The Costs of Globalism--Diversify, Diversify, Diversify

The Coronavirus Exposes the True Cost of the China Price


Curtis Ellis
Breitbart News

We are now paying the true cost of the China price.

The China price is the ultimatum Walmart buyers give vendors: this is the price we will pay – if your factory in the U.S. can’t meet it, we have one in China that will, and we’ll be happy to help you move there.

The China price gave us an endless stream of cheap consumer goods. It was made possible by global supply chains, transoceanic containerized shipping, and just-in-time inventory management to control warehouse and carrying costs, all part of the logic of relentless cost-cutting Wall Street demanded of multinational corporations.

But the coronavirus has its own logic, and it does not respect the logic of Wall Street bankers, logistics managers, and mass merchandisers.  The pandemic has exposed the frailty of global supply chains and the fallacy of the management theory calling for intercontinental supply chains and just-in-time inventory management.

Quarantining more than 60 million people in over a dozen cities as a public health measure, the Chinese government has closed thousands of factories.

Going Viral

Response That Tells a Story

We posted a piece recently about the perverse effects of protecting children from being children.  It specifically focused upon what has happened in a school where "health and safety" rules were abolished in the playground.  The effects have been salutary and very positive.  The post was entitled Unintended Perverse Effects.

Once the story became public, the school principal has been inundated with requests for information and general interest.  This, as reported in Stuff:

An Auckland principal who bravely ditched the playground rulebook has been overwhelmed by the positive international response to his story.  The phone has been buzzing with calls and interview requests from around the world for Swanson Primary School principal Bruce McLachlan.  "It's been a busy week, I didn't expect it. It's the reaction against the cotton-woolling of kids, helicopter parenting and nanny states."

It's gone viral--showing that there is unease at the grassroots over the state's nannying propensities in the vain attempt to protect people from themselves and to make the world one without risk, threat, or injury.

Ash Clouds and Risk

 To God, or to Government We Entrust . . .

Risk is unavoidable.  Life is filled with the uncertain and the contingent.  A society's approach to risk and risk-taking peels back the skin, exposing its heart and the gods that dwell therein.

Consider this contrast.  In Europe, Icelandic volcano ash results in governmental authorities shutting down air-ports and terminating air travel.  In New Zealand and Australia, Argentinian volcano ash results in (some) airlines continuing to fly.  Why the difference? 

Prudence and Risk Awareness Go Together

Risk Reduction Leads to Speculative Booms

Capital markets, like all markets, are bi-polar. Periodically they go through a boom/bust phase. If this is unpalatable, the only other option is state control (ownership) of capital and labour. This was tried in the Soviet Union where it resulted in distortions and shortages for nigh on seventy-five years--all of which was blamed on serial and relentlessly bad weather.

Surely there has got to be a middle way, someone will opine. Surely if you keep capital in private hands (that is, out of government control) but regulate the worst excesses of private capital markets, keeping those markets on an even keel, so to speak, or within the railway tracks, the train of unending growing prosperity can ride off into the sunset in perpetuity. Boom and bust will no longer apply.

This sort of solution of regulation, controls, maintaining moderation, keeping the system working within reasonable bounds--all of this may work reasonably well when it comes to transport systems, which explains why the railway analogy is appealing. But the analogy breaks down when applied to capital markets.

A capital market is an exchange of capital where folk, who have some surplus money, supply it (at a cost) to those who need it. A market is, by definition, a decentralised decision making institution. Markets, in order to get transactions taking place, must be implicitly free, because value, worth, needs, goals, aspirations and ambitions vary amongst human beings. What is sauce to the goose is not necessarily sauce to the gander. One person may choose to invest his surplus capital in electricity producing windmills because that it highly valued by him. Others may choose to invest in Vegemite because it pays a regular dividend. Different strokes for different folks.

But all participants in capital markets tend to have one common concern: they implicitly measure the risk of their capital being wasted or destroyed. Implicitly providers of capital are reckoning up the likelihood that the return they are wanting would not transpire, were they to entrust their spare capital to a bank, or a windmill company, or a food conglomerate, or whatever. The vast majority of capital investors seek a monetary return on their capital. They want their original capital returned, plus some gain.

