Streetwise Professor

August 4, 2011

Look Out Below

Filed under: Economics,Financial crisis,Politics — The Professor @ 7:32 pm

I’ve been humming It’s the End of the World As We Know It for the last couple of days, and having 2008 flashbacks. Although a much attention has been on the US, the real epicenter is in Europe–though the US will not be immune, and is in poor shape to withstand the shock.

Europe is experiencing, I think, its Wile E. Coyote moment. It has been levitating over the chasm, for a lot longer than Wile E., actually. But with Italy and Spain in dire straits, and Greece, Ireland, and Portugal well-known basket cases, economic gravity is about to reassert itself.

Runs, be they on banks, currencies, countries, or romantic (but unnatural) supernational groupings, are coordination games, with multiple, self-fulfilling equilibria. The global games literature shows the role signals that agents get about the economic circumstances of the bank or currency, etc., play in sparking runs. Small changes in these signals (which are noisy representations of the fundamentals) can induce discontinuous changes in behavior by millions.

To some–like the old goat who is the Italian prime minister–the discontinuity of these changes demonstrate that “the market is wrong.” The abrupt shifts are no doubt disorienting to politicians and policy makers. But it’s not like there isn’t precedent–and it demonstrates the dangers of trying to skate by and avoid making fundamental changes that would appreciably reduce the likelihood of wandering into the run risk zone.

It may be well too late, coming as it has in a week when US government debt (the official stuff, not counting the countless zillions in government liabilities that aren’t in the calculation) breached 100 percent of GDP, but one would hope that American policymakers are taking serious notice. One would hope–but hopes like these are made to be disappointed, I fear. Europe is playing Ghost of Christmas Future. We should take heed, but probably won’t. The debt deal charade, and the hyperbolic reaction of the left to it (e.g., Rep. Doyle’s lament that the evil Tea Partiers have left the government without “any money to spend”, give or take $4 trillion) and the impending election mean that nothing serious will be done voluntarily before 2013.

Too many are taking solace in the fact that interest rates on US debt remain low–and indeed, are going lower as money flees Europe. But the European experience shows, yet again, that these things can turn on a dime. Or a trillion or two.

The aftershocks are being felt everywhere. Japan is playing beggar-thy-neighbor with its currency. Moreover, these events put a particularly interesting twist on Putin’s recent tirade before a Nashi audience about the parasitical US.

One consequence of the market shock has been a steep decline in the price of oil. Brent crude is down about $10/bbl in the last two days. A sustained economic downturn would put further pressure on the price.

Putin’s electoral strategy is to use oil rents to promise all sorts of goodies, including both guns and butter–a huge defense procurement binge and higher social spending. It is likely that this would be reversed post-election, as even with $120 oil these promises are unaffordable. Putin thought he was in fat city with turmoil in the Middle East and emerging market growth propping up the price. But now he realizes that–yet again–his grandiose plans are hostage to things outside of his control.

No doubt, like me, he is having very unpleasant flashbacks to 2008, when his dreams last came crashing to earth due to economic turmoil in the US. You know it just makes him hysterical to realize that he is at the mercy of the US. That his fate is driven largely by a country and a society he despises.

Put differently: if the US is parasitical (and there are certainly parasitical aspects to US policies, although the main host is productive Americans), then Putin and Russia are little more than parasites living on the bigger parasite. (H/T R), but I cleaned it up: check her out on Twitter for the unexpurgated version).

No, Vladimir. There will be plenty of pain to go around. You no doubt will rage at the injustice of it all. But few will listen, as they will have their own problems to deal with.

PS. I included this in the “Financial Crisis” category. I may have to add a new category to distinguish posts on the next financial crisis from the last one.

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  1. 2008 was not enough for putinoids to be thrown away from our country, probably this time they’ll follow the fate of Mubarack.

    Comment by a.russian — August 5, 2011 @ 3:06 am

  2. To be followed by theocracy.

    Comment by Sublime Oblivion — August 5, 2011 @ 2:23 pm

  3. After lots of vacillation S&P has downgraded US. Although it is somewhat academic (AAA to AA+) it is still a bold move. The markets had factored it in anyways. Nonetheless it is a very interesting development.

    Comment by Surya — August 5, 2011 @ 7:42 pm

  4. Speaking of 2008 flashbacks — will Washington soon bail out some shoddy Political crony Class staffed GSE after Kudrin unwisely invests in its triple-A rated garbage (and only starts frantically dumping the stuff a few months before the bailout upon being warned by certain Russian executives who’ve picked up the rumors during their forays in New York and Boston). Then the whole compliant U.S. media sweeps the whole thing under the rug to save both Washington and Moscow the embarassment. And a certain Government Sachs alumni former U.S. Treasury Secretary blames the whole bailout on the Kremlins conspiring with the Chinese to bring down the U.S. financial system, and doesn’t get questioned in the slightest about this weakly supported claim.

    Can’t hardly wait. Too bad no U.S. reporters actually did their jobs and y’know, pressed Paulson to back up his horse$%&* CYA. Because that might require taking on an American oligarch mafia Made Man, and American reporters don’t wanna get whacked.

    Comment by Mr. X — August 5, 2011 @ 8:38 pm

  5. Unfortunately, Our rebellious servant Vladimir has rebuilt Russia’s foreign exchange balances. Russia’s government external debt is unfortunately trivial at about 3% of GNP in dollar terms, and Russia’s financial sector’s external debt is only 75% of what it was in December 2008. The Russian government has less than $2 billion of external debt coming due throughout the remainder of 2011, and Russian banks have about $18.4 billion of external debt coming due in the same time frame. Other Russian sectors have about $28 billion falling due by the end of this year.

    Alas, We are unlikely to regain leverage on our rebellious servant Vladimir, or the country he misrules, however successful We are in so doing in the United States or in the Eurozone.

    Comment by a — August 6, 2011 @ 9:57 am

  6. As of April 2011, Russia had total (government, financial, corporate) foreign debt payments of of $110 billion scheduled in a year or less, and another $60 billion falling due in between one and two years.

    I fear Our rebellious servant Vladimir and the country he misrules is likely to be able to resist the re-imposition of Our good governance, as in the days of Our submissive servant Boris.

    Comment by a — August 6, 2011 @ 10:08 am

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