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Musings Report 2024-35 8-31-24 Hard Landings and the End of KTC-DTR
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Hard Landings and the End of KTC-DTR
Question #1: What's KTC-DTR? Kick the can down the road.
Question #2: what does "the end of KTC-DTR" mean?
To answer that question, we need to rewind all the way back to around 200,000 years ago when homo sapiens sapiens came on the scene as a species we recognize as very much like ourselves, give or take a few genetic / epigenetic tweaks.
Humans are hard-wired to seek windfalls and feel euphoric greed when happening upon a tree loaded with ripe fruit. We gorge ourselves, happily stripping the tree of its bounty, and then resume our search for the next windfall.
The flip side of the gratifying emotions of euphoric greed--an almost god-like sense that our skill and luck are boundless, and it is our destiny to jump from windfall to windfall--is fear, panic and the intense pain of loss.
Various studies have found that the pain of loss outweighs the euphoria of gains, and this is the foundation of our innate risk-aversion: gains are nice, but we might not recover from (or survive) losses.
Which brings us to the dynamic driving "kick the can down the road."
In our hunter-gatherer-premodern-agriculture days, there was little anyone could do when faced with losses but shrug off the agony.
But in modern civilizations with formal markets, concentrations of wealth, central banks and centralized governments of politicians and regulators, when the powerful are facing catastrophic losses, they have an alternative to accepting the loss with reluctant grace: they can call their ever-attentive central banker or politician and scream "save me!", because the central bank and central state have the power to conjure unimaginably large sums of money out of thin air and distribute it to those in need, for example a "too big to fail" private banker facing a market meltdown.
The central banker and politician have their own reasons to save the financial system from catastrophic losses: a market crash and Great Depression don't exactly spruce up a resume or endear the voters and donors in the next election.
And so some sort of expedient "rescue" is thrown together to stave off the pain of losses. It might be lowering interest rates (1957, 1960, 1970, 1974, 1982, 1984, 1990, 2001, 2007, 2019) or creating new cash and injecting it into the financial system (via the Federal Reserve Balance Sheet), or it might be less visible "saves" such as loan guarantees, backstops against losses, new lines of credit, paying high rates of interest on funds held as reserves, etc., or by changing regulations, for example, eliminating the requirement to mark assets at the end of each day to their current market value (i.e. mark to market).
There are many ways to stave off financial losses, and the critical element in the moment of panic isn't the mechanisms put into play, it's reversing the panic by restoring confidence: don't worry, we've created a windfall out of thin air, all is saved.
This is known as kicking the can down the road because the underlying causes of the crisis and panic are left unaddressed, as powerful players might lose ground if the system were truly reformed.
These expediencies--creating and distributing huge sums of cash and credit, changing the rules of the game when the home team is about to lose--are presented as temporary, but since the conditions that sent the financial system over the edge haven't actually changed, the "temporary emergency measures" become permanent.
These measures are not small; they ripple through the system and the emotions of the players, large and small, and each ripple reinforces the others, generating second-order effects which slowly build up into mighty waves.
One such effect is moral hazard, the disconnection of risk from consequence. Imagine sitting at a gaming table in a casino, and losing all your chips in a bet that went against you. Oh, the agony, woulda, coulda, shoulda. All is lost, "A horse, a horse, my kingdom for a horse!"
And then a well-dressed employee leans over your shoulder and whispers, "here are your supplemental chips:" your losses are covered, and so what do you do? You resume gambling, accepting even greater risks, because your losses are now being transferred to others. The net result is risk throughout the system increases, effectively transferring what were once private risks to the entire system, increasing the risk of systemic breakdown.
Other consequences of what were expedient, emergency measures in response to cries of agony--"save us from losses!"--pile up: debts taken on to fund various "saves" start accruing interest, which rises as the flood of rescue-money boosts inflation.
Since the fundamental sources of the systemic fragility are never addressed--nobody benefiting from the status quo will voluntarily relinquish their seat at the casino gaming table, so nothing really changes other than cosmetic lipstick on the proverbial pig--each new "rescue" must be larger and therefore more systemically consequential than the previous "save."
Where $1 trillion was enough to restore confidence and stop the market meltdown in the past, by 2008-09 the Fed had to conjure up $4 trillion in cash, and offer backstops / guarantees of $16 trillion, a set of "interventions" that by some accounts topped $30 trillion, double the entire GDP of the US ($14.8 trillion).
Since much of this vast scale is hidden from the public, we're blind to the risks generated by such unimaginably monumental "rescues." We don't understand all the mechanisms put into play, or the scale, or the risks or the resulting moral hazard. It all looks "normal:" the authorities responded, the crisis passed, everything's good now. Please proceed to the next windfall by gambling in zero-day expiration options on meme stocks.
This pernicious dynamic--every "rescue" makes the system more fragile and therefore each subsequent "rescue" must be even greater in scale, piling on ever larger systemic risks--sets up the endgame of "kicking the can down the road."
