gains a value in its own right. Except that what this produces is two currencies side by side. By doubling the amount of ‘money’ in circulation – when one of them has no intrinsic value guaranteed by a reliable government – the result is inevitable in the long-term: erosion of the real currency’s value – ie, inflation.
In good times, all this will go unnoticed. The tricky bit comes when economies stall, stock markets wobble, and lots of investors want to realise proper cash all at once – in order to buy the ultimately reliable things: gold, silver, platinum and so forth. Because this leaves a whole lot of folks suddenly holding paper with all the tradeable value of a Post-it Note.
Over the years, this is what I have come to call The Tulip Moment. In the 1630s in the Low Countries, a fashion for tulips turned into an insane obsession. A single Viceroy tulip bulb might sell for a value roughly equivalent to $1,250 in current US dollars, while a rarer Semper Augustus bulb might cost twice that. By the winter of 1636, Tulip traders were making over $60,000 a month at today’s prices. Then one day in Haarlem, just the one buyer failed to show up and pay for his Tulip bulb. Within ten days, Tulip values fell by a staggering 99%.
OK, that’s what we call a panic. Our current crop of leaders would have us believe that their control over every lever from buying toxic loans and worthless bonds to pumping liquid cash into the system ensures that any future ‘event’ can be controlled. This is bollocks: pure human hubris. There is no such thing as a gradual panic – and this is especially true of a system so complex, it takes even a high IQ person at least a week’s focused effort to even begin to understand it. As Woody Guthrie correctly observed, “Seems ter me, if a thang kint be ‘splained in two minutes, then t’ain’t worth a hill o’ beans”.
I believe we are very close now to our Tulip Moment. The Tulip this time is the entire credit default swap/derivate tickertape shadow currency that has been created for entirely venal reasons by the investment banking community. Only this time, it isn’t even circulating at a 1:1 valuation: the so-called derivatives sector is ‘worth’ ten times the entire real gdp of the planet.
None of this is new information. The problem is, this notional – almost astral – plane of ‘money’ is worth nothing at all: for it is no more and no less than a Xerox copy of what already exists in the physical world. Like an exact photocopy of the Mona Lisa, its value is 0.0004% of the real thing. However, thousands of naive souls out there have been convinced by snake-oil salesmen that 400,000 copies of the Mona Lisa are worth ten times the value of Da Vinci’s original masterpiece.
So when there is a run on Xerox copies, very quickly the owners will cotton on to what they bought. And once more, the 99% loss in ten days flat principle will apply.
I met a chap while on safari in Africa last Spring, and he explained to me at great length why, so long as derivatives aren’t traded at retail level, there will not be a problem. This is like saying that if we all keep Xerox copies of the Mona Lisa in Swiss bank vaults, they will keep their value. When macro-economic things go wrong, investors look for just two things: an insurer who will pay out on value, and other things not yet owned that cannot lose their value. They don’t give a good God Damn via what channel these things are available – they just want them.
When nobody puts a value on derivatives any more – and almost every government has diluted its currency to protect the banks who perverted their original purpose – there is no telling what will happen. This isn’t a Damoclesian warning – it’s a fact: this has never happened before. But as Rick Ackerman notes, there will be no place in the real world of value for this bathroom tissue.
My parallel is simple: what inflated currency is to precious metals, so derivatives and flakey insurance are to real asset valuations. When everyone at once wants to get cash for valueless derivatives – and/or to call on their insurance – the whole system fails. The one thing likely to create exactly that unhappy coincidence of desire is horrendous bad debt – not just on a global scale, but also on every dimension of credit from plastic cards to Sovereign bonds. This is exactly what we face in 2012: a banking system whose value rests upon bits of paper – ranging from sovereign bonds to default swaps and insurance – that, in the final analysis, lack that important fiat message: “We promise to pay”.
Add to this the crazy, almost unbelievable fact that a huge amount of lending has been backed by collateral consisting partly or entirely of such worthless paper……no: don’t go there, you’ll only want to sleep with the light on forever and ever.
The financial system as it stands today is flawed in many ways, but two stand head and shoulders above the others. First, it has failed to provide finance for anything beyond the mega-multinational sector of our economies. And second, it has served a mad form of capitalism that insists growth is the only thing that matters, and credit is the only way it can be sustained. In sticking rigidly to these precepts, it has turned capitalist renewal into stagnation, business creativity into bottom-line bourse mania, and social stability into potentially explosive imbalance.
Ironically, the very tendency to create wealth inequity using this model has made it nigh on impossible to stage the very mass consumption-led recoveries it declares to be sacrosanct; and the same insistence on false wealth grown through untargeted lending has rendered banks unable to release risk business money that could restore a desire to restock. The inevitable result throughout the West has been the emptying of Sovereign Treasuries in order to assume that ‘bankrolling’ function on behalf of the banks. But such efforts in turn have been grabbed by greedy short-termist banking firm managements and big multinational companies as a means of delivering returns to partners and shareholders respectively. These bonus and dividend ‘results’ are a total confection, paid for in full by the already hard-pressed governments and their cash-strapped taxpayers. Net-net, under this suicidally myopic approach, the only possible result is middle-class impoverishment, zero credit, and thus economic slump.
The viciously circular nature of mythical wealth and hyped valuation has produced some extraordinary spectacles in recent months: tactics and ‘explanations’ have been put forward worthy only of a place in the sort of black satirical novel that even Swift never quite got round to writing. But perhaps the most striking contemporary example is that of Mario Draghi’s European Central Bank providing money to private eurobanks, in the hope that they will carry on purchasing worthless government bonds, and thus stave off the sovereign defaults caused by incontinent lending by those very same banks to those very same sovereign States. What turns something potentially comic into certain tragedy is that none of this money will go to stimulate either the output or demand that these sovereign EU member States need to recover.
If ever there was a clear signal that we are months away at most from the Tulip Moment, this is it. For if the US recovery isn’t real (and trust me, it isn’t) and the EU economy is grinding to a halt (and trust me, it is) and Chinese growth is disappearing in this context of falling consumption (and trust me, it is) then all those stock markets based on results that are a confection – and stocks kept artifically high by those results – will collapse.
That is going to create a demand for cash never even envisaged before in the entire history of Bourse capitalism. And it will be, without any shadow of doubt, the Tulip Moment.
The Slog 