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Market Crises Spread and Mutate Like Infectious Diseases

The latest financial headline say's it all:
"Dow closes down almost 800 points as reality of epidemic sinks in"

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Globalization means that any severe shock or crisis anywhere in an interconnected world economy inevitably infects the rest. Like viruses, financial crises mutate and evolve, returning elsewhere, later, to defeat efforts to quarantine and vaccinate against the original strain. Throughout human history, economic crises go hand in hand with war and pestilence to weaken confidence in leadership, often leading to the collapse of institutions, dynasties, and civilizations.

The current crisis of transnational capital can be traced back to the 1997 "Asia Crisis," that erupted in July with the currency collapse of the Thai Bhat. Initially identified as a problem of inadequate foreign exchange holdings and excess foreign debt, the crisis quickly turned into capital flight and collapse of that nation's fragile banking system. Within months, financial contagion mutated into cross-market failures that swept through half a dozen fast-growing "tiger" economies including Singapore, South Korea, and the Philippines.

In the months that followed, the IMF intervened with a $114 billion dollar conditional bailout package. Politicians, Wall Street funds managers and World Bank analysts announced that the pandemic, the "Asian Flu" was contained to Asia. By February, according to a Congressional Research Service summary, "The sense of crisis in Asia ebbs. Stock markets continue recovery." [https://fas.org/sgp/crs/row/crs-asia2.htm] Bill Clinton dismissed Asia's currency turmoil at the time as “a few little glitches in the road.”

That illusion was burst on October 27, when the Dow Jones Industrial Index plunged 554 points or 7.2%. Trading on the New York Stock Exchange was suspended. The stock market decline led to a drop in spending confidence, and the scuttling of Clinton Administration plans to partially privatize the Social Security Trust Fund. Other indirect effects included the collapse the following year of Russian markets and private banks (and all that followed), and the dot-com bubble blowout in 2000. True to form, the debt crisis reemerged as the housing bubble and the subprime mortgage crisis that resulted eight years later in the 2008 Wall Street Meltdown.

The real long-term victim of the Asia Crisis was Japan's "miracle economy". Already devastated by the 1991-92 crash of the Nikki stock market and housing bubbles, the dollar exchange value of the Japanese yen fell in 1997 by 50 percent. That year, Japanese real GDP growth rate nosedived, from 5% to 1.6%. The Japanese economy has never really recovered, despite three decades of injection of below-zero real interest rate funds by the Central Bank, a period of economic stagnation set in known as the Lost Score or the Lost 20 Years (失われた二十年, Ushinawareta Nijūnen).

This central bank injection of discounted funds has kept the Japanese banking sector on life support ever since. This discount funds "solution" -- below zero real interest rate lending to banks -- is the cure adopted by the Federal Reserve following the 2008 Wall Street Meltdown. It has continued as the multi-trillion dollar Treasuries for Junk Bonds swap, known as "QE2". Since the end of the formal "special facility", and particularly in the past six months, the Fed has increased its intervention in the Repo Market, the trading platform for T-bills it operates with 15 large New York and multinational banks.

These rounds of bank bailouts has now inflated history's largest pustule of "Pangloss value", an assets bubble inflated by the expectation of continued state support of markets.  This is a form of moral hazard. Moral hazard manifests as information asymmetry, that gives the party with more information about its actions or intentions an incentive to behave inappropriately from the perspective of the party with less information.  "Moral hazard" is described by Paul Kruman as "any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly." [The Return of Depression Economics and the Crisis of 2008, W.W. Norton Company Limited, (2009)] 

Along with that expectation of continued government subsidies goes the requirement for increased public debt. The U.S. is hardly alone in aggregating enormous public debt to support putatively private markets and favored corporations. All of the Asia Crisis nations were export-driven economies with government subsidies for preferred manufacturers, financed through massive debt-financed spending and a currency pegged to the U.S dollar. China also subscribes to this formula. However, in 1978 it started to pursue a seeming contradiction: State Capitalism, a communist state following an American model of private sector debt acquisition, transforming a previous population of peasants into industrial workers with flat screen TVs and the rising consumer debt burden that goes with it.

