Sunday, January 4, 2009

"Tansitionary Betrayal"

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us.”
-Charles Dickens, A Tale of Two Cities

It was for all intensive purposes as good as it could get and as bad as it could possibly get all at the same time and the entire world over. And it is for this reason that 2008 will go down as one of the greatest transitions years in global economic history. By the time that last extra second had ticked off, (as if we needed any reason to make 2008 longer) the world was already a very different place. The great financial panic of 2008 wiped out more than $30 trillion in global market value. But to blame this wealth destruction on a panic or foolish crowd would be a serious mistake because at the end of the day, “Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.” This fantastic quote comes from John Mills’ paper titled Credit Cycles and the Origin of Commercial Panics, and I can’t think of one sentence that more appropriately sums up this tumultuous year.

Investors discovered just how carried away they had become in their obsession to chase the economic miracle that was globalization. And while this last bubble probably won’t lead to Great Depression II, it is the first truly global asset bubble and thus is bound to be somewhat unique in its scope and with respect to the challenges it creates for policy makers.

Thus, I have decided to skip the 2009 forecast for now as I have read way too many good notes on the topic. Instead, I have decided to offer up some of what I think were the “great revelations” of 2008.

1) Barbarians Slaughtered at the Gate-

We discovered that Tom Wolfe’s “Masters of the Universe” couldn’t even “Master their own Domain”. The utter collapse of the stand-alone investment banking model in a matter of months surprised even the most pessimistic market pundits, but at the same time it exposed the great folly that had become high finance. Those who thought their names were worth their weight in gold quickly discovered that in a debt driven deflationary cycle everyone is vulnerable. The fab five quickly turned into a terrified twosome, and then with Goldman and Morgan Stanley’s conversion into bank holding companies on September 22nd; the United States stand alone investment banking industry all but disappeared. Masters of the Universe brought to their knees and undone by a mountain of debt and a crisis of confidence, and all it took was seven months.

2) Real Estate gets Debunked-

If there is any good thing that came out of 2008 it is that maybe, just maybe, a few people realized that real estate is not everywhere and always a good investment. Yes, unlike a stock a home is tangible. You can touch it, put stuff in it, and even sleep in it. It’s a good inflation hedge, and in some jurisdictions it’s an efficient tax shield. But just like a stock, if it is bought at the wrong price, and at the wrong time, it can lose you a lot of money. Over the last couple of years I was starting to feel like the national association of realtors had discovered some sort of mind control device. Trying to convince a person that there is a price point at which renting makes a lot of sense or that buying a home is not a no brainer investment was an exercise in futility. I guess enough commercials of people flushing money down a toilet with the words “why rent” in big bold letters will do that to a nation.

3) Decoupling gets De-listed-

We discovered that the world’s consumption engine can’t falter without taking everyone else down with it. If the level of global aggregate demand has been artificially and unsustainably inflated by the illusion of limitless free credit, then capital will be hopeless betrayed by overinvestment in unproductive works. Too many dry bulk shippers, too many new mega-casinos, too many niche retailers, too many flat panel screens, too many textile mills, too many cement factories, too many residential units, and of course too many leveraged buy outs. Too much of anything can be a bad thing. Too much of everything financed with insane levels of short-term debt can be disastrous. Ironically, through the use of clever derivatives the US managed to export a lot of their land of too much to the rest of the world. And when you consider the fact that the bulk of global capacity for just about everything outside of financial hocus pocus rests beyond the borders of Uncle Sam, you quickly start to realize that the brunt of a crisis that was made in America will most likely be felt in the developing world. Who would you rather be a US consumer who now has realized he has to consume less or the producer who was making goods for this consumer? There are of course two answers to this question. In the short term, you’d rather be the consumer. In the long term, you’d probably rather be the producer. But if we are all dead in the long run….well I think you get the picture.

4) Free Markets get Fracked

Nobody wants a free market on the way down. Adam Smith’s invisible hand is there alright, and if left alone it will sort things out with razor sharp precision. So, much so that massive wealth redistribution would become the norm. Sadly, to reach that point the world must enter chaos, and many of the great masters of industry would be swallowed whole. And this my friends will never be allowed to happen. As we have recently witnessed, even the most ardent free market proponent, your ruthless trader or B.S.D, will scream uncle when he finds the invisible hand wrapped around his throat.