Saturday, July 24, 2010

The Bondsman's "Fear of Death"?

I spent the afternoon reading a fascinating paper by Shimshon Bichler and Jonathan Nitzan, Systemic Fear, Modern Finance and the Future of Capitalism (PDF file is available here). The introduction sets out the intent of their research:
The specific focus of the article is two historical ruptures of modern finance – the periods of 1929-1939 and 2000-2010. During both periods, capitalists abandoned the conventional forward-looking ritual of capitalization, resorting instead to the backward-looking posture of pre-modern finance. In our view, these rare episodes are of great importance for understanding the nature of capitalist confidence and the capitalists’ ability to rule – as well as the possibility that this system of rule will collapse. Our inquiry seeks, first, to characterize key features of these episodes; second, to speculate on their causes; and third, to assess, however speculatively, what they might imply for the future of capitalism.
While I recommend you carefully read the entire article, I want to focus on a few passages that are particularly interesting to financial market observers and pertinent to my post. First, let's begin with the takeoff:
The capitalist class is finally seeing light at the end of the tunnel. For many months now, its analysts, statisticians and public officials have been spotting “green shoots” everywhere they look. The snowballing global recession, they say, seems to have slowed down and perhaps even ended. Managers the world over are purchasing more inputs after a period of buying much less; the factories of Asian exporters are running at full steam; raw material prices have rebounded strongly; bank lending is reviving and home owners are starting to refinance their mortgages at lower rates; and in the United States, the world’s biggest producer-consumer, initial unemployment claims seem to have peaked, while consumers are beginning to loosen their purse strings. But the most important sign that the worst of the crisis is over comes from the equity market: stock prices are the ultimate barometer of capitalist health, and they have been soaring.

The market takeoff is evident in Figure 1 (above). The chart traces the U.S. dollar price of three key indices – all world equities, U.S. equities, and the equities of the U.S. FIRE sector (finance, insurance and real estate). All three indices show a sharp, synchronized rise. In slightly more than a year, from February 2009 to April 2010, the world index gained 67%, the U.S. index 62%, and the U.S. FIRE index – previously the most battered of the three – a whopping 93%.

Suddenly, the bulls are everywhere. The greatest returns are usually earned during the initial part of a rally, and no respectable fund manager likes being beaten by a rising average. With the economy apparently bottoming out and with the stock market having been in a major bear phase for nearly a decade, investors are no longer afraid of losing money; their fear now is not making enough of it. And so arises the specter of “panic buying,” a frenzied attempt to jump on the bandwagon before the really large gains are gone.

Of course, not everyone buys this rosy scenario. Many observers continue to feel that the recent stock market rally is no more than a dead-cat bounce. In the eyes of the pessimists, investors are knee-jerking to a false start. The economic recovery, they say, will be W-shaped, and the market will re-collapse before any real boom can begin. This recession, they warn, is nasty and likely to linger for years.
Bichler and Nitzan then discuss why this debate is fundamentally wrong:
Regardless of who is right, though, there is something fundamentally wrong with the debate itself. The current news may be good or bad, revealing or misleading – but, then, investors aren’t supposed to take their cue from the current news in the first place.

To trade assets on the basis of today’s statistics is to be backward looking. It is to be retrospective rather than predictive, to react rather than initiate, to trail rather than lead. It puts investors at the tail end of social dynamics.

Needless to say, such behavior is entirely improper. According to the sacred annals of modern finance, formalized a century ago by Irving Fisher (1907) and popularized during the Great Depression by Benjamin Graham and David Dodd (1934), asset prices are forward looking: “The value of a common stock,” dictate Graham and Dodd in their immortal doorstopper, “depends entirely upon what it will earn in the future” (p. 309).
The authors then explore why investors depart from this conventional forward-looking practice:
In our view, the reason is systemic fear. Systemic fear is a class of its own. It has little to do with the periodic downswings that make capitalists cautious, and it has no connection to the dread and apprehension that regularly puncture their habitual greed. “Business as usual” is always uncertain, and with capitalism constantly in flux, investors are forever fearful about profit and wary about risk: they are concerned that earnings may not rise as quickly as they hope, or that they might fall; that volatility will increase; that interest rates will rise; and so on.