[vague-charts2] 

As in many things, China surpassed the rest of the world in the scale and growth of its engineered private debt. According to the World Bank, China's current domestic credit to the private sector banks is 161% of GDP. The 1997 crisis started in Thailand when its level was 166% of GDP.  Central bank support to drive growth of private sector  consumption and debt is symptomatic of the Pangloss value problem of cross-market contagion that was associated with government guarantees of private asset values. [See, Krugman, P., What Happened to Asia? (1998), https://web.mit.edu/krugman/www/DISINTER.html ]

High levels of total public, private and corporate debt is also commonly cited as a factor in the onset and international spread of financial crisis. The burden of sustaining debt has shifted from the U.S. to China since the 2009 Meltdown. Bear in mind the rolling brownout approach to asset bubbles in considering the below. China’s total debt has doubled since 2008 and is now 303% of GDP or over $40 trillion., now accounting for approximately 15% of the world total. [See, https://www.reuters.com/article/us-china-economy-debt/chinas-debt-tops-3... ;and related, https://www.reuters.com/article/us-china-economy-debt-idUSKCN1UD0KD] By comparison, the U.S debt to equity ratio as of Q3 2019 stood at .85. [https://fred.stlouisfed.org/series/TOTDEUSQ163N] That translates to about the same level as China's 300% of GDP. The difference, however, is that while China has been acquiring debt, the U.S. has been deleveraging, and total debt is down from the 400% pre-Meltdown level a decade ago, a substantial decline. [https://www.nwcapitalsolutions.com/project/us-deleveraging-analysis-tota...

Like Influenza or the emergent Novel Coronavirus, financial crises emerge and progress in viral fashion, changing form, hopping across continents and markets, returning as new genetic strains years, decades and even centuries later. Every now and then, they wipe out their host population and the civilizations that incubate them.

As history shows, the most complex and overextended societies that have transformed into empires dependent upon the acquisition of territory and export markets. This often entails the costs to the state of far-flung military garrisons and sustained military conflict, along with rising population density and escalating levels of economic inequality at home. These are the factors that led to the decline and fall of empires throughout history -- Imperial Rome, the Aztecs and Mayans, Venice under the Medici -- indeed, plagues and epidemics appear throughout history as precursors to social crisis and collapse of empire. [See, https://historycollection.co/20-of-historys-most-devastating-plagues-and...

Diminishing Marginal Returns and the Collapse of Complex Societies

As I wrote recently: https://caucus99percent.com/content/seeds-destruction-endangered-mytholo...

[I]n even the most modern, technological and complex society, order relies upon the essentially irrational, superstitious belief systems that justify the relative disadvantage, subjugation, and self-sacrifice of majorities on the altar of elite privilege. The more complex, technological and wealthy the society, the greater the inequalities, and as Tainter shows, the higher the marginal costs of maintaining inequality the higher the probability that society will collapse. As Tainter has demonstrated using the cases of the collapse of the Mayans and other complex civilizations, the costs of social complexity invariably increase over time so, too, do the costs of maintaining superstitions, social privileges, inequality, and social order. As will be shown below, corporate profits and property rights, must be protected by elaborate mythologies of law and economics. In 21st century America, the maintenance of those myths is becoming extremely expensive.

On a similar note, Howard Kunstler writes this week:

Are we taking this thing too seriously (some might ask)? I don’t pretend to know the answer, except, again, to point to China and think that they can’t possibly just be fooling around with all those zombified cities and shuttered factories. The next question might be: will the global economy return at some point to “normal” operating conditions, that is, the fabulously complex network of supply lines, markets, and payment arrangements as they worked up until January 2020? I am for sure not sure about that. Once a gigantic and fantastically precise mechanism breaks, I doubt it comes back together neatly and quickly. In the physical universe, the power of emergence is like the cue ball on a billiard table, and it appears that all the rest of the colored balls will be bouncing off the bumpers and sinking into pockets for a while… and eventually the global table will look a lot different.

