Wednesday, November 16, 2011

It wasn't supposed to be this way: Socialism without money

A lot has been written about the pitfalls of allowing people to govern themselves. One of the best such analyses, if not the most recent, was written by Plato 2,500 years ago, in the parable of the “ship of state”. His criticism was that the skills of the politician are not the same as those of the statesman. The statesman (philosopher/king) must understand not only how to get power, but how to exercise it, and that those who rise to command are more likely to be skilled in the former than in the latter:

The sailors are quarrelling with one another about the steering. Every one is of opinion that he has a right to steer, though he has never learned the art of navigation and cannot tell who taught him or when he learned, and will further assert that it cannot be taught, and they are ready to cut in pieces any one who says the contrary.
They throng about the captain, begging him to commit the helm to them; and if at any time they do not prevail, but others are preferred to them, they kill them or throw them overboard.
Having first chained up the captain's senses with drink, they mutiny and take possession of the ship and make free with the stores. Thus, eating and drinking, they proceed on their voyage in such a manner as might be expected of them.
The man who leads the crew in their plot for getting the ship out of the captain's hands and into their own they compliment with the name of sailor, pilot, able seaman. But that the true pilot must pay attention to the year, seasons, sky, stars, winds, and whatever else belongs to his art, if he intends to be really qualified for the command of a ship, has never seriously entered into their thoughts or been made part of their calling. (Republic, Book VI)

This is precisely where we stand today (or at least, stood last week) with respect to the governance of the postwar Western democracies. The crew has been in command of the ship for some time (about forty years), and has been making free with the stores, eating and drinking in such a manner as might be expected of them.

They have been enabled in this debauchery because they inherited a ship of state with stored wealth in the form of unused debt capacity. They have been using this debt capacity to bribe each other for the temporary right to steer the ship. The four decades of eating and drinking the ship’s stores have been pleasant.

But now there is a problem on the horizon, to which Plato only alluded: what happens when the ship’s stores run out or, in the modern case, when the ship reaches its debt capacity?

We have the great (but temporary) luxury in the US of being able to watch as other counties around us run out of stores. In the past we have seen this happen to countries run by “other kinds of people”, such as communists and banana republicans. But now we are seeing it happen to countries not too different from our own: countries crewed by western Europeans, until recently regarded as “well run”. Indeed, the lifestyles on board some of these countries have been even more civilized than our own.

The people running these countries have never known any statescraft besides mortgaging the future in order to live beyond their means. This is all they know how to do: how to slice up this year’s piece of their children’s inheritance.

They don’t know it, but these politicians have left this world and have entered a completely new one: a world of not only finite financial resources, but a world in which the supply of resources is completely exogenous. They are learning that their long-honed skills of compromise, negotiation, bribery and flattery have no more value than necromancy, alchemy or phrenology. In a world of finite financial resources, the only valuable skills are economy and decisiveness, skills that not only do they not possess, but which they deride as inappropriate (see: all the printer's ink now being spilled about the “fetish of austerity”).

As Myron Minsky pointed out, the inflection point in the debt supercycle does not manifest itself gradually, such that it can be planned for and ameliorated. It happens when it happens (a black swan), and then it follows its course as the cycle changes decisively from leveraging to deleveraging, as lenders go on strike. (N.B.: Once the cycle turns, it is not merely a matter of not being able to borrow more, but rather the much more serious matter of having to repay what you have already borrowed.)

In the case of the current crisis, the black swan was the Greek government’s announcement in the fall of 2009 that Greece had been cooking its books for at least a decade. This caused a loss of confidence in Greece and unleashed the bond market jackals to begin to hunt down other other weak members of the herd.

This problem could have been contained if such a thing as “Europe” had existed in a corporate, as opposed to geographical, sense. But Greece soon revealed that Europe is not a country but rather a club, with no governance other than the membership committee.

The Eurocrats first said that the Greek problem was transitory and irrelevant because default by a eurozone sovereign was unthinkable and, in Trichet’s words, “not under discussion”. This was a somewhat persuasive argument until, last summer, Germany insisted that a precondition of any sovereign bailout would be a bond default. In other words, bond default went from being unthinkable to being a precondition of a bailout. That was the moment when the gas began leaking badly from the eurozone bubble. Things got dramaticaaly worse this week when the president of the Bundesbank stated decisively that the ECB would not act as a lender of last resort to eurozone sovereigns.

With this statement putting the nail in Italy’s coffin, the markets began to attack not only the non-AAA weakings but also the  “strong”, AAA sovereigns such as France and Austria. Insted of trusting and waiting for long-promised  “fiscal and structural adjustment”, the eurozone bond market is saying: “Show me, show me now, not tomorrow.” Overnight, the bar for market credibility has been raised ten notches higher.

As I said earlier, the political leadership of Europe is skilled at compromise and negotiation, skills which are completely lost on the capital market. You can’t negotiate with Bill Gross, or take Barclay's country risk committee out to dinner. These people owe you nothing, and they have nothing to gain by “working with you” or “being reasonable”.

I can see this epiphany already dawning on the Continent's leadership. You can hear it in the recent public statements of Papademos, Monti, Zapatero and Sarkozy. Their mouths are all saying the same thing: “We have no alternative to austerity. This is no longer a policy debate. There is no other path. It’s getting late.”

They are saying this because overnight they have become statesmen instead of politicians (and Monti never was a politician).

Unlike everyone else in their political systems, they have responsibility for financing the state. That responsibility concentrates the mind when the first thing you do each morning is to check Bloomberg to see how your bonds are doing. Each of these guys is doing that now, and what they are seeing is reflected in the frightened things they are saying.

Right now, diminishing credit market access is happening to Greece, Italy, Spain, Portugal, Ireland, France and Austria. Of these, France, Spain and Italy fall into the category of “too big to wargame”. Which means that they need to be wargamed now.

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