Black Swan Free World (8)
On April 7 2009, the Financial Times published an article written by Nassim Taleb called Ten Principles for a Black Swan Free World. Let’s look at them one at a time…
8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.
George Soros has said that he believes that the GFC is the beginning of the unwinding of a fifty year credit buildup. Clearly there was too much leverage. But does anyone know what the right amount of leverage for a smoothly functioning capitalist system should be?
There is always a problem after a bubble. Many people keep comparing things to how they were at the very height of the bubble. Stock valuations are compared to the height of the market. Employment is compared to the point where the most people had jobs. But these are often not the right comparisons. If in the month of May, for 30 days, I had an outstanding offer for my house of $300,000 and on one day a person flew in from far away and offered $3 million, and if I never made that sale, do I forever after compare the offering price for selling the house to $3 Million?
People talk about a “New Normal”. Possibly, the new normal means nothing more than returning to the long term trend line. Going back to where things would now be if everything had stayed rational.
That may seem sensible, but this new normal may be a very different economy than the overheated and overleveraged one that we had.
Taleb suggests that the only possible transition from excessive debt is cold turkey. If Soros is right and we are going to transition to a new normal that is more like 50 years ago than 5 years ago, there that will be a long bout of DTs.
What we are seeing in the way of debt is the substitution of government debt for private debt. While Taleb is probably too harsh, the Fed does need to be careful. Careful not to go too far with the government debt. The Fed should be acting like the football player who passes ahead of the teammate, not to where they are standing right now. The amount of debt that they should be shooting for is a level that will make sense when the banks fully recover and again take up lending “like normal”. That will keep enough money flowing in the economy to soften the slowdown to the economy from the contraction of bank lending.
However, if the Fed is shooting to put us back where we were at the peak, then we are in trouble and Taleb’s warning holds. I would restate his warning as “Using too much leverage to combat the problem of too much leverage…” But using the right amount of leverage is just what is needed.
But that does mean learning to live with much less leverage. It means that we need to better understand how much leverage is the right amount. And we need to stop blaming the Chinese because they hold so much dollars and want to lend them to us. We need to develop a structural solution to the global imbalance that the Chinese balances are a symptom of.
Like some of our other problems, the purely market based solutions will not work. China is not playing by the market based rule book. They are a mercantilist economy that is taking advantage of the global market economy systems. We need to stop whining about that and develop strategies that work for everyone.
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