The Kaleidoscope Has Turned, Again

The business scene and its participants can be looked on as a staging contest of rival orientations, rival ambitions, rival exploitations of the world. It is capable, for all the analyst can tell ex ante facto, of realizing some one or other of these visions in some degree, and thus of presenting an appearance of momentary or temporary orderliness during the ascendancy of one orientation and its sponsors. Or the contest may be inconclusive and sterile, and result in a period of rudderless backing and filling of the sails and of untidy, blind struggle and groping for decisive policy.It will be a kaleidic society,interspersing its moments or intervals of order assurance and beauty with sudden disintegration and a cascade into a new pattern. Such an account of the politico-economic process may at various epochs or in the course of various historical ages appear less or more suggestive and illuminating. It invites the analyst to consider the society as consisting of a skein of potentiae, and to ask himself, not what will be its course,but what that course is capable of being in case of the ascendancy of this or that ambition entertained by this or that interest. The rival orientations, in the pure form of each, if it were conceivable that one or the other would be perfectly realized, would define the boundary of the possible situations, or transforms of situations, through which the society might pass in the course of a few year or a few decades. The partial or mixed success of several would lead to interior paths within this boundary, or to the temporary loss of a sense of direction. Such a loss of direction, in the economic aspect of affairs, might consist in a catastrophic slump or an uncontrollable inflation and the destruction of the currency and the society's confidence.

-G.L.S Shackle
Epistemics & Economics: A critique of economic doctrines (1991) P76

The above words written by G. L. S. Shackle, I believe, are among the most beautiful and insightful words ever written by an economist.

With these words, Shackle describes the nature of economics, of what we can and can't know about the economy, and at the same time recognizes the deceptive orderliness that we sometimes see in the market, that can quickly change.

Placing this template over the current financial crisis, we can see that few have understood what has occurred to date, and more important, few understand what the future may hold.

The current crisis  started in a curious way. The real estate market was being fueled by a huge money printing operation, years long, that convinced most that real estate could only go up in price.  This is what Shackle would consider the orderliness. There were a few, myself included, that knew this bubble would not last. But, it would be impossible to predict in advance just how and when the kaleidoscope would turn. In fact, what happened is that  it was turned twice.

The start of the financial crisis can now be pegged to the February 27, 2007 announcement that The Federal Home Loan Mortgage Corporation (Freddie Mac) would no longer buy the most risky subprime mortgages and mortgage-related securities. Prior to that announcement the real estate market was in a roaring full-fledged bull market.

One key to a roaring bull market is that more and more money needs to be added to the ballooning structure to keep it climbing. If the flow of money simply slows down, then the most leveraged who are betting on a quick return will find difficulty making that quick return. In the stock market, those seeking quick returns are exemplified by day traders, in the real estate market it is the equivalent "flippers".

The Freddie Mac announcement slowed the flow of the most risky, most aggressive money that was blowing up the real estate bubble. It was enough to prick the bubble.

To this day, few are aware of this as the start of the real estate crisis. It was a turn of the kaleidoscope that changed the dynamics of the subprime market.

The crisis would have temporarily stopped there except for another turn of the kaleidoscope. In the summer of 2008, the Fed chairman, Ben Bernanke, stopped printing money. This collapsed the remainder of the real estate market and the rest of the economy.

In the fall of 2008, we had a knee jerk reaction from the Federal Reserve to the escalating crisis, when the Reserve mutual fund "broke a buck". This resulted in the Fed adding mounds of new money to the system. The money printing did not stop until the early spring of 2009. This fueled the stock market boom which has always been in long term danger because the Fed had stopped its aggressive money printing ways in the spring of 2009 and has not yet resumed them.

This lack of money printing suggested a strong dollar and lower gold. The strong dollar appeared and the gold ascent stopped. The lack of money printing by the Fed, along with the same lack of printing by the European Central Bank, also produced another problem for the global economy, a double dip in the crisis in the form of sovereign debt problems by countries that needed monetary inflation to devalue the true cost of their debt. Without this inflation they had started a slow decent into default.

With the defaults becoming obvious, the kaleidoscope has been turned once more with news of bailout money from other EU members for the PIIGS, and the ECB pronouncing that it will enter the European bond markets to support debt prices. The Federal Reserve has also appeared on the scene with swap money.

And this is where we stand today. Rumors swirl that Germany may abandon the Euro for a new Dmark. Greeks appear ready to riot more to break the Greek government's attempt to install an austerity program. And in the U.S., various states and cities are emerging with budget strains, and the first murmurs of "Federal bailout" are being heard for some of the 50 states.

News of the money printing by the Fed (via swaps) and by the ECB (via debt support programs) is most alarming. If this money printing is not sterilized by offsetting money drains in other sectors of the economy, then serious inflation may be around the corner. The climb in the gold price is an indication that many have placed the quite solid bet that the central bank money printing will not be sterilized. The inflation scenario appears to be the most likely at this time.


However, and here is where the kaleidoscope may turn again, a strong inflation will boost the coffers of governments as their tax structures are very much tied to inflation. At such time, the Fed may again tighten for fear of a great inflation. This would reverse trends in the stock market and gold once again, pushing them downward. It is an extremely tricky and delicate time period with minor moves that could ripple through out the economy. We must keep in mind what Shackle has written. This time period, for sure,:

... invites the analyst to consider the society as consisting of a skein of potentiae, and to ask himself, not what will be its course,but what that course is capable of being in case of the ascendancy of this or that ambition entertained by this or that interest.

Indeed, with central banks, riots, banksters, politicians and the public all mixed in this brew, one move this way or that could push the economy over the edge, in this direction or that. As Shackle writes:

The partial or mixed success of several would lead to interior paths within this boundary, or to the temporary loss of a sense of direction. Such a loss of direction, in the economic aspect of affairs, might consist in a catastrophic slump or an uncontrollable inflation and the destruction of the currency and the society's confidence.

A crisis is coming, the details of how it will unravel will be provided only to the alert and nimble minded. The most likely scenario is a strong inflation with gold as king, but this is just the most likely scenario. This is not the time, though, to fall into a belief in a pseudo-orderliness of any kind, even for gold. In a free market gold would most likely emerge as the means of exchange. Gold is a great inflation hedge and everyone should own some, but there are scenarios in the current environment under which it would not perform well. Should the Germans turn the kaleidoscope by abandoning the euro and re-launching a new Dmark. The Dmark would at once become one of the strongest currencies in the world. In Europe, it would likely cause a flight by non-Germans in Europe to the Dmark, and thus in a way not only a flight from the euro but a European flight from gold.

The only thing we know with certainty is what Shackle has taught us:

It will be a kaleidic society, interspersing its moments or intervals of order assurance and beauty with sudden disintegration and a cascade into a new pattern.

Stay alert. It is going to be very tricky out there, kaleidoscopic, if you will.