When does the boom occur? Booms always occur when perceptions of risk become cloudy. Simply put, when people believe they are investing in a "sure thing" they will be comfortable with investing. Booms occur when it is believed that not only is an investment a virtual guaranteed gain, but that the gain will be substantial and quick. When you see around you friends and acquaintances, colleagues and business rivals enjoying these gains--when everyone is doing it--the boom is on. It is not just that the potential returns have to be seen as substantial, but that they have to be understood as virtually certain. No doubts. No worries.

Here is where regulations and rules can indirectly cause booms. Instead of preventing booms and busts more often than not regulations and government controls cause them. Why? Because regulations are supposed to reduce risk. They implicitly are supposed to make returns more certain. A recent article in Foreign Policy magazine provides a telling picture of how regulation and inappropriate governmental interference actually indirectly caused the collapse of 2008. The author, Paul Seabright argues that we face a paradox in the matter of capital market regulation: the more clever the regulation, the more likely it will distort markets, and the bigger the collapse will be.

There are important lessons to be learned from the crisis. But we'll learn them better if we realize that the intellectual and political architects of the system that failed us were not naive at all, but immensely clever and subtle; it was their cleverness and subtlety that undid them. And that is bad news for all of us, for naivete can give way to learning, but cleverness has no obvious higher state.

The more people believe that central banks can control bubbles and deflate them before bursting, the more a truly destructive collapse will happen. Why? Because providers of capital think that the authorities have effectively removed risk from the investing equation. Therefore they are prepared to take huge risks, telling themselves the risks do not really exist.

In effect, the second and third lines of defense came down to this: trusting the other to do more of the work than either was prepared to shoulder. The better the central bankers performed, the more everyone else was content to rely on them to sort out the obvious tensions in the system, such as the fact that real U.S. housing prices rose nearly 150 percent from 1995 to 2006. Everyone knew it couldn't go on forever, but if Greenspan had taken care of the crises of 1987, 1991, 1998, and 2000, surely he would be on hand if there were a crisis this time. Not everyone agreed there was a bubble, but the danger lay not with those who didn't believe in bubbles. It lay instead with those who thought there might be a bubble but that we could handle it.

Here is the paradox: the more a financial system is engineered and regulated to reduce risk, the more likely systemic risk will break out causing a collapse of the system. The less regulation, the more risk is controlled and booms less likely to occur.

Banking creates the illusion -- the necessary illusion -- that there exist islands of stability in a sea of risk. Depositors who settle payments with a check need not worry -- most of the time -- whether a check drawn on one bank is worth the same as a check in the same nominal amount drawn on another. As the economist Gary Gorton has put it, banking does for the nonexpert in finance what the electricity grid does for the nonexpert in electricity: allowing one to use the system and benefit from its technical sophistication as reliably as the expert can. How? By enabling most who ultimately bear the risk not to have to worry about it on a day-to-day basis.

But as we discovered once the crisis broke, it was not just nonexperts who had stopped worrying about risk on a day-to-day basis. Most professional investors had also gotten into the habit of not worrying about it either, including those who had money invested in the repo markets and other parts of the vast shadow banking system. Before we rail against their stupidity, we should remember that not worrying about risk is precisely what a modern banking system enables its customers to do. That the lack of worrying had gone too far is now undeniable, but it happened precisely because of how impressively the modern banking system works when it is working well.

There is one egregious component in the most recent debacle, however. Governments stepped in as the liquifier of last resort: the cost of capital loss was cast forth upon future generations. This left most of us solvent. In terms of behavioural economics, this sets us up for a much bigger collapse to come--because, once again, the regulators have prevented loss; they have reduced our risks. The moral hazard mounts.

