Meditations On A Market Gyration

A Note About The Ponziness of Things 

Ponzi schemes seem to be everywhere. Ever since Evergrande started running in to trouble late last year we have been hearing that the entire Chinese property development sector is effectively a gigantic state-sponsored Ponzi scheme. A closer inspection seems to reveal that yes, they take the money coming into pay the money that needs to go out and there's an intricate web of credit and debt that gets created around the developer and their suppliers and it's all very complicated with shadow-banking and political intrigue and local government interference and... yet there's a simple thing going on. The newer customers are paying to cash out the older customers and by any measure, that's how a Ponzi scheme works. 

That's the part that got me thinking about a few other things that are like that. Which ever way you look at it, the crypto market - as opposed to cryptocurrencies themselves is in most part, - is a Ponzi scheme. The next coin is being financed by the next investor coming in, and the earlier holder of the currency exits with cash. The only thing that keeps it from being an outright Ponzi scheme is that you could in practice, lose money in the transaction along the way. You might be inclined to cash out at a price below what you bought in at, for whatever reason. Plenty of people are in that position. And yet, over time the value of Bitcoin has gone up and most other major cryptocurrencies have found an upward trend so it's less than even chance that people are losing money as they cash out. It even begs the question, given how much Bitcoin has gained since its inception, why the hell would you risk getting out?

This is without getting to what a cryptocurrency actually is, which is a bunch of blockchain data without any dividends or payouts. The existence of the currency is as virtual as the off-the-plan apartment that people bought from Evergrande and the other Chinese developers. It's not physically there, and let's face it, can you really use that as collateral? In a way the piece of paper you get for putting your money down to Evergrande to build you an apartment seems a lot more prudentially secure than crypto - but it's still just a piece of paper. 

Faith in Pieces of Paper

That then got me to thinking about the equities market. There's a video out there on Youtube where Peter Lynch explains that the bourse tends to gain an average of 8% a year, so if you did nothing but sit on the index you would double your investment in 8 years or so. Overall, Peter Lynch is talking about a bias towards the inflation of asset value, much like the crypto market as a whole has behaved. And that asset inflation and the way traders buy in and out of it in turn, had me thinking that the equities market as an aggregate was a giant Ponzi scheme. That is to say, it is a kind of scam that depends on the next sucker coming along and putting down a great sum of money for the same bit of paper.  

The trick is what is on the paper. If the paper has no underlying value, it's fraudulent. But value is like what meaning is with Wittgenstein, and totally 'socially-determined'. Worse still, not only does it fluctuate, it is assumed to fluctuate and that is built into its existence. Therefore - as with porn - fraud has the quality of being understood to be what it is only when one sees it. Otherwise it's a slippery slope of ideas, valuations, projections, perceptions and public opinion. You might think bank shares are solid - but that's only because they pay dividends. When is the last time you felt you truly owned a piece of the business on the basis that you owned shares? How solid do you feel partial ownership over a company that doesn't deliver dividends? How confident do you feel about the valuations of a penny-dreadful lithium mining explorer that overnight becomes worth over a dollar a share on the back of a few announcements and estimates? Do you really believe in that valuation of that piece of paper? That is to say the fraudulence of any financial instrument might all be very relative. 

The reductio ad absurdum of this is paper currency. We are all putting trust into piece of paper. It is deeply ingrained. Even the biggest goldbug who fears and hates inflation thinks the paper bills in their bank accounts stand for something. The paper currency represents a divided up bit of our faith that a sovereign government will pay up on its debts. So when we buy financial instruments like shares and bonds and derivatives and collateralised debt obligations (CDOs, read 'contract-for-dickheads'), we're exchanging our faith in the sovereign government to pay up its debts with the fluctuating promise of a payout somewhere down the line, also in the same faith sovereign government promissory notes that we happen to think are money.

But money is important: that's why we call it money. 

The Risk Management Machine

All of the above is just to say we accept money. And because we accept money we accept banks. And because we accept banks we accept bonds. And because we accept bonds, we accept a bourse that transacts the bonds and equities. And because we accept all of those things, we accept the more arcane financial products. And by extension of all these things we accept cryptocurrencies. 

And yet this sits at odds with existence of Ponzi schemes that we accept for years and years and then the draconian sentences are handed out to Ponzi-schemers. Fraud is bad - it goes without saying - but it flies in the face of our acceptance of things like Evergrande and other Chinese developers or Bernie Madoff's amazing 8% returns year after year regardless of market fluctuations. Society seems to let these things go for years on end. 

I think the regulators' collective blindness comes down to a couple of things. One is that while Ponzi/Madoff/Evergande/Chinese Developers were completely unregulated scams, they produced seemingly credible outcomes for their investors over a very long time. If the market as an aggregate was already a Ponzi scheme, any quiet Ponzi scheme operating inside of it looks legit. Even if it is robbing the big game customers and disrupting the monopoly. 

