The Breaking Point

by James Dale Davidson

  Peter J. Taylor has identified the Thirty Years’ War as an important milestone of transitions of power in the world system. He writes: “As well as being on the winning side, the hegemon has a ‘good war’ economically. This is the case with the Dutch during the Thirty Years War, and it also fits the British during the Napoleonic war and the Americans during World Wars I and II.”24 Obviously, the patterns of the past are based on conventional conflict.

  Notwithstanding the fact that war has been a common feature of the terminal crises of hegemony, it is possible to imagine collapse without a nuclear war. Indeed, given the easily imagined prospect of annihilation, one has to hope that collapse could proceed in a more ordered and less devastating way that does not entail humanity being all but extinguished by the widespread detonation of nuclear weapons.

  Yes, I agree, hope is a flimsy strategy for avoiding a destructive war.

  Yet the postcollapse world of Mad Max—where Sydney, as seen in Beyond Thunderdome, is a ghostly carcass of ruined skyscrapers—is not the only outcome you could expect from even a full-fledged collapse sequence. With better weather, and a splash of rain, your options in the declining state would not necessarily come down to a choice between joining Hell’s Angels and morphing into a fifteenth-century peasant.

  There will certainly be a crisis surrounding Tim Morgan’s undeniably logical conclusion about the fate of a huge excess of claims that cannot be met by the real economy. As he states, “The only solution to this mismatch is the destruction of the value of money and debt on an unprecedentedly vast scale.” Put simply: a collapse.

  Notes

  1 http://fskrealityguide.blogspot.com/2010/07/real-gdp-is-crashing-2000-2009.html.

  2 http://www.wri.org/blog/2013/08/majority-china%E2%80%99s-proposed-coal-fired-power-plants-located-water-stressed-regions.

  3 Durden, Tyler, “The Latest Contribution to US GDP: Promises . . . No Really,” Zero Hedge, May 6, 2013.

  4 Williams, John, Shadow Government Statistics, commentary number 740.

  5 Holz, Carsten, “Here Be Dragons? China’s Economic Data May Not Be All Bad,” http://theconversation.com/here-be-dragons-chinas-economic-data-may-not-be-all-bad-23047.

  6 “Foreign-Based Companies Investing in the U.S. Auto Industry,” Office of Aerospace and Automotive Industries International Trade Administration U.S. Department of Commerce, August 2007.

  7 Williams, John, “Government Economic Reports: Things You’ve Suspected but Were Afraid to Ask!,” Shadow Government Statistics, October 6, 2004.

  8 Bruder, Jessica, “The End of Retirement: When You Can’t Afford to Stop Working,” Harper’s, August 2014, 29.

  9 https://www.scribd.com/document/222414663/Declining-Business-Dynamism-Hathaway-Litan.

  10 http://www.aecf.org/blog/17-million-more-children-live-in-low-income-working-families-today-than-in/.

  11 http://www.industryweek.com/global-economy/why-2000s-were-lost-decade-american-manufacturing.

  12 http://www.huffingtonpost.com/robert-d-atkinson-phd/worse-than-the-great-depr_b_1368219.html.

  13 Degner, Randy, “U.S. Economic Growth: GDP Minus the Federal Deficit Doug Short,” http://www.advisorperspectives.com/commentaries/dshort_42811.php.

  14 http://www.chapwoodindex.com.

  15 Grantham, Jeremy, “The Beginning of the End of the Fossil Fuel Revolution (From Golden Goose to Cooked Goose),” GMO Quarterly Letter, Third Quarter 2014, 14.

  16 Visnic, Bill, “Worrying Sign for Automakers: Americans Burning Least Amount of Gasoline a Generation,” Forbes, March 25, 2015.

  17 Ibid.

  18 Carroll, Lewis, Through the Looking-Glass and What Alice Found There, chapter 2, https://www.gutenberg.org/files/12/12-h/12-h.htm.

  19 http://www.ekathimerini.com/199997/article/ekathimerini/business/retailers-see-turnover-fall-by-up-to-70-pct.

