It has been raining in London every day since we got back from the United States. Not only that, the wind whips up so hard that you can barely make any headway. You’d hardly know it was May; it feels more like February.
Out in the Atlantic, the same storm played hell with the Volvo Ocean Race. They thought they had completed the hardest part of the program — the treacherous passage around the Cape Horn at the tip of Patagonia, and then up the Atlantic coast to the United States. After that, the trip from New York to Portsmouth, England, should have been a cakewalk. But when the waves rose, one sailor was washed overboard and drowned. He was pulled back on the boat, but couldn’t be revived. Another boat sank in the high seas; its crew had to abandon ship and was rescued by the boat with the dead sailor still aboard. “The weather has been absolutely atrocious,” said one of the sailors.
Remember all those dreary months when nothing happened in the financial markets? Week after week, prices barely moved, except for gold, which moved up steadily, but quietly.
And remember all those satisfied pundits, those confident investors, those self-sure economists? They thought they had figured out how to control the weather! They expected nothing but sunny skies and clear sailing.
Last week, the white caps came out in the world’s markets as well as the North Atlantic. And now, everyone is watching the skies. How bad will it get? Is it over already? How will our little bark hold up against the high seas?
Yesterday, the sun came out for a while; the seas seemed to grow calm. Gold, knocked down below $660, went up $16. The Dow dropped a bit, as did the dollar…but neither very seriously.
At 78 years old, Henry Kaufman has seen plenty of bad weather, more than many investors. Recently, he warned an audience in London that the financial world may be more dangerous than they thought. According to the Times, he expressed concern about “the extraordinary build-up of derivatives…concentrated in the hands of relatively few financial institutions.” These financial institutions are hedge funds and investment, which are manned by the smartest people in the world, or so they believe. In theory, they are hedged against disaster — one taking one position, another taking the opposite one. When the weather gets rough, some should flourish, while others sink.
But what actually happens is that the managers all come to see things in more or less the same way. They all follow the same procedures and make the same trades.
Not only are they vulnerable to tempests, they practically cause them. When the going is good, the money managers are all faced with the same incentives: to maximize performance. The youngish fund managers have little personal experience with financial storms. What’s more, it’s not their own money they are gambling with. Since they see no risk, they unfurl the spinnakers, letting every inch of canvas catch the wind. The idea is to win the race, not protect the boat.
In the natural world, a man cannot stir up the wind. He can whirl around his arms and huff and puff as much as he wants; nature will remain as indifferent as cake-pan to a lover’s quarrel. But in the financial world, if he creates enough financial pressure, he can cause a hurricane. The Hunt brothers did it, almost single-handedly, back in the silver market of the ’70s. Imagine if you had thousands of hedge-fund managers, with billions of dollars to spend, all trying to run up the same prices. Eventually, you’d get a swirl of some sort. And then, the whole system is at risk…even people who wouldn’t know a derivative from a deconstructionist.
You will recall, one of the oft-mentioned strengths of the U.S. economy, in particular, and the world financial system, in general, is that they are flexible. This is thanks to the many sharp operators managing them and the many complex, sophisticated derivatives available. In fact, the complexity of these derivatives is a liability, not an asset.
“Organizations can be viewed as a form of network in which webs of people interact,” writes Eric D. Beinhocker, in The Adaptable Corporation. “A very general phenomenon in networks, called a ‘complexity catastrophe,’ helps explain why large organizations often find it harder than small ones to adapt. Highly interdependent systems can sometimes become so complicated that they go into gridlock and change becomes impossible…As an organization’s size and complexity grow, its degrees of freedom drop.”
In other words, when the storms blow up, don’t expect hedge-fund managers to quickly sell off their high-risk positions and batten down the hatches. Who will buy them? And who will buy America’s houses at higher prices…once the real estate bubble finally bursts?
• Isn’t debt a remarkable thing? It reduces your freedom of action. A man who has a debt must service it; he must repay it. He is a slave to it until it is finally removed, written off, or paid. In the past, if he couldn’t keep up with his debt, he would be put into debtor’s prison, which even further restricted his freedom.
If you are locked in to a particular course, you don’t have the ability to maneuver when the wind blows up. A nation of people in debt is like a whole fleet that can’t change course…like the Spanish Armada, after the battle of Gravelines. It couldn’t return through the English Channel, so it was forced into the North Sea, where it washed up on Scotland’s rocks.
• If you deny that the United States is now an empire, you are as big a fool as we were. For a very long time we resisted the concept. We did not want the United States to be an empire. We thought it was a political choice. We liked the old republic of Jefferson, Washington, the U.S. Constitution…the humble nation of hard money and soft heads; we didn’t want to give it up. We thought that if the United States acted as though it were an empire it was making an error.
What morons we were. We missed the point completely. It didn’t matter what we wanted. There was no more choice in the matter than a caterpillar has a choice about whether to become a butterfly. This was an important insight for us. Until then, all of the blustering and slapstick pratfalls on stage seemed like “mistakes.” Why would the United States run such huge trade deficits, we wondered. It was obviously a bad idea, the nation was ruining itself. And why would it launch an invasion of Iraq…or begin a war on terror — both of which were almost certain to be costly blunders. It was as if the United States wanted to destroy itself — first by bankrupting its economy, and second by creating enemies all over the globe…
• Jules is back from his first year of college.
“How did you like it, Jules?” we asked.
“It was OK. Well, actually, it was horrible. No, I don’t mean it was horrible. It was just OK. I mean, I don’t think it would have been any better anywhere else. The people were OK. And some of the courses were good. Some weren’t so good. I don’t know. I didn’t really like it. But I don’t know if I’d like anything else any better.”
Jules is not sure he is going back. He has applied to some other colleges just to give himself options. But he is also considering taking a year off.
“What will you do, if you take a year off?” we asked.
“I don’t know. I probably should go out into the real world and get a job. A year of that would probably make me feel good about going back to school.”
Yesterday, we took Jules to the office with us. We got up early. Got dressed. Rushed to the subway. The train was crowded, so we shoved our way into the car, along with hundreds of other commuters, all dressed the same, all reading their newspapers. And then, we got to the office and took our positions in our little cubicles. We became one with all the thousands and millions of office workers all over London…and all over the world. We were tap, tap, tapping on our keyboards and chat, chat, chatting with our colleagues, all day long, from eight in the morning until the office grew quiet after six.
At 7 pm, we grabbed our attach cases, walked to the subway and took a train back to the South Kensington station. There were fewer people on the train, because we left work later than most office workers. But otherwise, the trip was the exact opposite of the one we had taken in the morning. Same suits. Same newspapers. Same subway stops. And so, we arrived back our little cottage…ordered a pizza (Elizabeth is still in America), and prepared for tomorrow.
“How did you like the workaday world?” we asked Jules.
“It sucks, ” Jules responded.
Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis.