More darkly, Schumpeter’s intuition was that the evolution might end not in socialism but in fascism. The two are not incompatible. Socialism is the sugarcoated, do-good Trojan horse that fascism can ride to power.
A persistent myth is that fascism represents a condominium of corporate and government power, sometimes called corporatism. A corollary is that corporate interests dominate, and government is no more than a channel to protect corporate interests. In this view, Hitler was a pawn controlled by rich German industrialists to serve their ends until his megalomania got the better of him and led to catastrophic defeat in the Second World War. In another telling, Dick Cheney was an agent of Halliburton who ensured that corporate interests were protected by the fascist Bush 43 administration.
These views are nonsense. Hitler was a murderous fascist, while American presidents, including Bush, are of the democratic “friendly fascist” kind. What both brands of fascism have in common is state dominance. Corporations are powerful, yet distinctly subordinate to the state.
In a fascist system, a Faustian bargain is struck between big business and big government. Fascists are perfectly willing to allow private companies and private property to exist. They are unwilling to allow private realms to stand in the way of state power. Hospitals and health insurers may be private enterprises, but their products, prices, and policies are controlled by Obamacare. Google, Twitter, and Apple may be private companies, but Internet access and fees are regulated by the Federal Communications Commission, an agency established in 1933 by FDR, almost sixty years before the World Wide Web was launched. Banks are private entities, but are highly regulated under Dodd-Frank, the Federal Reserve Act, and a litany of other statutes.
Initially business lobbies against new legislation. In the end, business embraces it and provides expertise to agencies it formerly opposed because these agencies damage emergent competitors more than established enterprise. Compliance costs are easier for large enterprises to bear. Aggressive enforcement adds to compliance costs with fines, penalties, and sanctions for technical violations not difficult to find because regulations are voluminous and opaque.
Since the Panic of 2008, hundreds of separate regulatory projects have been launched under Dodd-Frank. Certain risky activities were prohibited, capital requirements increased, deposit insurance premiums raised, consumer disclosures expanded, and billions of dollars of fines, penalties, and restitution extracted by government from banks.
Have banks been hobbled? No. The five largest banks in the United States are larger and control a greater percentage of all banking assets than they did in 2008. Bank profits are greater. Executive compensation is higher. JPMorgan CEO Jamie Dimon is a billionaire just for working at a bank.
In an impressive piece of regulatory jiu-jitsu, banks captured the regulatory process through lobbyists and campaign contributions and shaped regulations to their liking. The Dodd-Frank victims were not big banks but community banks that faced the regulatory burden without the benefit of too-big-to-fail status. Silent victims of Dodd-Frank were banks that never started at all, the kind of local bank formerly formed by Chamber-of-Commerce-type entrepreneurs who used their own business deposits to get the bank off the ground. Those banks are like aborted children who never saw the light of day.
The government is pleased with this resulting oligopoly. Politicians pretended to get tough on bankers, while banks played Houdini to escape shackles like a ban on derivatives. Despite this, the Treasury and Federal Reserve still hold a gun to the bankers’ heads in the form of stress tests, living wills, and resolution authority. When the Fed balance sheet hits a confidence boundary from excessive money creation, banks will be reliable buyers of last resort of new Treasury debt. Banks that don’t buy Treasuries will find their living wills being read at their own funerals.
Big business is a shared monopoly with barriers to entry for upstarts and government-subsidized profits. When upstarts like Uber emerge nonetheless, a remnant of Schumpeter’s creative destruction, new government regulations are almost immediate. Private property has its space, but only to the extent government permits, and never to the detriment of state power.
Schumpeter viewed economics through a lens of long historical trends. He considered historical processes that played out not in terms of a single business cycle, but over decades and centuries. Schumpeter clearly foresaw the end of capitalism. He wrote, “Since capitalist enterprise, by its very achievements, tends to automatize progress, we conclude that it tends to make itself superfluous—to break to pieces under the pressure of its own success. . . . The true pacemakers of socialism were not the intellectuals or agitators who preached it but the Vanderbilts, Carnegies and Rockefellers.” He presciently said that in its most advanced stages, “Capitalism, being essentially an evolutionary process, would become atrophic . . . the rate of interest would converge toward zero.” Schumpeter, writing in 1942, expected the triumph of socialism by 2000.
