29 Sep 2010

Ferguson: A Crash Is Coming

Economics, Financial Economics 3 Comments

I am not kidding when I tell people the economy is like Wile E. Coyote before he looks down. (And of course I didn’t invent that great metaphor.) I truly check the financial news every morning, wondering if the dollar had crashed earlier that hour.

I was flipping through my radio yesterday and hit upon Fred Thompson reading from an op ed that summed up my views better than anything I’ve heard in a while. It turns out the author was Harvard historian Niall Ferguson. Check this out:

In imperial crises, it is not the material underpinnings of power that really matter but expectations about future power. The fiscal numbers cited above cannot erode U.S. strength on their own, but they can work to weaken a long-assumed faith in the United States’ ability to weather any crisis.

One day, a seemingly random piece of bad news — perhaps a negative report by a rating agency — will make the headlines during an otherwise quiet news cycle. Suddenly, it will be not just a few policy wonks who worry about the sustainability of U.S. fiscal policy but the public at large, not to mention investors abroad. It is this shift that is crucial: A complex adaptive system is in big trouble when its component parts lose faith in its viability.

Over the last three years, the complex system of the global economy flipped from boom to bust — all because a bunch of Americans started to default on their subprime mortgages, thereby blowing huge holes in the business models of thousands of highly leveraged financial institutions. The next phase of the current crisis may begin when the public begins to reassess the credibility of the radical monetary and fiscal steps that were taken in response.

Neither interest rates at zero nor fiscal stimulus can achieve a sustainable recovery if people in the United States and abroad collectively decide, overnight, that such measures will ultimately lead to much higher inflation rates or outright default. Bond yields can shoot up if expectations change about future government solvency, intensifying an already bad fiscal crisis by driving up the cost of interest payments on new debt. Just ask Greece.

Ask Russia, too. Fighting a losing battle in the mountains of the Hindu Kush has long been a harbinger of imperial fall. What happened 20 years ago is a reminder that empires do not in fact appear, rise, reign, decline and fall according to some recurrent and predictable life cycle. It is historians who retrospectively portray the process of imperial dissolution as slow-acting. Rather, empires behave like all complex adaptive systems. They function in apparent equilibrium for some unknowable period. And then, quite abruptly, they collapse.

Washington, you have been warned.

For those of you who are inclined to “big player” worldviews, note that the op ed is adapted from a paper Ferguson wrote in Foreign Affairs, the publication put out by the Council on Foreign Relations.

As I blogged just last night: deep doodoo.

3 Responses to “Ferguson: A Crash Is Coming”

  1. fundamentalist says:

    I don’t think Ferguson is that good of an economist. Did you see his show on PBS about the crisis? It made some good points, but overall was lame. The crisis didn’t happen because people quit paying their mortgages.

  2. K Sralla says:

    Tipping points. Are we near one?

    Let’s hope not, but my bet is with practical fellows like Peter Schiff and Jim Rogers (and Bob Murphy too), and not with the guru econometrics guys with their tidy computer models and engineering code. The latter are the same folks that told us in 2007 that housing prices would continue to go up indefinately, and that the inflated housing market was a mark of a healthy and vibrant economy.

  3. Andrew says:

    I was thinking about the main idea behind this article, that these changes are in fact sudden, and I had a thought. Now, I’m not really an “economist”, just an interested and avid reader of the subject, so forgive me if this sounds either dumb and/or obvious.

    When we finally do get that “seemingly random piece of bad news”, what are the chances that the banks unload their unprecedentedly massive excess reserves in as effort to save themselves, further precipitating the decline of the dollar?