  20 http://www.ft.com/cms/s/d6877d5e-31ee-11e5-91ac-a5e17d9b4cff.

  21 https://www.sprottmoney.com/blog/us-wages-have-fallen-every-quarter-of-the-recovery-jeff-nielson.html.

  22 Tilly, Charles, “War Making and State Making as Organized Crime,” in Bringing the State Back In, ed. Peter B. Evans et al. (Cambridge: Cambridge University Press, 1985), 169.

  23 Playboy 42, no. 7 (July 1995), 51.

  24 Taylor, Peter J., The Way the Modern World Works: World Hegemony to World Impasse (Chichester: John Wiley & Sons, 1996), 4.

  Chapter Nineteen

  Black Swans on the Horizon

  The Accelerating Collapse of the Status Quo

  Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse.

  —Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable

  “Peasants Vote to Leave the Feudal Manor”

  Unless you have been doing a Rip Van Winkle somewhere, you know by now that voters in the United Kingdom decided by a margin of about 52 percent to 48 percent to secede from the European Union on June 23, 2016. John Bolton, a former George W. Bush aide, quipped that the “peasants had voted to leave the manor.” This act of insubordination hit world markets like an earthquake. Aftershocks rattled the foundations of the status quo. According to Bloomberg, $4 trillion in paper wealth vaporized on world stocks in the two trading days immediately following the vote. Most of those dramatic stock market losses were subsequently retraced, in the wake of central bank intervention and jawboning that helped spike an epic short squeeze, the biggest since the 2008 financial crisis.

  On the other hand, the impact of the British vote, known under the shorthand of “Brexit,” looks to have been more enduring effects in the bond and currency markets—enough to qualify Brexit as a world-changing Black Swan event as defined by Nassim Nicholas Taleb.

  Currencies seem to have experienced a dramatic realignment, particularly the British pound. This, in turn, had carry-on consequences. For one thing, tourism to the United Kingdom surged as the weaker pound made travel in Britain more affordable. For another, Eleanor of Acquitaine’s dowry fattened the coffers of Bordeaux wine-makers. As you may know if you are a wine snob or a medieval history buff, the Bordeaux region became a personal fiefdom of the English king, Henry II, when he married Eleanor of Aquitaine in 1152. From that point forward, England became a major market for Bordeaux wines. Many Bordeaux brands have traditionally been marketed from bonded warehouses in the United Kingdom and priced in pounds sterling. The plunge in the pound after Brexit stimulated a surge in orders with London wine merchants. BI, one of the foremost wine merchants in the world (sponsors of BI LiveTrade, the “only 2-way market-making screen for buying and selling top Bordeaux”), reported, “We literally had to close our screens at the moment of Brexit.”1 In an environment where many central banks have been angling to reduce the exchange value of their currency, Brexit produced an immediate eighteen-standard-deviation devaluation of the pound sterling. I joked that the Japanese should announce their intention to withdraw from the European Union.

  Of course, that was a joke. But it appears likely that the Chinese could take advantage of the tumult associated with Brexit to permit a larger devaluation of the yuan. This could confound the efforts of the central banks of “advanced economies” to notch inflation higher and devalue their own currencies. A lower yuan would help China export its deflation to the West, as it faces what hedge fund superstar Kyle Bass calls “the largest macro imbalance in history”—an epic asset/liability mismatch (bad debt) equivalent to 10 percent of GDP.2 Compare this with gap of 2.5 percent in the United States during the 2008 financial crisis. As the Chinese authorities seek to fend off a 1929-style depression by caulking the cracks in China’s $22 trillion edifice of “social financing” with still more credit, their effort to “buy time” is likely to translate into lower imported inflation in the West, as well as a stronger US dollar, implying a still more deflationary environment.

 
; The blowback from Brexit in the bond markets testified to significant cross asset stress. The ten-year German bonds gapped higher in a larger move than that experienced on any day in 2008. Global bonds rose in price, as yields on sovereign debt traded to all-time lows, with $11.7 trillion in sovereign issues sporting negative yields. Swiss yields turned negative fifty years out, trading as low as -2.7 basis points.