Socialism and fascism have shared traits. Both exalt the role of the state in directing the economy and, by extension, human action. Both expand the public sphere and diminish the civic sphere to a point where there are few truly private activities or associations. Smoking, eating, drinking, lightbulbs, toilets, health care, and more all conform to government mandates.
What distinguishes socialists from fascists is the former have historically been patient and willing to work within parliamentary processes. Socialists believe time is on their side; Schumpeter agreed. Fascists by contrast are men and women of action. They prefer orders to debate. Ends justify the means.
Another distinction between socialists and fascists is found in socialist toleration for religion and family, traditional sources of authority. Religion and family guide behavior by establishing norms and imposing limits. Fascists believe the state is the sole source of norms and authority. Fascists inevitably collide with alternate and far older family arrangements.
Fascists thrive on action and never let a crisis go to waste. Among the best crises to advance a fascist agenda are war and financial panic. The 9/11 attacks produced the Patriot Act, which opened the door to massive surveillance of American citizens without probable cause. The 2008 financial crisis produced Dodd-Frank, which institutionalized the role of six megabanks, JPMorgan, Citibank, Bank of America, Wells Fargo, Morgan Stanley, and Goldman Sachs. American savings and investments were herded into these portals, where they are controlled by government. A few more mega-asset aggregators—MetLife, Prudential, and BlackRock—are also in the government’s crosshairs. The fact that their clients’ wealth is digital makes confiscation and control for reasons of state even easier.
The next financial crisis will not be merely a bigger version of the 1998 and 2008 crises. It will be qualitatively different. It will encompass multiple asset classes on a global scale. It will exhibit inflation not seen since the 1970s, insolvency not seen since the 1930s, and exchange shutdowns not seen since 1914. State power will be summoned to contain panic. Liquidity will come from the IMF as directed by the G20, including a large voice for China. Capitalism will be discredited once and for all.
The difference between twenty-first-century neofascism and 1930s fascism is that state resources are all the greater. Democratic fascists of the Wilson-Hoover-FDR type relied on orders, experts, and government agencies with broad mandates to impose state control. Nondemocratic fascists such as Mussolini relied on black-clad thugs to gain power, then ruled as dictators once installed. History shows there is never a shortage of people willing to don black shirts, march in lockstep, and do as they are told.
Today state power is vastly more pervasive. Digital surveillance, social media, data mining, and customized content are at the fingertips of those with a fascist agenda. Selective prosecution for ill-defined crimes and selective enforcement of incomprehensible tax laws are available to silence enemies of the state. When dissent spills outside state-approved boundaries, militarized police are
waiting.
This prospect does not make a case for anarchism. The state is required, crimes must be punished, and laws must be enforced. The issue is civic space. How much space should the state occupy in daily life, and how much should be reserved for private citizens in pursuit of a former ideal of liberty? The fascist impulse is to crowd out liberty and mandate all human action. Private property is allowed but only if its use is subordinate to state designs. In the fascist utopia, comportment in civil society takes a village that plays by government rules.
Schumpeter died in 1950, but not before predicting the demise of capitalism, the rise of socialism, and the progression of socialism to fascism over a fifty-year frame. His historical method is the antithesis of the two-second attention span that plagues analysts today. Time has vindicated his dystopian dissection of the dynamic forces at play.
CHAPTER 9
BEHOLD A BLACK HORSE
False messiahs and false prophets will arise and will perform signs and wonders in order to mislead. . . . In those days . . . the sun will be darkened and the moon will not give its light. . . . But of the day and the hour no one knows. . . . You do not know when the time will come . . . whether in the evening, or at midnight, or at cockcrow, or in the morning.
