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? 

 

The Mythic Catastrophe Of Government Debt

Taro Aso's Version

Japan's government is deep in debt. Some are claiming this is catastrophic, if not today, some time soon. Taro Aso, the Finance Minister for Japan - former Prime Minster and manga aficionado - begs to differ. In fact there's a video of him explaining why, that dates back to 2010. It's interesting so I'll try and pick the eyeballs out of the little lecture.

Basically, everybody's jumping up and down about government debt. What nobody stops to consider is just to whom the government of Japan owes this money. The answer is simple, it's the people of Japan. If you have any loan book, you'll have a column for debts and column for credits. So on one side of the ledger the Japanese government is borrowing, say 100yen, and then on the other side there must be somebody correspondingly lending that 100yen.

Now, people might disagree and say they don't hold any national bonds for Japan, but actually, they do. They put their money in the bank, and the bank then has to either invest or park that money somewhere, and it turns out, they buy national bonds of the government Japan. And it all happens in Yen.

As for the Banks, they are in their essence simply money-lenders, so if they don't lend out the money deposited to them, they're not going to make money. Unfortunately nobody's borrowing in Japan. There's roughly 30Trillion Yen = AUD$300billion each year of the money, looking to be invested with nowhere to go. And if it doesn't get invested, you get deflationary pressures from the money not getting invested - so the government borrows it to stave off asset deflation.

So yes, the government has borrowed a lot, but the lenders by and large are the people of Japan. Something like 94% of bonds are held by Japanese people, and the rest by foreigners. And even those people are buying those bonds with Yen, so 100% of government debt in Japan is in Yen and no other currency. This is in stark contras to Greece, where only 30% of Greek government debt is held domestically, and it's all denominated in the Euro and not a domestic currency. Greece thus puts out 70% of its government debt to be financed by international markets, who in turn don't trust the Greek government so the going interest rate for their bonds sits at (in 2010 figures) 13%. By contrast, Japanese bonds are going for a return of 0.9% or so, which means Greek debt is going around with 13times more risk.

Even if the debt comes due, the Japanese government can simply print the Yen and pay it. If the money was owed overseas in foreign denominations, the story would be different. It's a totally different kettle of fish to Greece, according to Taro Aso.

How Much Of This Applies Here?

This is the interesting bit. How much of Australia's Government debt is issued in foreign currency? One imagines the international market version is denominated in the US Dollar, so if the AUD goes down, it gets harder to pay back the government debt. Even so, in a pinch, the Government of Australia could just print what's necessary to pay it back. If the debt is enormous, then presumably this would lead to a currency collapse, but in most part nobody's going to be calling all the debts at once, and the RBA knows exactly how much money there ought to be in the market place to the extent as to know what the currency price should be, or whether printing that money is going to usher in massive inflation or not, as the case may be.

So even if government debt in Australia were to reach, say, 100% of GDP, it's probably not going to be the same as the Greek government's debt situation. And because it is more like 20-odd% and not 100%, there probably isn't a case for making the kind of fuss the Coalition made in opposition and then during 2014 with their fateful budget. Which is all an elaborate way of saying, all this fixation about government debt that the Coalition keeps using to bludgeon the ALP is a load of bullshit.

Not only is Australia not in any kind of debt crisis as the Coalition alleged at the top of their lungs this decade, even the debt we have is not going to have the kind of dire consequences for us as private sector debt is going to have. If the Coalition government under Tony Abbott had had a shred of decency and intellectual honesty, they would have formulated policy to tackle the ballooning private sector debt instead of banging on about the government sector debt. After all, if there are savings there looking to be invested and the government doesn't utilise that money, it contributes to a deflationary pressure on assets, as per Taro Aso 's lecture.

As things stand, the Australian Dollar is stubbornly high by the RBA's estimation; money is flooding in to Australia, buying up property and commercial assets. It's hardly the picture of currency collapse. People want 'in' on the Australian economy as it is. The constant banging on about the government debt essentially exposes the Coalition as inferior economic managers, who will necessarily hurt the Australian economy through their policies that always centre around cuts. You'd certainly wonder if this government actually understood what it was dealing with when it talks about government debt. One wouldn't advocate endless stimulus packages, going deep into the red like the Japanese government has done in the last 25years (it isn't necessary), but one probably shouldn't be fretting about the debt level when there are other things to worry about like a looming economic slowdown.

Twenty-Five Years, No Recession

This leads me into this weird anomalous state of affairs, of what's been happening for twenty-five years. There is a whole generation of people walking around Australia who have never experienced a recession. Back in the 1980s, Australia spent half its time in a recession of one kind or another. There are many explanations for how this came about, one of which is the rapid expansion of the Chinese economy and our role in supplying that demand; but also the cumulative effects of the macro-economic reforms and deregulation that unleashed the massive growth in the domestic economy as well as the enormous impact of IT on productivity.

If you look at any one of these elements, we're not likely to get them again. So, if you think about the slow down and change in China's economy, the limits of deregulation, and the limits of IT-induced productivity growth, we're not likely to see the same sort of stretch going forwards. That would indicate that at some point we'll be back to the 1980s scenario of a recession every few years, and by then we'll well be wondering just how lucky we got when we had 25years of uninterrupted growth.

It really is hard to see where the next big growth engine is going to be. Some have suggested India, but India is wilfully avoiding the kind of manufacturing-&-export led growth that east Asian nations have undertaken. They've gone straight into developing a high tech sector based on computers, IT and services. This means it is unlikely to duplicate the Chinese scenario for Australian commodities exports. Both the Gillard and Abbott governments banked on housing and construction as growth engines to take over after the mining boom but it ignores that constructing buildings or infrastructure isn't a growth engine for an economy in of itself. If anything, it's a recipe for sending us back to boom and bust cycles of the 1980s.

Of course we could get lucky again and have another mining boom. It's hard to see who would fuel it, but we tend to get lucky that way - hence our self-inflicted moniker, the lucky country - but the problem remains that we don't really have a good plan for when the luck is not there. When the luck is not there, the Federal government is going to have do a lot more than run around talking about government debt; we've seen how austerity in down times simply does not work. If anything is likely to lead us to being like Greece, the obsession with cutting government debt at all costs just might be the path that leads us there.