The Most Colossal Policy Blunder of Our Lifetimes?
I mentioned this on Twitter just moments ago and it’s worthy of its own post so here goes:
A European apocalypse would have to be the most talked about and forecast event of all-time….
The thing about black swans though, is that they surprise you. They aren’t seen by anyone and everyone in advance.
So if this all comes crashing down on our heads now, it would be the most colossal policy blunder of our lifetimes….
If we were to allow this all to unravel in some sort of Lehman 2.0 style event I believe it would be one of the greatest policy blunders in modern times. For an event to be so broadly analyzed and critiqued to eventually result in some sort of market/economic collapse would be really unbelievable. That doesn’t mean I have faith in Europe’s leaders to do what is right, but one would hope that they now understand the urgency of the situation and the necessity to prepare for the worst. I still think the Euro crisis resolution is simple. You’re either in the Euro 100% (meaning a move towards fiscal union) or you’re out (meaning a worst case scenario of default/defection). Thus far they seem to all want to stay in the Euro and understanding of the fact that Europe is only getting smaller and more interconnected as time goes on. So the choice seems clear to me. But where’s the bold action and the leadership? And why do they insist on walking the cliff of being responsible for what could potentially become the most colossal policy blunder of our lifetimes?
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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49 Comments
Black swans don’t occur when they’ve been this broadly predicted.
Yeah, that housing market / mortgage securitization / credit default swap Black Swan in 2008 came out of nowhere. No one saw that one coming.
I’d say only for namesake. Simply because all can see the issue does not guarantee all understand it and therefor can avoid it. Yea it wouldn’t be a “black swan” but the consequence would likely be quite similar.
Some invariably would even prefer that outcome if they stand to benefit. John Paulson certainly had his day in the sun when mortgages were exposed as toxic.
I think they’re just hoping it will all fix itself. And it might take a big disaster to make them realize that isn’t going to work. So buckle up.
Come on, Cullen, you’re too astute to be asking those final two questions. “They” are not leaders of “Europe,” they are leaders of separate countries and entities with separate goals and incentives that are as much opposed as they are aligned. (Germany won’t pay without strings attached, PIGS won’t accept the strings.) Each knows “a deal” is in their best interest, but each is holding out for the best deal they can get. The danger is that they hold out too long, past the point of no return, because they cannot identify precisely where that point is. Just because the danger is known, and therefore is not a black swan, doesn’t make it less dangerous.
Taleb had some interesting comments in Business Week recently — basically that Europe is in better shape than the U.S. because a de-centralized can better manage defaults and bank failures.
Europe is being forced to address its debt and spending issues today, rather than paper over them as we are doing in the U.S.
The breakup will be difficult but a worse case would be a one-state Europe ruled by bankers with a printing press in Brussells.
hear,hear…
Agreed. Let it fail, let the foolish lenders take their foolish losses. Let the system sort itself out afterwards, everyone will be better off in the long run. Truly.
Read the papers in Italy and Germany, people don’t want to be tied to the EUR any longer. It’s the technocrats and plutocrats in power that tremble with fear when confronted with the notion that their power depends on cross-cultural collectivism. Won’t work, not in Europe, cultures are much too different to assimilate via fiscal union.
And I applaud the Italians, Greeks, and other “southern” nationals that want to leave the EUR. They’ve got dignity! How refreshing. Seriously.
Get on with it, please.
This is not a case of the market saying the system is failing. It’s a case of an incomplete system that was designed to fail because it was never completed. Sort of like a car with an incomplete engine that keeps breaking down. The response isn’t “oh, let the car die”. The correct response is “fix the car”.
Of course you are correct Cullen, but I tend to agree with Hugh Hendry on the situation:
“the problems are larger than the politicians ability to deal with them”
Respectfully, I feel you need to acknowledge that they may not be able to fix this. I believe that all the Europeans, especially Germany, want this fixed but the problems are simply too large for them to deal with.
Its fine to say that if it disintegrates it will be a colossal policy blunder. But this isn’t a simple affair like whether it will be a policy blunder in the USA to cut government spending next year. The issues involved in the Euro crisis are incredibly large and complex and I believe that despite them really trying they probably won’t be able to find sufficient common ground to fix this.