I’ve long maintained that of all the many networked systems we depend on, banking and finance are the most fragile, the most susceptible to dangerous disorder. And, of course, that is exactly what we’re seeing in the stock markets. Trillions of dollars in notional wealth have vaporized. Over on the bond side, interest rates are crashing toward zero as loose capital desperately seeks a safe harbor. But how safe is Bond Harbor, exactly, when all the advanced nations are so deep in the borrowing hole that they can never really meet their obligations? And Gawd knows what is going on with the “innovative” financial IEDs in Derivatives Land. How can they not be blowing up with price movements of the kind that went down last week?

The Mandate of Heaven is Provisional

The Mandate of Heaven (Chinese: 天命; pinyin: Tiānmìng; Wade–Giles: T'ien-ming, literally "Heaven's will") is a Chinese political and religious doctrine used since ancient times to justify the rule of the Emperor of China. Unlike the European system of Divine Rule of Kings, the Chinese Dynastic system was not strictly caste-based and restricted to a ruling hereditary nobility. Emperors who ruled badly amidst unfortunate circumstances could be, and were, replaced from below, sometimes by leaders from quite humble backgrounds. Historically, the Chinese system of rule was a meritocracy conditioned upon legitimacy of sustained performance.  So it remains, thus far, under State Capitalism.  So it remains, thus far, under State Capitalism, a policy regime that dates only to 1978. A blink of the eye.

Some of the signs that Heaven had withdrawn its mandate from a ruling Emperor included natural disasters such as floods, droughts, famines or pandemics.

Add to that, now, the economic crisis that accompanies Coronavirus containment and quarantine efforts, destabilizing effects that most immediately theaten to undermine what has been termed the "performance legitimacy" of the Xi regime. [See, HONGXING YANG and DINGXIN ZHAO, "Performance Legitimacy, State Autonomy and China’s Economic Miracle", Journal of Contemporary China, 2015 Vol. 24, No. 91, 64–82, http://dx.doi.org/10.1080/10670564.2014.918403 ]

Key to the current ruling regime of President Xi is China's "economic miracle" and the two-fold successes of continued economic growth while the regime apparently successfully manages the threat of massive disparities in income enjoyed by urban industrial elites and millions of relatively impoverished rural agricultural workers. The main strategy that has diffused this, Yang and Zhao demonstrate, is one of reform - the creation and financing of a consumer economy within a communist state - and massive state investment in developing infrastructure to transform a large portion of these former peasants into industrial proletariat inhabiting dozens of newly constructed cities and factories that are, as Kunstler states, now silent in lockdown. As with the Japanese economy after the 1991 bubble blowout, this miracle may be fleeting, and the medicine of state subsidy of markets may end up killing the patient and the doctor, together.

The Central Committee of the Communist Party has avoided, thus far, the peasant rebellions that have historically been taken as evidence that the emperor had lost the support of Heaven. However, it is this very group of newly transplanted peasants in Central China who are now suffering the worst privations attendant to the outbreak and the lockdown of Wuhan and the rest of Hubei Province. See, "Hubei -- known for its car factories and bustling capital Wuhan -- is paying the price, with the mortality rate for coronavirus patients there 3.1%, versus 0.16% for the rest of China." [https://www.bloomberg.com/news/articles/2020-02-05/china-sacrifices-a-pr... ]

While the ritual of dynastic rule in America is less meritocratic, the basic mythology of the Mandate of Heaven operates in America according to the same Dynastic Cycle: amidst famine, war and pestilence, the peasants eventually rebel, the Dynasty is then over.
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