Time Trap

[K-Dog]

The Consciousness of Sheep

Physicist Albert Bartlett made the case that humanity's greatest weakness is our inability to understand the exponential function.  If this is so, then surely our inability to process time must be our second greatest weakness.  As I wrote in my book, The Consciousness of Sheep:

"The overwhelming majority of us are completely disconnected from our future selves.  We understand at a cognitive level that we will become a different person in the future to the person that we are today.  But we struggle to understand that these people that we are to become are really ourselves.  If they become unwell, we are going to have to experience their pain.  If they are poor, we are going to have to experience their poverty.  If they are obese, we are going to have to struggle for breath as we lug their excess weight around...

"This... highlights a key reason why so many people stay stuck in unpleasant situations simply because they will not put effort into making change.  Again, we all 'understand' this at a cognitive level.  For example, we know that someone who is in a poorly paid and/or stressful job would be better off taking up a night school or distance learning course than, say, going to the pub in an attempt to unwind.  Nevertheless, adult education is struggling to recruit students while pubs are full of people complaining about their jobs!

"To most of us, our future selves are complete strangers.  Indeed, we are often more caring about our present friends and relatives than we are about our future selves.  And if our future selves are strangers, is it any surprise that we offer them no greater support than we would to a stranger today?  It is not that we wish them harm.  But – let's be honest – how many of us would give up a small box of chocolate today so that someone else can have a large box next week?

"Of course, many of the issues facing us are so much greater than who gets chocolates.  An adult will not educate themselves so that a stranger can get a better job.  A drunk will not turn down a drink so that a stranger will be spared a hangover.   A smoker will not turn down a cigarette so that someone else does not get cancer.  And none of us will leave our cars at home or turn down holidays abroad so that strangers do not have to cope with economic collapse and climate change."

In short, while we are able to understand immediate cause and effect, almost all of us are incapable of mentally processing circumstances in which an immediate action has only a longer-term effect.  This is one reason, for example, why Mars rovers are autonomous rather than operated by humans back on Earth – the time delay (between 5 and 20 minutes) between issuing the instruction and it reaching the rover makes crashing too great a risk... and steering a Mars rover is straightforward compared to the many other time-delayed processes we have to deal with.

Nor is the problem solely about feedback.  A large part of humanity's inability to process time concerns our tendency to discount the future.  Rather like the old joke about the man who leaps off a tall building and is heard to say "100 stories down so far and no ill effects," we all too easily assume that the future will be just like the past.  Ignoring the potential for things to turn out badly, however, seldom works out well.  Attempting to balance inflation and economic stability using interest rates, for example, has been described as being like trying to lift a brick by pulling on an elastic band.  You pull and pull and pull, and all that seems to be happening is that the elastic is stretching.  And so, you comfort yourself with the thought that you can keep pulling.  But then, one final pull causes the brick to fly up and hit you in the face!

Interest rates – the Maslow's Hammer that the central banks use to (fail to) regulate prices – have, of course, been far higher than they are today.  But there has never been a time in modern history when they have risen this fast.  For this reason, they risk both the feedback and the discounted future threats.

Consider that as many as fifteen percent of publicly listed companies across the OECD are what has been called "zombie companies" – those that have been able to service their outstanding debts (at historically low interest rates) but have no means of repaying them.  Because the banks have no desire to have to learn how to run companies – or, to sell houses and cars for that matter – they had been content to use the low interest rate environment between 2008 and 2021 to roll over outstanding debt in the hope that the companies involved might one day return to profitability.  In the meantime, since the firms were able to pay the interest, and since the interest could be sold on as a derivative, the banks could play the game of "extend and pretend."  And so long as governments didn't do anything really stupid like locking down their economies or starting an economic war with one of the only remaining resource-rich states on the planet, the system might have continued long into the future.

Lockdowns smashed the just-in-time supply chains which had kept the lid on prices for a generation.  And then, self-destructive sanctions on essentials like oil and gas, fertilizer and even food itself, caused the price of essentials across the world to spiral upward.  The problem was compounded by the short-term impact of excessive state spending during the pandemic.  When economies began to open again, enough people had saved just enough of the furlough payments and stimulus cheques to feed into the supply-side shock to produce an inflationary spike.

Paradoxically, the short, post-lockdown spending spree caused companies – including the zombie ones – to act as if it was the beginning of a new economic boom.  As consumers went on a spending spree, retailers double and tripled their inventory, and manufacturers desperately sought workers to fill the vacancies created by the sudden leap in demand... and then everything crashed into reverse.

Central banks were finally prodded into action once it became clear that price increases were not going away.  But by this point, most consumers had blown their pent-up savings and were back to more constrained spending patterns.  Monetary inflation had all but disappeared from the economy, but the impact of sustained high energy and food prices continued to prevent disinflation – a fall in the rate at which prices were rising.  In such circumstances, interest rate rises do nothing to solve the problem, and often act to make matters worse... particularly for those thousands of zombie companies which had only just been getting by.