The pain that would have been distributed had the first panic been left to run its course--burning down malinvestments and risky gambles that didn't pan out, bankrupting players large and small who leveraged up and took on too much debt and risk--would have hurt but it wouldn't have threatened the entire system with collapse.
A recent example of this acceptance of losses / pain is the savings and loan crisis of the 1980s-1990s, in which the 32% (1,043 of the 3,234) of savings and loan associations (S&Ls) failed from 1986 to 1995. The proximate cause of the crisis was the removal of various regulatory safeguards intended to "ease credit" led to widespread fraud and malfeasance as just about anyone could set up an S&L in various states, start accepting deposits and then issue loans to cronies, shell companies, speculators, etc.
It took the better part of the decade to work through the losses, but the pain was distributed and absorbed, much of it by blameless taxpayers.
As each "rescue" becomes larger in scale, the second-order effects increase the risks of the system failing, as each new "rescue" suffers from diminishing returns even as it burdens the system: the "rescue" is now of unprecedented scale, but it barely keeps the financial system afloat.
At some point the "rescue"--which we politely call "stimulus" or "intervention"--backfires and actually pushes the system into crisis, as either 1) the "rescue" fails to reverse the downturn or 2) the "rescue" is now so large that the market recognizes the "rescue" itself poses an uncontrollable risk to the system.
Alternatively, the second-order effects of previous "rescues" have boxed the rescuers into a canyon they cannot escape. This is where we are today, though few recognize it: the Federal Reserve cannot drop interest rates to zero again and add trillions to its balance sheet without generating inflation, and so it is now hamstrung.
The federal government can't keep borrowing trillions of dollars to distribute to various constituencies, as the interest payments are now squeezing out other spending.
As for "easing safeguards" to make it easier to gamble with abandon, the bets already on the table will collapse the system all by themselves, as moral hazard has increased the risks being taken to a degree that few recognize as systemically dangerous.
The end result is the losses that will have to be taken are now multiples of the pain that would have been distributed had the players not been "saved" by "stimulus, intervention and emergency measures" 15 years ago.
There is no way to rescue a system rendered fatally fragile by ever-larger doses of moral hazard, leverage and debt as expedient "rescues" kicked the can down the road.
The fantasy of a "soft landing" generated by yet another "save" will give way to a hard landing as leverage, debt and moral hazard implode.
The can-kicking is about to end, but due to recency bias--can-kicking has worked splendidly for decades, of course it will continue to work wonders--few recognize we're in the endgame and we're only a few moves from checkmate.
Highlights of the Blog
The La-La-Land Fairy Tale of a "Soft Landing" 8/29/24
Success Is a Trap 8/27/24
We've Left the Bottom 60% in the Dust, but Never Mind: S&P500 to 6000! 8/25/24
Best Thing That Happened To Me This Week
Modest goals have the great advantage of being reachable, and it is in this context that I was pleased to exceed 5,000 subscribers (mostly free, some paid) on Substack since launching my account 14 months ago. I have a friend with 80,000+ subscribers, so 5,000 is modest indeed. I recently read a description of the Internet as a series of waves, and content creators have to constantly exit the dissipating wave and try to catch the next one. Back in 1998, I caught the first wave by learning HTML. Now Substack is the wave thousands of writers are trying to catch.
What's on the Book Shelf
The Great Wave: Price Revolutions and the Rhythm of History David Hackett Fischer
From Left Field
NOTE TO NEW READERS: This list is not comprised of articles I agree with or that I judge to be correct or of the highest quality. It is representative of the content I find interesting as reflections of the current zeitgeist. The list is intended to be perused with an open, critical, occasionally amused mind.
Many links are behind paywalls. Most paywalled sites allow a few free articles per month if you register. It's the New Normal.
Olympic basketball: Steph Curry's 3-point shots in slow-motion.
Diabetes Rates by Country 2024
gold 100-year chart
pineapple infusion
You’ve Lost Weight Taking New Obesity Drugs. What Happens if You Stop? -- you put back on the weight you lost...
Japan's wholesale inflation quickens to fastest in nearly a year
Inflation has come for one of Japan’s most beloved cheap eats: Ramen.
How Entropy Drives Us Toward Degrowth (via Carl M.)
Everyone You Know Is Rich and That’s Why You’re Confused.
Reclaiming Strength and Rebuilding Lost Muscle.
Earth to Moon by Moon Unit Zappa review – waspish, funny account of life as Frank Zappa’s daughter
EVs Are Losing Up to 50 Percent of Their Value in One Year
A boomer couple on Social Security moved to Guatemala because they couldn't afford to retire in the US. After 2 years, they moved back.
"Effective health care depends on self-care; this fact is currently heralded as if it were a discovery." Ivan Illich
Thanks for reading--
charles |
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