Just because we can all “see” the problems and broadly agree on what needs to happen doesn’t mean it will. Its just too hard – look at how the Euro political landscape is fragmenting rapidly and nationalism taking over. It gets harder with every passing day for them to work together and I feel you’re being very unsympathetic in saying “just fix it”…
“The issues involved in the Euro crisis are incredibly large and complex and I believe that despite them really trying they probably won’t be able to find sufficient common ground to fix this.”
Of course the problems in the US are instead easy. All those 50 millions on food stamps are in the US and not in Spain, Italy not even in Greece or Ireland. Stockton is a nice place… in Greece ? Ireland ? Italy ? Come on folks, look at your problems, try to fix them if your are good at it and let the europeans try to adjust their broken boxes.
Come on Alberto, that’s not really a fair comparison – the USA doesn’t face an existential crisis where there is a real chance that its monetary and political system shattering apart. If you truly believe the USA does, well I feel you’re focused on the wrong things…
The Euro project was a political project with very poor groundings in economics. Its been revealed as such and the problems have become so large that its doubtful the bumbling politicians (who don’t understand he economics of the monster they have created) can get their act together to find POLITICALLY VIABLE solutions…
a decentralized banking system cannot deal with banking crises as well as a centralized one. you always need a BoE, Fed, or similar
In a centralized system, if Greece fails or Lehman fails, the cascade of events bring down the entire system.
Centralized systems bring more efficiency in some ways, but are much more vulnerable to failure. Doesn’t matter if it’s economics or biology, systems are more robust when a failure in one part doesn’t bring about the death of the whole.
I am not concerned about a single EU government ruled by rapacious banksters. Their threat to the USA is minimal. What concerns me is the potential for a Napoleonic or a Hitlerian figure to arise as a future ruler of the EU Superstate. We can’t take the chance of this. The EuroZone needs to be broken up, and the USA should do everything it can behind the scenes to break it up.
The slogan from our revolutionary days was “No Taxation without Representation.” What Angela Merkel is demanding from her European counterparts is basically the same thing. If you want German money, you will have to give up sovereignty. Sounds like a very reasonable request to me.
We all want something for nothing, but that’s just not possible. Germany is NOT the obstacle here, the PIIGS and France are.
Although the benefit of the euro has been enjoyed by all at some time or another. How strong would the German economy be with a currency of a much higher value.? How many less goods would be sold at the higher prices to these “takers”?
For an extended period prior to 1914, Europe seemed repeatedly on the brink of a war many knew would be disastrous.
The crises – Agadir, Fashoda – seem over ludicrously trivial matters now. Moreover, Germany, having acquired its (huge) desired boundaries, and winning the economic war hand over fist, drove Britain into the arms of its enemies by pursuing colonies and battleships it had no real use for (the latter partly due to the Kaiser’s complexes viz his British first cousins – shades of W. and the Iraq War; these proved irrelevant in the actual conflict, while the lowly submarine could have tipped the balance if utilized all out from the start).
When a real crisis, Sarajevo occurred, the Germans, in particular, pushed for war largely with the feeling that ‘we just need to get this over with’.
Our hope has to be that the current European Zeitgeist, and the quality of its leadership. has greatly changed since those times.
Note: the culmination of the colonial land grab in Africa in the period prior to WWI illustrates that the ‘profit motive’, and ‘greed’ are not the same thing: the first term implies a degree of rationality, the second does not.
Acquiring colonies earlier on had some economic incentives (both terms are applicable to the King of Belgium turning the Congo into his personal slave plantation, with consequences that included an estimated third of the population perishing, and are continuing to play out currently).
At the close, the motivation to acquire the last native territories was simply, ‘if we don’t take it, they will’.
IMO, it’s a clear case of the Tyranny of Small Decisions/Tragedy of the Commons.
The solution requires shared sacrifice. A functional political or authoritarian system for divvying up the sacrifice doesn’t exist yet, and it needs to be created on the fly.
This is counter to a couple thousand year trend of explicit non-cooperation. I’m not sure most Europeans are culturally prepared for this.
In the mean time, Mr. Market is attempting to sort things out. And I think quite a few folks are content with that.