Reaffirming the need to take responsibility will require not just that individuals who are exposed to risk should realize that fact and act on it, but also that individuals who create risk bear more of the consequences. The fact that creditors have borne so little of the cost of recapitalizing failing banks is one of the great scandals of modern times. It is a scandal due to panic and not only to capture by special interests -- policymakers bailing out creditors were rightly terrified of the consequences if the bailouts failed -- but it is no less unacceptable for that. This massive bailout of imprudent creditors will matter for many reasons, not least of which is that crises will recur in the future and we shall need to anticipate how to manage the bailouts that will be needed when they do.

A risk-aware market is a prudent market. In capital markets there is a lot to be said for "caveat emptor". If it fails, you are on your own. Rules and regulations should focus upon honesty, integrity, and disclosure and not on ensuring safety. Risk-reducing regulations and bail outs perversely create far more systemic risk over the long term.

Booms and Busts Inevitable

Economics Always A Dismal Science

To the secular humanist, chaos or randomness is evil. This, despite the fact that the faith of the secular humanist asserts that chance is the fundamental reality of everything there that exists. The modern world wants to control, to plan, to rule, to regulate. Especially this shows up in matters economic and financial. It frustrates and offends--even as one is offended at blasphemy--that the government cannot control and adequately regulate the market.

Yet economics remains to this day the "dismal science" and this will always be the case. Alex J. Pollock explains why.

Is Economics a Science?

By Alex J. Pollock Saturday, November 6, 2010


It would be, if it weren’t for the people.

Economics aspires to be a science. But in this it does not succeed. Neither does finance. This despite the fact that there is an annual, optimistically named Nobel Prize in “Economic Sciences.”

Financial crises keep happening—the list is long. Could they be avoided if economics and finance were science? To paraphrase financial observer James Grant: science is progressive, but finance is cyclical.

But why should this be? Do we not learn from experience? Does economic knowledge not increase? And how about having computers, vast amounts of data and information, and new mathematical models to guide lending and investing decisions?

Do we not learn from experience? Does economic knowledge not increase?

The former CEO of Household International, first bought by HSBC and then brought low by the subprime mortgage collapse, is said to have bragged that his operation had 150 PhDs to model credit risk. The idea that improved knowledge will keep us out of trouble is not new. “[Benjamin] Disraeli had asserted that the boom of 1825 would not turn to bust because the period was distinguished from previous ages by superior commercial knowledge,” wrote Edward Chancellor in Devil Take the Hindmost: A History of Financial Speculation, but there was a big bust anyway.

Our 21st-century housing bubble, now deflated, was inflated despite—indeed partially because of—amazing computer power, reams of data, and sophisticated models operated by exceptionally bright analysts informed by Nobel Prize-winning financial theories. These computerized models created a sense of security, just as did the “superior commercial knowledge” of 1825.

As the great investment guru, Benjamin Graham, wrote in his classic, The Intelligent Investor:

The concept of future prospects . . . invites the application of formulas out of higher mathematics to establish the present value of the favored issues. But the combination of precise formulas with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wishes . . . Mathematics is ordinarily considered as producing precise and dependable results: but in the stock market [or in the subprime mortgage-backed securities market] the more elaborate and abstruse the mathematics, the more uncertain and speculative are the conclusions.

Models and Recursiveness

Consider Moore’s Law of Finance, as I call it (after my bond-market friend Mike Moore): “The model works until it doesn’t.” Perversely, the more everyone believes the model, and the more everyone uses the same model, the more likely it is to induce changes in the market that make it cease to work.

Our 21st-century housing bubble, now deflated, was inflated despite—indeed partially because of—amazing computer power, reams of data, and sophisticated models.

In this cycle, the market and the regulators became enamored of the statistical treatments of risk, whereas the most important issue is always the human sources of risk. These human sources include short memories and the inclination to convince ourselves that we are experiencing “innovation” and “creativity,” when all that is happening is a lowering of credit standards by new names.

For example, with the spread of “stated income” loans during the housing bubble, the disastrous previous experiences with “no doc” and “low doc” loans seem to have been forgotten. Such loans are a notable temptation, or even invitation, to a little lying in order to facilitate the dream of buying a house whose price will always keep rising.