But these fears, no matter how intense, are self-contained. They pertain to the level and pattern of profit, not to its existence. They do not impinge on the normality of profit – i.e., on the belief that assets have a “natural” tendency to grow and that capitalists have the power and right to enforce and appropriate such expansion. And most crucially, they reflect the belief that expected profits, whether high or low,could always be priced to their present value. Regardless of the market’s ups and downs, the underlying assumption is that the capitalization process itself – the ritual that creorders modern capitalism and anchors its dominant ideology – will remain intact.

Occasionally, though, there arises a very different and far deeper type of fear: the terrifying thought that the entity of profit – and, worse still, the very institution of capitalization on which the entire capitalist megamachine stands – might cease to exist. This latter fear is associated with systemic crisis – that is, with periods during which the very future of capitalism is put into question. It is what Hegel meant when he spoke of the bondsman’s “fear of death”:
For this consciousness [of the capitalist bound to the steering wheel of a megamachine gone wild] was not in peril and fear for this element or that [such as falling profit or rising volatility], nor for this or that moment of time [like a sharp market correction or a declaration of war], it was afraid for its entire being; it felt the fear of death, the sovereign master [the ultimate wrath of the ruled]. It has been in that experience melted to its inmost soul, has trem-bled throughout its every fibre, and all that was fixed and steadfast has quaked within it [will capitalism survive?]. (Hegel 1807: 237)
The first time capitalists were gripped by such systemic terror was during the Great Depression of the 1930s. The second time is during the present crisis, a protracted turbulence that started in the early 2000s and is still ongoing.
Looking at the current crisis, Bichler and Nitzan write:
And then there are those, like financial commentator Gideon Rachman, for whom the problem is largely temporary. The economists, Rachman suggests, have actually made great strides in understanding how the economy works. But from time to time the delicate machine gets infected by a “new type of economic virus,” and we need to be a bit patient until the economists discover the cure (Rachman 2009).

By 2010, though, it seems that the virus continues to elude the pundits. The threat of default has spread from business enterprise to sovereign governments, with countries like Iceland, Dubai, Greece and who-knows-who-is-next flirting with bankruptcy. Participants at a special conference hosted by Soros’ Institute for New Economic Thinking at Kings College, including five Nobel-winning economists, expressed grave concern that “many investors now find it hard to judge the ‘real’ riskiness of sovereign debt.” Gillian Tett conveys the atmosphere of theoretical bewilderment and ideological anxiety:
Three years ago, it seemed inconceivable that a country such as Greece would be allowed to default, or exit the eurozone. But back then it seemed equally hard to imagine that Lehman Brothers might fail. Now that Lehman has gone, who knows what the worst-case scenario might be? Could the eurozone break up? Could Greece default? What might happen to other debt-laden nations, such as the US, if the worst case scenario occurred? The one thing that is clear is that the answers to those questions now depend as much on culture and politics as on macro-economics. . . . In this new world of sovereign risk, what really matters is a set of issues that cannot be plugged into a spreadsheet. The old compass no longer works. (Tett 2010)
The predicament is so serious that even the know-all “market” – the collective brain of the capitalist class – has become disoriented. According to Martin Wolf, chief economics commentator at the Financial Times, the markets “don’t know what to fear: will it end up in deflation, default, inflation, financial shocks, or all of these?” “Markets are unpredictable,” he informs his son, “like children. . . .” And when the youngster asks “So what’s going to happen next?” the elder, who is usually able to answer questions that most people cannot even ask, replies: “If I knew that, I wouldn’t be a mere economic journalist. . . .” (Wolf 2010)
Finally, Bichler and Nitzan ask whether capitalism is heading for systemic collapse:
The decade-long breakdown of capitalization is no fluke. The fact that for ten years now capitalists have been pricing equities based on past profit betrays deep distress. Their fear now is not only that the level of capitalization may be bumping into a glass ceiling; it is also that the very ritual of capitalization – the universal crystal ball through which they have been “seeing” the future for nearly a century – may be giving them awfully wrong signals. And when the future looks bleak, and the dominant ideology appears opaque if not misleading, there arises the specter of systemic fear.

