We are in a worse situation than The Great Depression
Barry Ritholtz linked to a video of Paul Solomon of the PBS News Hour interviewing with Dr. Nassim Nicholas Taleb, famous economist and author of The Black Swan : The Impact of the Highly Improbable” and Taleb’s mentor, French mathematician, Dr. Benoit Mandelbrot, Professor Emeritus of Mathematics at Yale University. Dr. Mandelbrot, a pioneer in the development of chaos theory, is regarded as the father of fractal geometry. Both say that the present economic situation is actually more serious than the Great Depression. In fact, they fear the U.S. is in the worst situation it has been in since the American Revolution.
The reason, Dr. Taleb explained, is that “Never in the history of the world have we faced so much complexity combined with so much incompetence in understanding its properties.”
Both men agree that the attempts thus far to resolve the crises are actually making matters worse. Dr. Taleb explained that “the ecology of the banking system” is being “over-optimized” because of an incompetent belief that it is more optimal to save one giant banking firm, rather than ten smaller ones.
Dr. Taleb said that the past two weeks, the financial crises have begun to disturb his sleep. He wakes in the middle of the night fearing what might happen next.
Groundbreaking economist, Herman Daly, zeroes in on the root cause of our financial meltdown:
The turmoil affecting the world economy unleashed by the US sub-prime debt crisis isn’t really a crisis of “liquidity” as it is often called. A liquidity crisis would imply that the economy was in trouble because businesses could no longer obtain credit and loans to finance their investments. In fact, the crisis is the result of the overgrowth of financial assets relative to growth of real wealth— basically the opposite of too little liquidity. We need to take a step back and explore some of the fundamentals that growth-obsessed economists and commentators tend to neglect.
After winning the Nobel Prize for chemistry, Frederick Soddy decided he could do greater good for humanity by turning his talents to economics, a field he felt lacked a connection to biophysical reality. In his 1926 book Wealth, Virtual Wealth and Debt: The Solution of the Economic Paradox, (a book that presaged the market crash of 1929), Soddy pointed out the fundamental difference between real wealth – buildings, machinery, oil, pigs – and virtual wealth, in the form of money and debt.
Soddy wrote that real wealth was subject to the inescapable entropy law of thermodynamics and would rot, rust, or wear out with age, while money and debt – as accounting devices invented by humans – were subject only to the laws of mathematics.
Rather than decaying, virtual wealth, in the form of debt, compounding at the rate of interest, actually grows without bounds.
Now it is clear that the Fed and the Treasury have lost the game. If a depression is to be avoided, it will have to be the work of other arms of the government, with other tools and powers.
The failure to contain the crisis will ultimately be traced, I think, to excessive concern with the first two subsidiary objectives: reining in Wall Street princes and keeping economic decision-making private.
Because it tried to keep the private sector private, it sought to avoid partial or full nationalization of the components of the banking system deemed too big to fail. In retrospect, the Treasury should have identified all such entities and started buying common stock in them - whether they liked it or not - until the crisis passed.
I would disagree about being overly concerned about Wall Street profiting from the bailout, but you can go read DeLong’s argument for yourself. Interestingly, DeLong’s article first appeared in The Guatamala Times.
Consumer purchases collapse two quarters in a row
Chairman of Morgan Stanley Asia, economist Stephen S. Roach writes on the New York Times editorial page:
It’s game over for the American consumer. Inflation-adjusted personal consumption expenditures are on track for rare back-to-back quarterly declines in the second half of 2008 at a 3.5 percent average annual rate. There are only four other instances since 1950 when real consumer demand has fallen for two quarters in a row. This is the first occasion when declines in both quarters will have exceeded 3 percent. The current consumption plunge is without precedent in the modern era.
Worse, millions of homeowners used their residences as collateral to take out home equity loans. According to Federal Reserve calculations, net equity extractions from United States homes rose from about 3 percent of disposable personal income in 2000 to nearly 9 percent in 2006. This newfound source of purchasing power was a key prop to the American consumption binge.
As a result, household debt hit a record 133 percent of disposable personal income by the end of 2007 — an enormous leap from average debt loads of 90 percent just a decade earlier.
”When they forgot the nuts and bolts, everyone got screwed”
Today’s ”When they forgot the nuts and bolts, everyone got screwed” award goes to Joseph Nocera for a short New York Times profile of the only remaining independent U.S. tractor-truck maker, Navistar
The company’s chief executive, Dan C. Ustian, had just returned from Washington, where he had attended a big executive conference held by The Wall Street Journal.
No sooner had he shaken my hand than he launched into a passionate speech about the failure of the banking industry to do what it was supposed to be doing to help get us out of this crisis.
“It appears that money is being loaned by the government to the banks at a very attractive rate, and that money is not getting down to consumers or businesses,” he said. “We have had 2,500 bankruptcies in our industry in a nine-month period. You can’t believe how many of those trucking companies have been in business a long time, and they’re profitable, but they can’t get working capital. And when they can get it, they have to pay an arm and a leg. Some of the midsized customers we do business with are paying 14 and 15 percent for money, with a lot of onerous covenants. So that is what is happening to our customers.”