+1 very well articulated. A tragedy of the Commons it is!
you act as if sept 2008 was unexpected; the market then, as now, expected a federal backstop, for a long time.
This sounds like revisionist history. We all seem to forget that the market fell 40% in a 6 week period in 2008. Very few people expected that and the market crash is exhibit A. And I was 100% cash in August 08 and I will tell you that I 100% did not expect that.
Cullen, It is true that very few people expected a 40% market drop, and very few expected that the US govt would allow a huge bank like Lehman to fail. At the time I spent a lot of time on the website of Yves Smith naked capitalism. At least on that website and on big picture, very many stated that Lehman was technically insolvent and could fail. It is just that most thought the gov’t would bail it out, like they did with Bear Stearns.
The reason the unthinkable happened is that politicians believed that they didn’t have enough money to bailout both AIG and Lehman, so they thought they had to choose between the two. Obviously the politicians did not believe in MMR, so a tragedy ensued.
In the case of Europe, it is possible that an accident could happen for similar political reasons and a political unwillingness to use the power of the ECB to its full extent.
Einhorn was on Lehman in 2007. THe edifice of the entire system was crumbling all the way back then as well. It just took time. the fact of the matter is that a lot of people were watching it but suspending disbelief based on govt bailouts and central bank interventions. the same is true today, just that the EU is in the spotlight, but the market still believes that govts can and will backstop. THe “can” is always up for argument, but even if we assume that they can, the will is fully questionable with Germany in particular. many, including you and me, understand what the only courses of action are, but whether they will (and just as importantly, the time it takes for it to happen),is the point. Policy inaction and/or delayed action & the blowack is most definitely non-zero (and greatly so), which really is not what the market thinks will happen. germany hold all the cards here and will not be pushed; they are grabbing for power (which they get whether they delay or withhold)
Cullen,
Have you ever checked how much people talked about war possibility before the onset of world war I and II? Please check, and you would be surprised. And those were quite obviously much more significant and value destroing developments then possible break-up of some fiat construct.
I think it is just specifics of human nature, as Dalio rightfully mentioned in related piece. It all might look as extremely stupid, not benefitial to anybody, and easy to avoid, and yet it happens with frightening inevitability…
Cullen, in most of your posts you look at this issue from a macro perspective. but this is not a macro issue. it’s a European one. it involves countries with different mentalities, different politics, and most important different stigmas about their neighbors. the germans see the bailouts as a mechanism which takes their hard earned money and gives it to irresponsible countries that parasitically feed of germany. in this climate, it is political suicide from Merkel to back down her demands. the path of least resistance, destructive as it is, is the path of complete or partial disintegration.
In other words, economics is not history. (While CR and this site have provided my schooling in the former, I know a fair bit of the latter: my excuse for recent extensive postings – apologies if these have been excessive.)
Sometime I just don’t understand you, Cullen. You seem so wise on the one hand, yet you can’t seem to allow for possibilities that result in a negative outcome for the econmical good.
Let’s try an old saying. Have you ever heard the phrase “…cut off your nose to spite your face…”? This phrase wasn’t just made up, it was an analogy to something that happened in the distant past.
It could also be applied to Europe in regards to the Euro. Millenia of culture and heritage is on the line vs. the economical good. It is a distinct possibility that fiscal union won’t ever occur. Risk-on, risk-off; find the balance (and cross your fingers).
How does it help to let Europe fall apart?
the same way that allowing a divorce in a dysfunctional marriage can save both participants from killing each other
Even if couples counseling could make all parties in the marriage stronger than they were in the first place?