Given the foregoing, the obvious question to ask is: does systemic fear signal the imminent collapse of capitalism?
They conclude with these thoughts:
In order to see that something is systemically wrong, we need to think not positively, but negatively. Specifically, we need to look for market patterns that are inherently inconsistent with forward-looking capitalization. The manifestation of such patterns would then prove, by negation, that the ritual is broken. The specific pattern emphasized in this paper is one in which stock prices, instead of looking into the deep future, nervously trace the ups and downs of current and past earnings. This backward-looking pattern goes against the very gist of forward-looking finance. And when it emerges – as it did during the crisis of the 1930s and again in 2000 – we can be fairly certain that capitalization has broken down and that the ruling class has lost its confidence in obedience.

A shrewd academic might have leveraged this apparent anomaly into a full-blown mechanized model, complete with a universal taxonomy of “fear-of-death” eras, a sliding scale of price-profit correlations alerting investors when to switch and reswitch between forward- and backward-looking postures, and an easy-to-follow list of “how to profit” from both. And judging by what is on sale in the analysis market, this model could end up having plenty of paying followers.

We prefer to forego this investment opportunity and instead keep our speculations tentative and free. Capitalism may survive this systemic crisis, as it survived that of the 1930s. As before, this survival may require a significant transformation – one that restructures the entire architecture of power, including its material technology and dominant ideology – and such transformation is certainly possible.

But there is also a very real possibility that the current crisis will prove too much for the capitalist class to handle. “The history of all hitherto existing society,” write Marx and Engels in the opening paragraphs of the Communist Manifesto, “is the history of class struggles.” And that struggle can end “either in a revolutionary reconstitution of so-ciety at large, or in the common ruin of the contending classes (Marx and Engels 1884: 57-58).

So far, the capitalists’ loss of confidence in obedience hasn’t elicited significance opposition – but that can change quickly. However, if the opposition fails to establish an effective and hopefully progressive alternative – an alternative that so far seems absent – it is not impossible for the reverberations of the clash, amplified by the high complexity of capitalism, to culminate in systemic collapse and collective ruin.
Tomorrow, I will go over some leading indicators that are being misinterpreted and show you why I'm more optimistic that the economic recovery will continue. As for the stock market, it is in the best interest of the financial oligarchy to reflate risk assets, and inflate their way out this mounting debt problem. Debt deflation will ultimately lead to systemic collapse and "collective ruin".


Warren D. Matthei of NYU sent me these comments:

Thanks for calling our attention to this important work.

Interesting to me that a Marxist perspective is creeping into the mainstream financial press.

I am a bit surprised, however, that the authors do not cite Lenin’s seminal work-Imperialism..

You might also wish to research the collected work of I. Wallerstein re: world systems which details the spread of capitalism since the 16th century, the geography of wealth extraction and, by implication, predicts the inevitable, self-fulfilling collapse of that system.

The resolution of crises in the global system has frequently entailed widespread war and destruction…”patriotism and sacrifice”.

I am skeptical about the prospects for the massive project presently underway: an atavistic reversion towards a global American Empire built on the Roman/British model; the flaw is that it seems to entail impoverishment of the American populace, and this will undermine political stability. Manipulation of public consciousness and severe domestic political repression may or may not work. I see it as a sign of desperation.

By the way---since recent rally capitalist/financier insiders have been sellers, mostly dumping their worthless paper, directly and indirectly onto the Fed’s balance sheet.

My note: I am not a Marxist-Leninist, and never will be one. George Orwell's Animal Farm convinced me of the futility of communism as a political/economic system years ago. Having said this, what we have now is corporate welfarism, and there are no rules governing modern day capitalism. CEOs should have significant skin in the game, so when shareholders lose big, they lose a huge percentage of their net wealth (Buffett is dead right about that). And I believe in a more humane capitalism, where we take care of our weak and disenfranchised. Who is taking care of the poor, the unemployed, the disabled, the elderly, and other minorities which are vulnerable to the vagaries of Casino capitalism? Our collective attitude is "let them starve".

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