Of course, Ponzi schemes collapse because eventually it runs out of investors with money. What the legal/legitimate market does, is spread out the buying and selling over time so it meets the demands of newcomers to the market. Just when mom-and-dad investors run out of steam, the next generation meme-stonks-bros come along and become new players. The equities markets depends on the new sucker being born every minute - it just can't be every second or every hour. What the aim of the bourse is, is to create an outcome where all participants in good faith have a shot at getting some kind of roughly okay outcome over a long duration. The effect Peter Lynch doesn't arise out of nowhere - it arises out of a collective need for stability that bolsters an abstract system supported by our faith in what money is and how it is valued by everybody else. 

Should we be worried? Probably. But how the hell are we going to unravel the layers and layers of faith in paper that forms the foundation capitalism? 

 

Fiat Money Blues

The Latest From Peter Hartcher

Here's something interesting.

The economies that account for 96 per cent of the world economy are today running loose money policies. Most are happily handing out free money. Some are supplying money at rates so low that it's actually cheaper than free.

It's done for good cause. When money is cheap, people are more inclined to invest or spend. So it aids economic recovery. The former chief of the US Federal Reserve, Alan Greenspan, was named as Time magazine's person of the year in 1999 for his ready resort to loose money.

But if there is too much for too long, it ends badly. Exactly a decade later, Time named Greenspan as No. 3 on its list of "25 People to Blame for the Financial Crisis". And I think they let him off lightly.

The evidence of the past three decades should be enough, but you can go back further. In fact, every major financial crisis in the four centuries of capitalism has had its origins in loose money.

How does it work? It's simple commonsense. The basis for value is scarcity. If scarcity is destroyed, so is value. And when money loses its value, it is abused.

The problem is deleveraging out of extreme debt positions that stem from easy money, when the bubbles pop. So far what we have learned from Japan post 1989 and the US in the 2000s is that nobody who is stretched out wants to take their medicine when the debts are called in. Consequently, the assets that should be written down don't get written down. In a sense, all the asset bubbles that form are deemed to be too large to fail.

It's not as if Australia has more moral fibre in the moral hazard stakes. It's just that it is in a lucky position where the debt collector hasn't come knocking, thanks to Peter Costello's balancing the books.

What history is showing is that the only two ways of paying your way out of debt is to tighten belts or inflate away the money. In a democracy, no administration or government seems able to survive the tightening of belts unless they rise to power with that specific mandate - and even then it remains to be seen if the Tories in the UK can keep it up and retain government. So that leaves the Weimar Republic option of inflating away the debt, which hurts everybody's savings (and explains why everybody rants about gold and decries fiat money).

There is another way of course  and this is simply not to pay what you owe. The fancy version of this is Chapter 11 in the USA, but in Australia we're seeing companies like the Swish Group get away without paying creditors and re-forming themselves as essentially the same outfit that racked up the debts. Not paying your creditors is an option - which Iceland is embracing.

If we had still had the Gold Standard and the value of money was locked into Gold, then we would not have had the option to print the money, which means the fallout from the 2008 GFC would have crippled whole economies instead and the majority of us would be wandering the streets jobless wondering what the hell happened.

You can see why we keep repeating the soft option of inflating away our debts and hurting the entire population over all rather than sheet home the blame to the rich. I just don't see Lloyd Blankfein or Donald Trump hurting too much.

The World Is A Con(spiracy)

Try This On For Size

Alan Greenspan was the consummate Reaganomic Federal Reserve bank chief of our time. What if he was secretly an un-reconstructed acolyte of Ayn Rand? That's exactly what Peter Hartcher is postulating in the SMH today.

So why is Greenspan opposed, as a matter of principle, to any attempt at reform? Four possibilities come to mind. First, he is senile. But although he is 85, his statements were not the product of a wandering mind. Second, he is in the thrall of the big banks that oppose change. But while he has been taking handsome speaking fees from them in recent years, he has never been interested in money, selling his profitable Wall Street business to work at the Fed on a relative pittance.

Third, he is a blind ideologue who will not concede that any regulation could be good regulation. This is entirely possible. But he knows full well the terrible damage he inflicted on his country.

Or fourth, he is not a fool but a fox, playing a double game.

Greenspan's view is so absurd that it tempts us to wonder. In 10 days we will see the premiere of a movie of the Ayn Rand novel Atlas Shrugged. This cult 1957 novel is a warning against government intervention, a sermon on the virtues of laissez faire, and a reminder that Alan Greenspan was once a close acolyte of Rand and her Objectivist movement. Her 1966 book Capitalism: the Unknown Ideal included an essay by Greenspan on the virtue of the gold standard.

The young Greenspan advocated a return to a system where a government could only issue currency backed by a physical hard asset - gold. He wrote that "gold and economic freedom are inseparable". He derided the current system of fiat money, where a dollar is backed by nothing more than a government promise to honour its debts, as "paper reserves".

In Atlas Shrugged, the libertarian heroes smoke cigarettes branded with little gold-coloured dollar signs. It's unsubtle. The cigarette represents freedom of choice over government regulation; the dollar sign is a campaign message for economic freedom in the form of a gold standard.

