Father Insurance

Globalized Civilization has phased into a different fundamental condition defined by the increasing difficulty and expense of it's sources of energy.  This has made it costlier to grow in physical terms as well as to maintain past investment.  The impact of low economic growth or none at all, which comes about only through growing debt and credit, will be on the very credit markets which enable economic activity in the first place.  Imagine a snake eating its own tail.  The broad expectation of future growth, i.e., that this new debt would become a thing with a financial return, will someday be put on the chopping block once the expectation of a shrinking economy takes hold.

For the time being, the reckoning of past and present debt fueled investment, not to mention speculation, has been successfully pushed off into the future through the negative feedback of central bank intervention and government deficit spending since 2008.  When I say "central bank" I mean all of them, without exception, among the major economies.  In this way a national government through all its parts serves as the largest possible financial insurance company a nation can muster.  So when a banking system has undergone a speculative credit boom which leads to a debt crisis, the government of that same nation generally feels it has to get involved.  As often as not, this leads to a sovereign debt crisis, even if the sovereign chooses not to get involved.

Why intervene?  Because at the end of the day, when all the daily functions of society are accounted for, the government is not separate from the banking system.  The fortunes of the government are so bound to the fortunes of the banks that it is impossible to distinguish between them as far as their interests lie.  For some reason the phrase "privatized gain, socialized risk" just popped in my head.  It is the way of the world at this historical moment.  The proof is in the pudding, as someone pointed out once for some reason, as the total public (government) debt for the globe exceeds $100 trillion according to a Bloomberg article from March, 2014.  That was in March, for God's sake.  It's even higher now.  This figure does not include central bank "easement" since 2008 amounting to around $15 trillion.  This debt is what makes the public/private financial world go round.

These numbers cause the word "risk" to enter my head.  It's a word market playas use a thousand times a day.  It's a word that produces questions such as "What could possibly go wrong?" "how could I lose?".  The way one might answer this type of question depends on beliefs about how the world works.  A belief can be based on whether the system is stable or unstable.  The answer, of course is, yes, it is.  A good place to begin to find an answer is in Hyman Minsky's Instability Hypothesis.  Essentially it says that instabilities are formed during and are caused by what happens in the stable periods.  Call it a psychological cycle of greed and fear, where confidence born of stability leads to greed and ends with fear.  The market from this perspective is irrational and, hence, unstable over the long term.  What it means is punctuated crises are built into the system.

If you subscribe to this perspective, then it is no wonder that, according to an IMF working paper, since 1970 there have been 147 banking crises worldwide.  Furthermore, there have been 68 sovereign debt crises and 217 currency crises.  And the IMF should know because they have either caused these crises and/or have had to bail out many of these crisis nations. What's more, they seem to happen in waves and move around geographically.  I think we are moving into a new period of punctuated crisis.

I also think others are thinking this way as well.  That the Citibank composed "Swaps Regulatory Improvement Act" (who can argue against improvement?) just passed for the second time through the House of Representatives makes me think, as does Yves Smith, that the banks are just a wee bit worried about the financial situation of oil frackers.  This Act is a "reform" of parts of the Dodd Frank bill set to go into effect in 2015 that would bar the federal government from bailing out the shadow banking derivatives market.  This probably means that Wall Street banks have ponzied up the high risk junk debt used to finance drilling in the Bakken and Eagle Ford.  Now we have a fat new source of systemic risk.  Guess Wall Street better ask Dad to cover his gambling addiction.  It's unfortunate that the total value of American banks booked derivatives is $303 trillion dollars. 

One main function of derivatives is to act as an insurance policy for investment by spreading out risk.  It's a very complex system devised largely by MIT trained math and physics smart guys who apparently have nothing better to do than build high tech pyramids of fake value.  But that last isn't even quite true.  It does have value because it can make a poor prospect like the shale oil revolution seem like a boom for a time.  Doing this has enabled the entire economy to function in a way that feels normal by covering with debt the rising cost of resource extraction and the slow erosion Diminishing Returns and Entropy have on value.  One of these days we will be talking about "Too Big To Bail" ponzies in the system, when the God of Insurance can't come through anymore. 

This is the Maximum Power Principle at work.  Oil and money are the means to maximize production as the source and representation of energy.  That it (money, power) overextends itself is natural.  But Nature isn't just cute baby animals and gorgeous landscapes.  It is not reasonable.  It just has laws that can never be broken, unlike American laws.