Friday, May 21, 2010

THE Riddle Has Been Solved

Many readers will think that the last person whose opinion should be consulted on the issue of rating agency reform is a former rating agency employee. Maybe they’re right, but I did learn one thing from rating hundreds of complex securities. Contrary to what some may think, there are no easy solutions here. Unintended consequences are guaranteed. Gary Witt, former MD of Moody's Investor Services

What riddle?

Why is the industrialized world in the mess it's in?

Mr. Witt, writing at The Baseline Scenario answers this question, in my view, correctly.

We're in the mess we're in because there are no easy solutions. There haven't been easy solutions for quite a few decades as all of the "low hanging fruit" of industrialization currently being harvested in countries like China has long ago been harvested in the west.

Industrialization for economies is like adolescence for humans. It's a period of time when natural growth overpowers constraints that would hobble children or mature adults. There are easy solutions for adolescents and young adults but as we age our choices are more often an exercise in finding the lesser evil.

So it is, I believe, for US (and European and Japanese) economic policy makers. Shifting away from a financially centered economy will be painful. Wealth will be lost, interest rates will rise, and investment capital will become more scarce. We'll have to compete again, which tends to difficult for those who have grown accustomed to dominating.

"What evil," you might be wondering, "makes the above the better option?"

The alternative, in my view, is all of the above, but worse, and with less ownership. We won't be competing, we'll be sharecropping, as Warren Buffet once quipped.

In other words, I believe our economic woes are already built into the system. The expected growth in the New American Century, upon which dream, in part, credit was extended, didn't materialize.  Our choices now are between growing out of our dilemma- paying down debt with income(and lots of inflation)- or selling assets in lieu thereof.

Western Economies are, in a sense, middle-aged. There are no quick fixes available, just choices between accepting reality and having it forced on us.


Rob said...

Interesting, but this explanation leaves out at least two vital things:

- We are living in a world with finite resources and are now reaching the limits of those resources. This was not the case when Europe and America became industrialised

- It ignores the fact that to a great extent this crisis is due to plain old fraud

STS said...

Adolescence is a pretty good metaphor in some ways. It's a transitional stage into something a little closer to "equilibrium". But really the whole human race is in a sort of perpetual adolescence. We learn a little about the world, then have to hand it over to younger, more foolish people who then repeat the cycle.

A better analogy would be thermodynamic. The US was equilibrating during the post-WWII era, to a high per-capita, relatively evenly distributed income level. Then the globalization process kicked in and started draining 'heat' out of the US. Meaning that the relatively isolated US labor market got merged in with the rest of the world by stages.

Globalization essentially reversed generations of progress on labor and safety standards as capital was enabled to 'end run' around the rules (regulatory arbitrage) and effectively abrogate collective bargaining and domestic political agreements.

US prosperity was never especially 'fair' in global terms, but the process of equilibrating in a world of dramatic extremes of wealth and poverty will mean the US standard of living will be under a lot of drag over the next generation or two as the developing world catches up.

Dude said...


Man has always lived in a world with finite resources and has often reached "limits" (in the sense of man's ability to profitably extract them) sometimes to discover some more productive methods and grow, or not, and to shrink.

Like the notion of a world of finite resources (which I assume is always a given) man lies cheats and steals, and has for as long as he has been man.

Vital, yes. A permanent feature of man's life on earth, also yes.

Dude said...


As you are likely aware, I argue the main issues with economics are not physical but psychological, thus the choice of metaphor.

Adjectives like good, bad, better and worse, in my view, require a context to have meaning.

Physical metaphors for economic phenomena focus on the mechanical perspective. Their utility will depend on one's aim in using them.

啟佐 said...

How are you~.................................................................

STS said...


I'm reminded of Benjamin Graham's well-known remark: "In the short run, the market is a voting machine, but in the long run it is a weighing machine." In other words, it isn't entirely psychological or entirely physical.

My preference for "globalization as thermodynamics of mixing" as a model is a result of my tendency to look at longer range causes and effects. I suspect that we'll have more success in measuring things like the supply of oil, the opportunities for wage and regulatory arbitrage, etc. and their impact on longer term market movements, than we will with guessing when human beings will "grow up" (approximately never). Or at any rate, I suspect that *I* will do better with physical models. I'm not much of a judge of fashion trends.

Maybe one reason I'm not much for the 'gold bug' school is that I don't imagine there was once a time when money was money and men were men so to speak. For as long as there has been money, there have been opportunities to 'financialize' some asset or other, whether tulip bulbs, South Sea Company Shares, watered railroad stock, LBO-bloated equities, notes issued by fly-by-night local banks in the American west, etc.

"Men" will play adolescent games with whatever play "money" is available, but physical realities will ultimately yank on the elastic leash and force them to charge off in some other crazy direction. I think the direction of those ricochets is perhaps to some degree predictable, even if their timing is not.