It has often been observed that it was ironic that Greenspan, a leading critic of the paper money system, went on to become its chief, his signature appearing on every dollar bill.

But maybe it wasn't historical irony. What if Greenspan never did change his view, instead covertly dedicating his life to destroying the system he so despised? Could it be that he remained a secret agent of Ayn Rand all these years?

Talk about wild speculation. Long time readers would know that I've had a high opinion of Mr. Hartcher in the time I've been keeping this blog. He's always struck me as astute and level-headed to the point of boring. It's nice to see that he actually has a wildly imaginative side. This is the stuff of conspiracy theories and spy novels. We may never find out for sure, but if it's true Greenspa might have been a mole for the ideological lunar right all these years. If not true, then we have to face the other 3 possibilities - that he is senile, greedy or caught up in his old ways - none of which seem unreasonable in of themselves. That being said, it's a remarkable bit of connecting the dots. Ayn Rand to Alan Greenspan to Gold Standard vs. Fiat Money and the Fed to Cheap Credit and Low Interest Rates to Global Financial Crisis. The guy in charge was the guy trying to destroy it all. It wasn't the butler, it was the chief banker at the Federal Reserve!

It's all pretty good and makes for a gripping conspiracy theory-in-the-making. I think Mr. Hartcher missed April Fools by 4 days.

Money Blues

Greenback As Reserve Currency
Here's a cool column about money.

The all-pervasive US dollar is essentially the world's pricing marker for all leading goods, commodities and trade.

Given that, it can be argued that the world's currencies in effect derive their pricing by and large from the US dollar.

They are "de-facto derivatives" of the US dollar.

In this light, it is difficult to see how any of these currencies can usurp the underlying US dollar reserve in the foreseeable future, if at all.

Interestingly, none of the proponents are offering any notion of "sound" money as an alternative, but rather a redistribution of the current currency pie.

In effect the same game but a different split of the spoils.

But herein lies the dilemma: all the fiat currencies rest on essentially the same operating model.

An argument that the US dollar is doomed is an argument that the fiat currency model is doomed.

Instead, these non-reserve currencies are likely to face collapse first. The US dollar will be the last to go; a US dollar collapse would drag all into the abyss.

Maybe the real argument being presented by the pundits is whether imminent doom is awaiting the fiat currency system.

On this question, history is not very kind. It teaches us that all fiat currencies eventually reach their intrinsic value, zero. Some sooner than others, but the same fate awaits all.

So perhaps it is time to actually question and debate the nature of the money we currently use. One thing is for sure, the debate will eventually occur.

Yes. But it seems everybody who says fiat money is bad wants to tie currencies to something - most often gold - that you get the feeling that it's gold pundits wanting their assets to inflate in value in some proportion to the scarcity of gold.

Of course in the mean time, the Chinese are selling of US bonds.

CHINA sold $US34 billion ($38 billion) worth of US government bonds in December, raising fears that Beijing is using its financial muscle to signal that it has lost confidence in American economic policy.

Figures from December show that, following the sale, China is no longer the largest overseas holder of US treasury bonds. Beijing ended the year with $US755.4 billion worth of US government debt, compared to Japan's $US768.8 billion.

Since the subprime crisis that began in the US grew to engulf the global economy, China's leaders have repeatedly expressed concerns about US policy. December's $US34 billion sell-off made only a tiny dent in Beijing's total holdings of US assets, which amount to well in excess of $US1 trillion when stakes in American companies, as well as treasury bills, are taken into account.

But the news intensified concerns about China's appetite for bankrolling ever-widening American deficits. The Premier, Wen Jiabao, told reporters last year: ''We have made a huge amount of loans to the United States. Of course we are concerned about the safety of our assets. To be honest, I'm a little bit worried.''

When Timothy Geithner, the US treasury secretary, visited China last June, he sought to reassure his hosts. ''The US is committed to a strong and stable international financial system,'' he told them. The Obama administration fully recognises that the US has a special responsibility to play in this regard, and we fully appreciate that exercising this special responsibility begins at home.''

But Allan Meltzer, an economics professor at Carnegie Mellon University in Pittsburgh, said China's bond sales should be a wake-up call for Washington. ''The Chinese are worried that we have unsustainable debt levels, and we do not have a policy for dealing with it,'' he said.

China's sales contributed to a record drop in foreign holdings of short-term debt in December. Net overseas holdings of short-term bills fell by $US53 billion.

So doesn't this mean that China is actually not a believer in the Greenback? It's been said fr years that the day the Japanese sold their US bonds was the day a lot of this system was going to unravel. Japan for its part has held on to their US Bonds essentially to keep the whole mess going, even when it's put a big hole in its own economy to do so. The smart thing would have been to sell those bonds in the early 1990s. That would have burst quite a few bubbles around the planet along the way. By not doing so, Japan really played nice and is paying the price now.

You can see why China would want to sell out while it could... but what are they going to hold instead?