Charles Rowley's Blog

“Our inability to predict in environments subjected to the Black Swan, coupled with a general lack of the awareness of this state of affairs, means that certain professionals, while believing they are experts, are in fact not.  Based on their empirical record, they do not know more about their subject matter than the general population, but they are much better at narrating – or worse, at smoking you with complicated mathematical models.  They are also more likely to wear a tie.” Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable. Randon House, 2010

By early 2007, the housing market in the United States had peaked on the basis of dangerously highly leveraged mortgages and excessive household debt. The slide in house prices during 2007 and 2008 went largely unnoticed by economists and their associates, who had been seduced by the notion that systemic risk could not apply to the national housing market as a whole. Furthermore, those same economists and their associates remained convinced that even significant difficulties in the mortgage market would not much affect highly diversified investment portfolios in a global economy. Those economists and their friends, of course, were incorrect in forming those judgments…

The U.S. federal government, at this time, has leveraged the national debt to unusually high levels in terms of gross domestic product.  The U.S. Federal Reserve has leveraged its balance sheet to dangerously high levels on the basis of purchases of assets of unknown quality, much of which may be highly toxic.  The U. S. Federal Reserve has leveraged high-powered money to remarkably high levels by historical standards.  Economists and their associates, by and large, are complacent. Even as they see other advanced nations reining in their debt, they puff out the smoke that its international reserve status protects the U.S. dollar from precipitate collapse.

Such complacency ignores the interrelationship between confidence and reserve status.  The rest of the world holds dollars as a store of value and a medium of exchange because they respect the probity of U.S. financial institutions.  However, such probity no longer exists. The Emperor has no clothes.  The Black Swan by now may be paddling into view and shaking the U.S. economy to its very core. Let me speculate:

Let us suppose that on November 2, 2010, the House of Representatives falls into Republican hands, but not the Senate. Let us further suppose that the President does not respond by triangulation policies, but by progressive socialist defiance. Let us suppose that his hired hand, Ben Bernanke, opens up the spigots on  the monetary furnace, while the President threatens to veto all spending cuts for the remainder of his term. Let us suppose that the House buckles, rather than confront a Gingrich-style shut-down of the federal government,  and continues to fund an unsustainable budget deficit.

Now suppose that The People’s Republic of China justifiably loses its nerve, and its patience, and begins significantly to diversify its asset portfolio away from dollar holdings.  Suppose that this action triggers a contagion of dollar sell-offs throughout the global economy. Gold soars to $5,000 an ounce and upwards. Suppose that the exchange rate moves to $5 to 1 euro; then to $10 to 1 euro… Suppose then that inflationary expectations kick in as Americans increase their spending in anticipation of future price hikes…

Is this any less likely than what occurred in September 2008?  Do you trust Ben Bernanke and Timothy Geithner not to smoke you out with their unrealistic mathematical models and with their expensive ties and dark suits?  If so, is your faith based on probabilities. If so, are you not deep-down terrified of what you cannot know, or assess, in probabilistic terms?  Are you not seriously worried about the proximity of the Black Swan?

Tags: China decides to react, contagion in the dollar collapse, The black Swan and the collapse of the US dollar, the Fed gambles with the money supply, the federal government gambles with the budget deficit

This entry was posted on October 27, 2010 at 4:41 am and is filed under budget deficits, economics and public choice, economics of John Maynard Keynes, monetary policy, Personality Disorders Among Politicians, political philosophy, politicization of the Fed, progressive socialism, relevance of economic knowledge, Uncategorized, weakening of the dollar. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.