Human elements of risk also include optimism, gullibility, short-term focus, genuine belief in momentum or the extrapolation of so-far successful speculation, group psychology or the lemming effect, and, inevitably, fraud.

We should not be surprised that as optimism increases, so does credulity. The father of central banking theory, Walter Bagehot, observed: “The good times of too high price almost always engender much fraud. All people are most credulous when they are most happy . . . Almost everything will be believed for a little while.”

In this cycle, the market and the regulators became enamored of the statistical treatments of risk, whereas the most important issue is always the human sources of risk.

The subprime boom and bust cannot be discussed without considering securitization of subprime pools through tranched, senior-subordinated structures based on mathematical models. The lower tranches of subprime mortgage-backed securities were extremely highly leveraged to credit risk. They were often gathered into collateralized debt obligations and further tranched, thus creating securities hyper-leveraged to credit risk.

Some of these tranches went to buyers who were greatly surprised by the vast losses. This must put us in mind of Stanton’s Law (name after Tom Stanton, author of A State of Risk): “Risk migrates to the hands least competent to manage it.” This is because the more competent can manage their risk by passing it to the less competent.

But there is another possibility: “When genius fails,” (the title of a book about the failure of long-term capital management) the extremely clever may believe too much in their own models and cleverness, then find out they had much more risk and much less science than they thought—and so the fall of famous Wall Street firms. As Bagehot also said, “Every great crisis reveals the excessive speculations of many houses which no one before suspected.”

Belief—For Example, Belief in House Prices

In the bubble, according to the Case-Shiller national house price index, U.S. average house prices increased by an enormous 90 percent from early 2000 to the peak in mid-2006. Then they fell more than 30 percent from the peak, back to about the level of 2003.

Perversely, the more everyone believes the model, and the more everyone uses the same model, the more likely it is to induce changes in the market that make it cease to work.

We are now almost four years into the housing bubble’s deflation. National average house prices have gotten about back to their longer-term trend line. As gravity pulls a thrown object back down, house prices are coming back to their trend.

Indeed, how could anybody believe that the prices of houses do not go both up and down? For that matter, how could anybody believe that the price of anything could not go down as well as up? That is the nature of a price.

Risk and Uncertainty

To forecast and, moreover, control the financial future correctly is literally impossible. This is because of the exceptionally complex and very rapid recursiveness of financial markets and the resultant Uncertainty. This “Uncertainty,” with a capital “U,” means, remembering the classic definition of economist Frank Knight, that you not only do not know the odds of events, but you cannot know the odds.


It is in vain to think that an official “systemic risk regulator” like the “Financial Stability Oversight Council” anointed by the Dodd-Frank Act or anybody else can or could foresee all future financial problems or prevent all future bubbles and busts. Everybody, no matter how intelligent and diligent, no matter how many economists and computers are employed, makes mistakes when it comes to predicting (let alone controlling!) the future.

Because uncertainty is fundamental, sometimes disastrous mistakes will continue to be made by entrepreneurs, bankers, borrowers, central bankers, government agencies, politicians, and by the interaction of all of the above.

Knight wrote: “If the law of change is known, no [economic] profits can arise.” Likewise: “If the law of change is known, no financial crises can arise.” But in economics and finance, the law of change is never known. So change reflecting uncertainty goes on, bringing booms and busts periodically, and Adam Smith’s “progress of opulence” on the trend.

Economics and finance might be science, if it weren’t for people.

Alex J. Pollock is a resident fellow at the American Enterprise Institute. Previously he spent 35 years in banking, including 12 years as president and chief executive officer of the Federal Home Loan Bank of Chicago.
FURTHER READING: Pollock recently completed Boom and Bust, an introduction to financial cycles and human prosperity. He also explained “Error vs. Fraud” in the banking industry and how “It’s Easier to Be Brilliant than Right.” He discussed “TARP and Leviathan,” outlined “The Future of Housing Finance,” says Fannie Mae and Freddie Mac create “A Nightmare on Every Street,” and dives into “Comparing International Housing Finance Systems.” (Links to all these found in the original article, published in The American)