I’m for another “Summit” with tea and crumpets–
CR you put way 2 much hope and hype in government and 2 little faith in markets and business
Europe cannot operatationally collapse because of the existence of the TARGET2 payment system. The ECB is the lender of last resort whether they like it or not, and whether they openly admit it or not but it is the reality. In fact in a not so dissimilar fashion than the Fed. “The TARGET2 balances of the of euro are NCBs reflect the uneven distribution of central bank liquidity within the Eurosystem. As there can be no upper limit on the value of payment flows within a single currency area, there can be no upper limit on the TARGET2 balances of NCBs. Similarly, in the United States, there are no limits on payment flows within the currency area formed by the 12 Federal Reserve districts. Interdistrict balances emerge from such payment flows, which are not more constraining than the TARGET2 balances are in the Eurosystem.” from the ECB Monthly Bulletin Oct.2011. The truth is that we do live in an Apocalypse Bubble, http://www.alhambrapartners.com/2012/06/24/the-apocalypse-bubble/ – no point to reflate it – you guys have a good grasp of how the monetary system in the USA works – let’s try to figure the same for the EU as well before we come with end of the world scenarios. If anyone is interested in the fact that the ECB has all the tools available AND is using them please check these two links: http://www.lums.lancs.ac.uk/files/23558.pdf and http://www.cps.org.uk/files/reports/original/120622112625-TheincreasingsignificanceofTarget2.pdf
TARGET2 functions as long as the Union remains intact. If someone leaves the EuroZone, the TARGET2 system is broken. And it does not matter who leaves, the result is essentially the same. That is the Black Swan – a EuroZone exit by a State. And although the barriers to exit are high, they are still much lower than they were for the South in the pre-Civil War era.
If California leaves the US then the US are broken too. The possibility that in the next 3 years a major country leaves EZ is the same that California leaves the US. But of course because I’m european I don’t know anything about Europe and I need a lesson from you, living 6000 to 9000 thousands km away.
“But where’s the bold action and the leadership?”
Welcome to Europe CR
Yes! Thousands of politicians. Few leaders.
The Black Swan could be Germany leaving the Euro. And for everyone who says this will never happen: that’s why it’s a Black Swan!
“Thus far they seem to all WANT to stay in the Euro……….and why do they insist on walking off a cliff…..”
Uh, lots of people WANT to quit smoking.
Lots of people WANT to lose weight.
i WANT to run a marathon.
i WANT……….
The reason people don’t set out to accomplish things they WANT is because there are factors or fears or discomforts that they feel are too big to surmount. It’s pretty basic psychology. Eurozone is full of old conflicts and unresolved fears, which are what surface in a crisis, often leading to regressed behaviors more suitable to a sandbox than an international financial arena. But then again, my father always said: “War is a stupid way to settle an argument.” But that hasn’t stopped wars from happening ad nauseum….. Colossal blunders happen all the time.
As much as I’ve learned economics from Cullen, he’s a bit too optimistic about human nature in aggregate. ah well, it makes him a happier person than Zero Hedge followers…. I think I’ll continue to read him!
I want to fly – just fears or maybe the laws of physics is a problem.
Optimism – does not mean that there is no science or considered thought behind it. People have survived a lot worse than this. It always appears as though this time is special. Humans have survived for 1,000′s of years. I think there is a rational well though case for optimism.
A unified fiscal union goes against centuries of history. Not to say that can’t happen, but it sure seems like the path toward that (if even possible) would not be quick.
I know lets make all the US States fiscally controlled by the federal government. And while we are at it lets remove the right for the States to make their own laws.
This seems easy to do and is a “simple” solution.
When you do not understand something everything is a simple solution…….Your lack of understanding produces simple solutions because you do not know enough to offer more practical solutions……
The states already are fiscally controlled at the federal level. Without the federal govt’s annual grants they’d all be bankrupt.
Of course there would be massive resistance to such a plan. Currently discussed plans for EU Fiscal Union are just like you describe. There is no serious discussion of the way the USA achieved fiscal union – with a Constitutional Convention. Even then, ratification and implementation took several years. The EuroZone may not have that much time, even if its leaders were willing to call a Constitutional Convention. Any political union they come up with will be undemocratic, run by elites, authoritarian, and dystopian.
Right. Because as we all know, if you have the ability to print money then that makes everything better, even if the ability to print money changes nothing w.r.t. underlying fundamentals, e.g. assets, productive capacity, labour force, etc.
Taleb called events like Europe imploding gray swans – seen as having a large impact but known. He called them after Mandelbroit work. He also said that expected events not did not happen could also be deemed gray swans so given Europe’s predicament it is probably best described as a gray swan whether they implode or not.
Taleb is a believer in Austrian economics so he would favour decentralisation. It should be remembered that about 12 months he gave an interview on CNBC saying there would be hyper inflation in the US.
add obamacare to the list.