The American Black Hole of Value

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Martin Wolf, chief economist of the Financial Times is worried about the Geithner plan, he writes:

The crisis has broken the American social contract: people were free to succeed and to fail, unassisted. Now, in the name of systemic risk, bail-outs have poured staggering sums into the failed institutions that brought the economy down. (...) If this scheme works, a number of the fund managers are going to make vast returns. I fear this is going to convince ordinary Americans that their government is a racket run for the benefit of Wall Street. Now imagine what happens if, after “stress tests” of the country’s biggest banks are completed, the government concludes – surprise, surprise! – that it needs to provide more capital. How will it persuade Congress to pay up? The danger is that this scheme will, at best, achieve something not particularly important – making past loans more liquid – at the cost of making harder something that is essential – recapitalising banks.

Nobel Prize winner, Joseph Stiglitz, was blunt:

"Quite frankly, this amounts to robbery of the American people. I don't think it's going to work because I think there'll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer."

And of course that other Nobel, Krugman, blogged:

"What an awful mess."

In my opinion there was something much more important than Geithner's plan floated this week:

Are the Chinese just worried about the sagging value of the $1.4 trillion in U.S. Treasuries they hold or are they really on to something? That's the big question now that China's central banker, Zhou Xiaochuan, has called for the greenback to be jettisoned as the world's dominant currency and replaced by a new type of benchmark controlled by the International Monetary Fund. Zhou made his call in an essay that appeared on the website of People's Bank of China, China's central bank, on Monday. It was clearly timed to make a splash in the run-up to the G20 meeting that starts in London on April 2. Calling the use of the dollar as the world's benchmark currency "a rare special case in history," Zhou urged the "creative reform of the existing international monetary system towards an international reserve currency." Zhou said the reserve currency, managed by the IMF, should be "disconnected from individual nations and is able to remain stable in the long run." Talk about a vote of no confidence on the future of the U.S. economy! Washington Post

Of course the moment the US dollar ceases to be the world's reserve currency, the American economy will no longer be able to pay its debts with money it prints in its basement... The jig will up. Meatloaf will take the place of Camembert on many a formerly festive board from that day out.

Pushing aside all the epidemically anecdotal sound and fury, what has happened?

One of the world's most interesting and influential, even seminal, economists, the Peruvian, Hernando de Soto wrote the following article in the Wall Street Journal that gets right to the heart of the present situation:

Today's global crisis -- a loss on paper of more than $50 trillion in stocks, real estate, commodities and operational earnings within 15 months -- cannot be explained only by the default on a meager 7% of subprime mortgages (worth probably no more than $1 trillion) that triggered it. The real villain is the lack of trust in the paper on which they -- and all other assets -- are printed. If we don't restore trust in paper, the next default -- on credit cards or student loans -- will trigger another collapse in paper and bring the world economy to its knees.

If you think about it, everything of value we own travels on property paper. At the beginning of the decade there was about $100 trillion worth of property paper representing tangible goods such as land, buildings, and patents world-wide, and some $170 trillion representing ownership over such semiliquid assets as mortgages, stocks and bonds. Since then, however, aggressive financiers have manufactured what the Bank for International Settlements estimates to be $1 quadrillion worth of new derivatives (mortgage-backed securities, collateralized debt obligations, and credit default swaps) that have flooded the market.

These derivatives are the root of the credit crunch. Why? Unlike all other property paper, derivatives are not required by law to be recorded, continually tracked and tied to the assets they represent. Nobody knows precisely how many there are, where they are, and who is finally accountable for them. Thus, there is widespread fear that potential borrowers and recipients of capital with too many nonperforming derivatives will be unable to repay their loans. As trust in property paper breaks down it sets off a chain reaction, paralyzing credit and investment, which shrinks transactions and leads to a catastrophic drop in employment and in the value of everyone's property.

Something truly stupefying has occurred, something which has not yet been fully taken in. The United States of America, precisely at its moment of triumph and mastery, its moment of unique preeminence, has chosen to destroy the concept of value itself.

At the risk of offending Catholic readers everywhere, imagine this "parallel universe", a metaphorical, Saramago-like scenario by which I have chosen to describe through analogy the American financial sector's crisis and by extension the social crisis it brings with it:

One Sunday, all over the world, every Catholic, man woman and child, who takes Holy Communion develops a persistent diarrhea and an unsightly rash.... Health authorities discover that the pathogen causing these ailments is only found in consecrated communion wafers... unconsecrated wafers are found to be harmless, scientific tests determine that the transformation occurs precisely upon the Host's elevation and is not due to faulty storage procedures.

Priests all over the world try consecrating other forms of bread, but with the same result: anything any of them consecrates brings on the diarrhea and the rash. The diarrhea and rash are not fatal, but this universal outbreak brings into question all the sacraments of the Church, especially other vital ones of "deferred payment", such as baptism and the forgiveness of sins.

On one hand this rationally inexplicable crisis is taken as the definitive proof of a supreme being, one who actually and unmistakeably intervenes in human affairs, but on the other it also undoubtedly damages the Church's franchise as a credible representative of that being on earth.

Without a viable sacramental role, what would be the status then of the Pope? He would still have the trappings of the office, the "pope-mobile" and the stunning wardrobe, but what of his apostolic authority?

Having proven God's existence, while simultaneously demonstrating his disfavor, would this then lead to mass conversions to Islam or to Pentecostal sects?

What would be its effect on the Italian tourist industry?

The blow-back and knock-on effects of the proven or potential toxicity of the Church's most important assets, its sacraments, might be endless.

Business and the sanctity of property are and have always been America's religion.

In America's case read commercial paper and the dollar for "communion wafers" and POTUS for "Pope" and you get my drift.

America has in a sense committed suicide. Can its stomach be pumped out in time? DS