By the second half of 2022, something had changed.  But the things which were changing are things not included in the models used by the central banks.  Indeed, central bank models are based around so-called "backward-looking" indicators such as GDP and employment – data which tells us what the economy was doing three months ago.  Qualitative changes in consumer behavior, for example – such as those recorded in the Bank of England's Citizens Panels – are only factored in when they become manifest in retail sales and GDP data, rather than being used as an early warning signal.  The same goes for the announcements of thousands of retail outlet closures and tens of thousands of job losses across the tech sector, which will only be included in central bank modelling months from now when their effects are seen in the GDP and employment figures.

In the meantime, the big banking and financial corporations have also radically shifted their behavior.  In the aftermath of lockdowns, and accelerating in the wake of the economic war, the big institutions have generated a global dollar shortage as a consequence of an accelerating race to safety.

One of the remaining myths about currency, is the idea of the bank reserve – the belief that their has to be a token, a central bank reserve or a piece of precious metal, against which banks multiply their lending.  The reality – which will become better known when the coming crisis is over – is that the only limit on bank lending within the Eurodollar system is perceived counterparty risk.  That is, so long as an international bank believes that the corporation or nation which wants a loan is good for the repayment, they can create as many dollars as they wish... entirely independently of the US Treasury or the Federal Reserve.

By 2022, the big multinational banking and financial corporations had radically altered their perception of counterparty risk.  In part this was due to the lack of investment during lockdown, in part the impact of broken supply chains and the rising cost of essentials, and in part the likely impact of state and central bank policy.  Either way, they began the process of tightening lending standards, while seeking to generate a safe cash cushion on their own ledger books.  In practice, they ceased rolling over the debts of zombie households, companies and even countries, while buying up whatever "safe" government debt they could find – in theory, governments cannot go broke because they can always screw their taxpayers for more currency.  Although this might not work out in practice.

The feedback signal from the collective change in multinational financial institutions' behavior is what is known as a "yield curve inversion" – one of the most historically accurate predictors of a near-term economic downturn.  A yield curve inversion occurs because the global financial corporations are prepared to lend to the government in the long-term at a lower interest rate than they could get by simply parking their money at the central bank overnight.  They only do this when their data – which is far more accurate than the data used by governments and central banks – points to a weakening economy.

To some extent, this becomes a self-fulfilling prophesy, since the main consequence of the institutional behavior change is to pull currency away from the real economy.  That is, zombie households and companies which had been servicing their debts are no longer able to do so – at least, not at an interest rate they can afford... a process not helped by the central banks raising interest rates at the fastest pace in history.  Analyst Stephanie Pomboy uses the analogy of having to drink a gallon of water to explain why the speed of rate hikes is more important than the level they rise to.  If you have to drink a gallon of water and you have a month to do it, it will be easy.  But if someone is forcing you to drink a gallon of water in less than a minute, you are going to drown.

Rapid rate rises fuel the coming economic conflagration, as Walter Frick at Harvard Business Review explains:

"The current economy is bad news for zombie firms. Higher interest rates put pressure on them, for a few reasons:  Higher interest rates lower demand in the economy, meaning less revenue for many companies, which in turn means even less cash to pay down debt.  They make raising new funding more challenging, as firms that couldn't cover their interest payments at lower rates will fall even farther behind if they borrow at higher ones.  As interest rates rise, investors and banks have less interest in lending to zombies, because higher rates mean they have better, safer options.

"As such, rising rates will likely push more zombie firms into bankruptcy...  And it will push more healthy firms toward zombie status: Companies that could cover their interest payments may no longer be able to if they have to borrow at higher rates."

This sets up what analyst Jeff Snider refers to as the "2008 trap."  When it comes to interest rate rises, it can take months for the effects to filter through.  And so, viewed through the lens of employment and GDP data – which, remember, tells us about how the economy used to be, not how it is going to be – the picture looks far more positive than it ought to.  The result is that economists and central bankers begin to talk about "soft landings" or even no landing at all, just at the point that inverted yield curves – synchronized across the western economies for the first time in history – are pointing to the mother of all economic downturns just weeks from now.

The 2008 trap, in short, is that the central bankers still believe that they have time – that high employment and vacancy rates provide a buffer which allows them to continue to raise rates.  As we saw in 2008 though, by the time households and firms went under, it was too late to prevent a systemic collapse from which we never really recovered.  This week, even as the first banks began to crash, the central bankers decided that there is still room for more rate rises.  The market in government debt says otherwise.  As Pomboy warned on Wednesday:

"I do expect we'll get 25, however... I think that we're going to be looking at much more rapid rate cuts than the market has presently expected... Honestly, what we're seeing here is not just the banking sector issue. The everything bubble has now burst, and that's going to hit, as to quote the movie, everything everywhere all at once."

On a much longer timescale, we have lived through a growing gulf between the nominal value of debt and currency claims on the economy and the true value of the economy itself for more than half a century.  Each time it has faltered, the "solution" has been to inject even more debt into the system.  But by 2008, we had reached "peak debt" – which is, in reality peak resources, as there is no longer enough surplus energy and resources to expand the real economy any further.  And so, the reckoning that states and bankers have been putting off for decades – in shorthand, the bursting of the "everything bubble" – is at hand.

It could be that the only question left to be resolved is how much of what was considered to be "too big to fail" last time around will prove to be too big to save this time?