  Ever-lower interest rates imply ever-wider financial fallout.

  For example, over $500 trillion in global derivatives trade based on bond yields. This may be one reason that the stocks of big banks and other financial firms with large derivative books did not participate as much as other sectors in the central bank-engineered stock rally that followed two days of waterfall selling in the wake of Brexit.

  The fine print on the stock pages in the wake of Brexit offers another important “tell” on the world after Brexit. As noted by Gillian Tett in the Financial Times, a surprise among the worst performing stocks in the first trading days after Brexit was MetLife (MET NYSE), down 14 percent.3 MetLife plunged not because it expected a drop in policy business in the United Kingdom. It has none. MetLife plunged because, as an insurance company already suffering from “Financial Repression” (or martial law for money), it was faced with a higher prospect of suffocation as Brexit deepened deflation expectations. With $11.7 trillion in sovereign issues sporting negative yields, the prospect of still lower long-term bond yields promises nothing but woe for insurance companies that have come to rely on income from long-term bonds for funding their policy liabilities. This challenge has gotten serious, according to Bloomberg, as North American insurance companies have experienced a plunge in their bond investment income back to 2011 levels. Insurers such as Prudential Financial and MetLife find themselves holding $132 billion of bonds either in or close to default. Most of these now distressed bonds, by the way, were “investment-grade bonds from energy drillers and retailers that ended up heading south.”4

  Note that in the ex-growth world of the twenty-first century, there will be a strong tendency for any Black Swan event to have deflationary repercussions. Why? Because governments have chosen to disguise the failure of growth with credit spun out of thin air. Almost any disruption will tend to jeopardize the ever-more fragile architecture of unpayable debt upon which the status quo depends. The logical consequence of an ex-growth economy is difficulty in meeting interest payments on outstanding debt. This was underscored in the wake of Brexit by the collapsing prices of European bank stock. Monte dei Paschi, the world’s oldest bank, grabbed the headlines when it was warned by the European Central Bank that it needs to shed another €10 billion in nonperforming loans.

  The Black Swan

  More on the deflationary risk below, but shifting focus slightly, you might like to better understand why an innocent water bird, the Cygnus atratus is being widely associated with economic collapse. Here is the backstory.

  Consider that the black swan has been emblematic of something improbable or vanishingly rare since the first century when the Roman poet Juvenal wrote about “a rare bird in the land, like a black swan.” At the time, and for another fifteen centuries, it was taken for granted that the black swan did not exist.

  That changed in 1697, when Dutch explorer Willem Hesselzoon de Vlamingh van Oost Vlieland (otherwise falsely credited for naming “Rats Nest Island”) sailed into what is now the Swan River in Western Australia (then known as “New Holland”) and found a number of large black swans, three of which he captured and carried away with him.

  The Black Swan Asymmetry: Verifiability and Falsifiability

  Black swans came to illustrate a shortcoming of inductive reasoning—namely, that even with a very large sample size, you cannot leap from particular observations to reach a valid conclusion (consequent) that generalizes from those observations (antecedents). The white swan/black swan example perfectly illustrates that.

  Before the seventeenth century, when all swans were thought to be white, you could have seen every swan there was to see for a millennium and a half and apparently concluded without mistake that all swans were white. But this would still have been an abuse of logic, as a tally of white swans can never mount so high as to disprove the existence of black swans. But once a single black swan was discovered, the idea that all swans are white was forever falsified.

  The philosopher of science, Karl Popper, analyzed this asymmetry that plagues exercises in probabilistic statistics. He made that a crucial factor in his doctrine of falsifiability in The Logic of Scientific Discovery: “My proposal is based upon an asymmetry between verifiability and falsifiability; an asymmetry which results from the logical form of universal statements. For these are never derivable from singular statements, but can be contradicted by singular statements”5

  Hence the black swan is the exception that disproves the rule. That is why the Black Swan (in caps) has become an important metaphor for the risks inherent in trying to infer universal conclusions from particular data.