Mark 13:22–35
There is a high likelihood of . . . another global crisis.
“The Geneva Report 16” (2014)
Countdown Clock
Complexity theory says we will not know the time of the next financial collapse in advance. This conclusion is not a case of throwing up one’s hands in half knowledge. It is the best science we have mixed with a dose of humility.
Complex systems in the critical state are fragile constructs with countless points of failure catalyzed by immeasurably small causes. That dynamic makes systemic failure certain. Experiments show that as complex systems grow in scale, the size of the worst possible event expands exponentially. The frequency of small-scale adverse events also increases. We simply cannot know when exactly events will occur.
Indistinctness in timing is not a failure of theory; it is the heart of the theory. Seismologists cannot precisely predict the timing of earthquakes. Then again we don’t build homes on fault lines, we take precautions. And there are warnings despite the lack of certainty on timing.
The United States Geological Survey defines “foreshocks” as “earthquakes that precede larger earthquakes in the same location.” Of course, “larger” is a relative term. A 3.0 MW earthquake can be a foreshock to a 6.0 MW earthquake that does some damage. A 6.0 MW earthquake can be a foreshock to an 8.0 MW earthquake, strong enough to level a city.
As with earthquakes, so with finance. We have had our foreshocks. In 1998, and again in 2008, the global financial system came within hours of complete collapse. For all that, financial shocks differ from earthquakes in one important way. Once an earthquake begins, it cannot be stopped. An earthquake stops itself once its energy has been released. In contrast, financial earthquakes can be stopped by government intervention. By this reckoning, 1998 and 2008 were 8.0 MW earthquakes truncated at the 6.0 MW scale. There was extensive damage both times, but the temple of finance was not leveled, and the surrounding city was soon rebuilt. But at what cost?
If the stored energy of financial instability was not released, the energy is still there. Policy intervention in 1998 and 2008, combined with added complexity in the time since, means financial energy awaiting release may have 10.0 MW potential, greater than any quake in recorded history, enough to sever California from the continent, enough to close every bank and stock exchange in the world. Importantly, a collapse of that magnitude will overwhelm the truncation capacity of already stretched central banks. The truncation task will fall to the IMF, and even it may not have enough financial capacity. SDRs, ice-nine, and martial law are three rings around the temple. Other instruments of state power may be required.
As concerns financial quakes, if timing is opaque and magnitude clear, what about fault lines? Where will the shock occur? We know where the fault line lies. It’s a financial abstraction, but it has a name. Liquidity is the fault line.
On Wednesday, October 15, 2014, an unprecedented shock occurred in the world’s most important financial venue—the market for U.S. Treasury securities. That morning, from 9:33 a.m. to 9:45 a.m. ET, in what the U.S. government later called a twelve-minute “event window,” the yield on ten-year Treasury notes shook like a seismograph in the great Sumatra earthquake. In the first six minutes of the event window, yields fell 16 basis points, from 2.02 percent to 1.86 percent. In the next six minutes, yields just as suddenly surged back to 1.99 percent, about 3 basis points from where they were when the event window started. Over the course of the entire trading session including the event window, yields experienced a 37-basis-point trading range, from 2.23 percent to 1.86 percent. The full trading day also involved a rebound; yields ended 6 basis points below where they closed the day before.
To put this move in perspective, one-day changes in yield of greater magnitude than the change that occurred on October 15, 2014, have been observed only three times in a sixteen-year period studied by the U.S. government, a total of about four thousand trading days. The first was a 43-basis-point change on October 8, 2008, when global central banks executed coordinated interest rate cuts at the height of the panic following the Lehman and AIG collapses. The second was a 47.5-basis-point change on March 18, 2009. That was the date the Federal Reserve announced an expansion of its money-printing program (“QE1”) and included Treasury notes on the list of assets purchased. The third was a 40-basis-point swing on August 9, 2011, when the U.S. credit rating was downgraded.
