Tuesday, November 18, 2008

Root cause of the crisis...same as it ever was

The salient feature of the current financial crisis is that it was not caused by some external shock like OPEC raising the price of oil or a particular country or financial institution defaulting. The crisis was generated by the financial system itself. George Soros

We are going through a financial crisis more severe and unpredictable than any in our lifetimes. Hank Paulson

Unprecedented. Unpredictable. Not exogenously caused.


One of the essential features of a scientific view of the universe is the notion that (at least some) events can be viewed from a general perspective. Once you decide that certain events are unprecedented and unpredictable you can throw any hope of a scientific response out the window.

That the Secretary of the Treasury is willing to argue thusly in the NYTimes is not a credit to his wisdom, but it is par for the course for a politician. After all, if the economic downturn was predictable, then he obviously failed, at the very least by failing to warn, if not avoid.

Far more curious, to me than a politician engaging in a bit of C.Y.A., is Mr. Soros take on recent events, particularly given his acceptance of the "mind-body" (or dualist) philosophy as basis for his economic view, reflexivity. The dualist premise is that there is always a dance between reality and conception- nothing is totally "end" or "ex" ogenous.

In his words: As a way of explaining financial markets, I propose an alternative paradigm that differs from the current one in two respects. First, financial markets do not reflect prevailing conditions accurately; they provide a picture that is always biased or distorted in one way or another. Second, the distorted views held by market participants and expressed in market prices can, under certain circumstances, affect the so-called fundamentals that market prices are supposed to reflect. This two-way circular connection between market prices and the underlying reality I call reflexivity.

This view is a specific application of a very old philosophical conception of consciousness which can be simply stated: there is a (variable) difference between what we think and what is. Plato wrote about his cave of shadow truth and the need to step into the light 2400 years ago. More recently and familiarly, Korzybski argued, the map is not the territory.

Soros' reflexivity is the same- the financial market map is not the real sector territory. When markets are operating efficiently, that map is a good facsimile and when they aren't, we get lost.

My argument with Soros (and his argument with himself) is that an endogenous financial sector crisis could only occur in the absence of real sector change. He makes this argument to push his view that more regulation would have helped avoid the crisis.

To stick with the map-territory analog, each time a new road is built, or an old road is washed away, burned out or becomes otherwise impassable, a (previously) perfectly good map needs to be updated. Soros is arguing that the territory is unchanged. The map, of itself, has been changed. Soros goes on to argue that if we had better regulated the map-makers, ensuring that they didn't change the map, we wouldn't have run into this problem.

I disagree.

Our crisis, in my view, is not entirely endogenously caused. There have been many changes in the underlying territory:

1) Increased competition for natural resource
2) decaying US infrastructure (the bricks and mortar mocked during the Tech Boom days)
3) redirection of resource towards destruction (with presumed hopes of loot at the end) rather than construction for almost 6 years

There are, of course, in addition, the chickens coming home to roost issue of our long standing abuse of the $ based international system to run perpetual and increasing current account deficits which increasingly constrains our options.

Our crisis, as are most financial crises, (and, in general, the root cause of most personal crises) is a result of denial of the potential (which continues as potential has become actual) consequences of our economic choices. The US went "all-in" on a Pax Americana and the cards didn't turn our way. The problem isn't, in a sense, a lack of regulation, as Soros argues, but a lack of vision.

Remember back a few years (and, if you listen to right-wing talk radio, even today...surrender monkeys) when dissent against the war, even if the dissent was couched in the form of "we need to rebuild our infrastructure and thus can't afford this Iraqi adventure," could cost one his or her job? Public opinion, which includes the financial type, became increasingly myopic- focused only on events or issues that reinforced the preferred view of reality.

Explanatory note: I'm not suggesting there is some grand conspiracy. Ever since humans became conscious we have exhibited a repeated tendency to self-deception with sometimes disastrous results. (This ability can, however, be a wonderful facility during periods of tragedy- not everyone can look grim truth in the eye all the time). The same myopia that can keep one on a very difficult path through terrible conditions with a happy ending can keep one on a very difficult path through terrible conditions with no pot of gold at the end of the rainbow.

In his American Theocracy, Kevin Phillips argues that this myopia is a recurring feature of modern western empires. A nation rises by virtue of a capital stock geared to a reality. Success in that context of reality leads the owners of the capital stock to take the reins of the country. As the underlying reality (as it always does) shifts, begging a redirection of the capital stock, the owners of the now increasingly obsolete capital stock fight the change by, inter alia, propagandizing a self-serving view of reality which becomes increasingly at odds with the facts on the ground.

Recapitalizing (and/or re-regulating) a financial sector that continues to adhere to a view of American dominance of natural resource flows will not help if, in truth, America is not directing those flows. The financial sector map won't match the real sector territory.

This, in my view, is the root cause of our crisis- political/economic inertia from a nation that had risen to the top of the food chain.

And that is one of the oldest stories around.

As the Talking Heads used to sing back when I was in school:

And you may ask yourself-well...how did I get here?

Letting the days go by/let the water hold me down
Letting the days go by/water flowing underground
Into the blue again/after the moneys gone
Once in a lifetime/water flowing underground.

And you may ask yourself How do I work this?
And you may ask yourself Where is that large automobile?
And you may tell yourself This is not my beautiful house!
And you may tell yourself This is not my beautiful wife!

Same as it ever was...same as it ever was...same as it ever was...Same as it ever was...same as it ever was...same as it ever was...Same as it ever was...same as it ever was...