  The Black Swan has been immortalized as the poster child for the “highly improbable events” that mathematician and hedge fund philosopher, Nassim Nicholas Taleb, has identified as likely to dominate history. Recall how this expressed itself in the innumerable “white swan sightings” that preceded the subprime mortgage crisis that brought the world economy to the brink of collapse in 2008.

  At that time, the record of recent history offered no examples of large clusters of Americans defaulting on their mortgages. Equally, experts testified that housing prices always went up. And for those silly enough to appraise risk in the mortgage market without taking Taleb’s care in considering the role of Black Swans, the data must have seemed convincing. From Alan Greenspan’s swearing in as chairman of the Federal Reserve Board in August 1987, through the peak of the housing bubble in 2007, residential real estate in the United States soared from a value of $5.5 trillion to $22.5 trillion—a fourfold appreciation.

  The white swans in view were all beautiful. No one among the bankers worried about the Black Swans that they couldn’t yet see—until those Black Swans landed on Wall Street. But Taleb was attuned to the danger. He famously proclaimed, “I know that history is going to be dominated by an improbable event, I just don’t know what that event will be.”6

  The Improbable Happens

  In Brexit, you have witnessed another “improbable event” with the potential to dominate history. In a development that heralds the unraveling of the status quo globally, the United Kingdom voted on June 23, 2016, in a referendum to leave the European Union. As Taleb suggests in the comment quoted at the top of this chapter, “Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse.”

  You do now. A strong hint of the “interlocking fragility” that characterizes global finance was provided by the Bloomberg screens blinking red as the realization that “Brexit” would win dawned on previously complacent investors around the world. An abridged summary of the financial pandemonium occurring forty-eight hours after the vote:

  • British pound falls as much as 11 percent to $1.3229—a three decade low and its greatest one-day loss in history—off an incredible eighteen standard deviations. Earlier that day (Thursday, June 23) the pound sterling traded at just under $1.49.

  • Implied volatility on the pound/dollar trade reaches twice that seen in the Lehman collapse.

  • Japan’s Topix index leads Asian stock losses, down more than 7 percent, as the Japanese yen soars to a multiyear high.

  • The Australian dollar loses 3 per cent to 73.8 US cents, as Australian stocks shed $50 billion.

  • FTSE 100 Index futures tumble 9 percent; contracts on Euro Stoxx 50 slide 11 percent.

  • Italian stocks (FTSE MIB) fall by 12.5 percent.

  • Spanish stocks (IBEX 35) plunge 12.3 percent.

  • S&P 500 Index fut
ures are limit-down overnight; the DOW falls 900 points post-Brexit.

  • Brazil’s Bovespa stock index falls 2.8 percent.

  • Yield on ten-year US Treasuries drops 29 basis points to 1.46 percent, the biggest daily decline since 2009.

  • Big banks trading in Asia post double-digit losses overnight.

  • The euro’s fall overnight is its worst ever.

  • Commodities (apart from precious metals) plunge as the US dollar soars.

  • New York crude oil retreats 5.1 percent to $47.56 a barrel, poised for biggest loss since February 2016.

  • Gold rallies as much as 8.1 percent to $1,358.54 an ounce, highest since March 2014.

  • Poland’s zloty drops by the most since 1993.

  • The South African rand tumbles as much as 8 percent to the dollar, joining the sharp sell-off on world market.

  • China devalues the yuan the most since the August crash, as Premier Li Keqiang warns “a disillusioned British butterfly flapped its wings and the entire global financial system could collapse.”7

  Tallying the Losses

  I confess that I lack the patience to undertake the long-running exercise in forensic accounting needed to comprehensively quantify the losses in paper wealth occasioned by Brexit. But I am happy to credit Bloomberg’s handy estimate that some $4 trillion in shareholder wealth vanished in the first two trading days after Brexit. Here are some other approximations to help you put the pandemonium in perspective.