These intraday yield ranges, between 37 and 47.5 basis points on four occasions, compare with an average intraday yield range of 8 basis points on the approximately four thousand trading days since October 1998. (Interestingly, the degree distribution of all ten-year Treasury note intraday yield ranges since 1998 is not a normal distribution as VaR advocates expect, but a perfect power curve—exactly what complexity theory predicts.)
The rarity of the intraday 37-basis-point flash crash in yields is troubling enough. More troubling is the observation of a 16-basis-point fall in six minutes. That move is completely unprecedented. The other three comparable events took place over the course of an entire trading day, not an event window measured in minutes.
But the most disquieting aspect is that the October 15, 2014, yield crash occurred on a day when nothing else happened. There was no news that day. The crash just happened. An official joint staff report from the Treasury, Fed, SEC, and CFTC summarized the events of October 15, 2014: “For such significant volatility and a large round-trip in prices to occur in so short a time with no obvious catalyst is unprecedented in the recent history of the Treasury market.”
Flash crashes are comprehensible on days when the world is panicked (October 8, 2008), the Federal Reserve rides to the rescue (March 18, 2009), or the United States suffers a credit downgrade (August 9, 2011). Those are highly significant events. The October 15, 2014, flash crash stands alone as an earthquake that emerged unannounced from an unobservable shift of deep tectonic plates.
Other foreshocks of comparable magnitude were soon to come. On Thursday, January 15, 2015, three months to the day after the Treasury yield flash crash, the Swiss franc surged 20 percent against the euro, and a comparable amount against the dollar, in a twenty-minute event window from 9:30 a.m. to 9:50 a.m. Central European Time. In effect, there was a flash crash in the depreciating currencies, the euro and the dollar. Before the event, one euro was pegged at 1.20 francs. Within minutes, one euro was worth only one franc. Collateral damage was extensive—Swiss stocks plunged 10 percent the day the franc was revalued.
Unlike the Treasury flash crash, the Swiss franc shock was triggered by a specific event. At the open of trading that day, the Swiss National Bank announced it would abandon the €0.8325 peg t
o the franc the bank had maintained since 2012. The purpose of the peg was to cheapen the Swiss franc relative to other currencies to promote Swiss exports and tourism. The problem was that global capital continued to demand Swiss francs as a safe haven because of Switzerland’s low inflation, strong gold reserves, and political stability. In order to maintain the peg in the face of strong demand, the Swiss National Bank printed francs to buy euros, which in turn were invested in euro-denominated bank deposits and bonds. The asset side of the Swiss National Bank balance sheet became a destination for the world’s euro liabilities. The position was nonsustainable. In a single, swift move, the Swiss National Bank broke the peg and alleviated pressure to keep buying euros with printed francs.
Still, the Swiss National Bank decision was a shock. As recently as the month before revaluation, on December 18, 2014, Swiss National Bank president Thomas Jordan issued a press release saying, “The Swiss National Bank . . . reaffirms its commitment to the minimum exchange rate . . . and will continue to enforce it with the utmost determination.” Four weeks later Jordan threw in the towel.
There was nothing orderly about the revaluation process. One prominent foreign exchange market participant, Kathleen Brooks, was quoted in The Telegraph on the day of the shock as saying, “The . . . market has basically shut down so far this morning, while it waits for the dust to settle.” When the dust did settle, traders counted the cost. Banks and hedge funds that relied on the peg had lost billions of dollars.
A third foreshock followed quickly. Now the scene shifted to China. On Monday, August 10, 2015, China’s central bank, the People’s Bank of China, stunned global markets with a devaluation of the Chinese yuan against the U.S. dollar. At the start of business that day, one dollar equaled ¥6.21. After central bank intervention, the yuan instantaneously sank to ¥6.33, a 2 percent move. Carnage grew worse from there. On August 12, the Chinese currency fell to ¥6.39. By August 25, the currency had sunk to ¥6.41, a 3.2 percent decline from start to finish.
The Road to Ruin Page 29
