I wrote this a couple years ago...
The Break, When it Comes, Will Come Swiftly
2pm. The sun is still high in the sky, only recently having begun its slow drift towards the horizon. The heat and the humidity hang there like a blanket, seeming to hold the gray smoke that now drifts with a slow interminableness along the open fields. The cannonading just finished, seeming to go on forever, has been the most amazing thing. So many guns. So much thunder. So much fire and smoke. Men on both sides marveled at it, knowing surely it was a prelude to something momentous.
Just east of Seminary Ridge, down in Spangler’s Woods, there is an awful, unspoken anticipation among the men lying in the shade of the trees, their stomachs empty because they had no appetite for lunch. Even for an army proud of spirit, one now long-used to victory and with an unflagging belief in their commander, this thing seems an impossibility. Peering out across the vast expanse of open ground – nearly a mile – they are gripped by thoughts of how this thing must unfold. They cannot escape wondering of their own mortality. Those who have caught a glance of Longstreet’s countenance cannot have been heartened.
And then come the orders. The men stand quickly to arms, forming up in their regimental lines. Standing shoulder to shoulder with their brothers and neighbors and friends, their bowels churning. And suddenly they want to just be on with it. To get it over with.
And so begins the long, terrible march. My great grandfather is among them.
A hundred and forty-eight years later, we all know how it turned out, of course. An unmitigated military disaster for the South, Pickett’s Charge gave proof that even the most exalted of generals sooner or later make a mistake. They fall victim to their own hubris. They are consumed once too often by their own confirmation bias.
With the benefit of hindsight, it is obvious to even the very least of military captains that Longstreet’s plaintive beseechment to Lee that “no fifteen thousand men ever arrayed for battle could take that position…” was utterly correct.
How was it then that Lee could have been so blind? How could he fail to see a picture so utterly clear, one without even a hint of mystery or obfuscation?
Sometimes you just shake your head.
Indeed. And so it is, yet again. Markets turn on one thing more than any other… confidence. The confidence which comes from a tomorrow that unfolds in a predictable arc, based at least loosely upon what happened today. The days turn into weeks. And the weeks into months. And the months into years. And after awhile there it is – the willful certainty of what the future holds. We pretend we don’t know. We tell others that we harbor no such belief, that we are as open to whatever the future might bring as is an eight-week-old puppy. But in our heart of hearts, where the truth lives, the certainty holds its candle up high. It is the monument upon which our hubris is built.
In something much less than a hundred and forty-eight years, people will look back upon us in wonder. They’ll look at the landscape that lay before us, like we today do of that long-ago field in Pennsylvania, and shake their heads.
They’ll see the 1960’s and an American economic goliath attempt – unsuccessfully – to fund both a long, drawn out foreign war and a vast expansion of social programs at home.
They’ll see the 1970’s and the object lesson that came from that attempt. They’ll see, notwithstanding the savaged economy that was part of that lesson, an increasing belief that economics had been mastered. They’ll see the removal of the last vestiges of a gold standard.
They’ll see the 1980’s and the start of something strange called supply side economics. They’ll see, written in the numbers, the first bump in the graph, the first bit of intellectual snobbery, the notion that debt doesn’t matter.
They’ll see the 1990’s and the beginning of two decades of economic malaise that would grip the world’s second most powerful economy. They’ll see the rise of activism by central banks, an accelerating belief that economies can be engineered, that recessions no longer need be part of the picture. They’ll see the curious transformation of a central banker from geek… to rock star.
At the dawn of the millennium, they’ll see it all pick up steam. They’ll see the advances in communications and technology which suddenly ushered in a multi-generational labor arbitrage. They’ll see free money and a flood of liquidity and the sudden strangeness of home values rising faster than wage rates. They’ll see the odd, incestuous business model via which rating agencies make money. They’ll see the unfettered explosion of unregulated derivatives, synthetic vehicles whose notional values dwarf the world’s real economies – yet which remain an opaque maze. They’ll see leverage, everywhere, on a breathtaking scale. They’ll see the loosening of regulations which allow banks to do pretty much anything they want.
More than anything else, they’ll see debt. Debt everywhere. They’ll see whole peoples, entire societies, who for two generations had lived beyond their means. Who consumed more than they produced.
They’ll see the Euro and instantly see the flaws in its concept. How it could not endure.
They’ll see the demographic tsunami that approached.
And then they’ll see the first cracks, the first fissures in the firmament: Iceland, Greece, Ireland, Portugal, Spain. They’ll see the rating agencies, newly chastened, floating sovereign ratings towards junk.
They’ll see broke states and broke municipalities.
They’ll see the largest bond fund in the world dump Treasuries.
They’ll see commodities reach generational highs.
From the periphery, they’ll turn their gaze towards the center, to the major economies of the world – and find it even worse. They’ll look around for a bastion of sanity in the developed world – a single society that did not choose recklessness, one economy that was managed with prudence and care – and not find one. They’ll look for the outrage and the opprobrium that ought to attend that fact, and find it scant.
In the end, they’ll look at the numbers. The simple math behind it all. The inexorable truth that lay before seven billion people, ignored.
And from that, more than anything else, they’ll shake their head.
The history will be clear to them. The break, when it came, was sudden and swift. Like an earthen dam crumbling away in a flood, inevitability made manifest.
It will be so obvious to them. What they’ll wonder is how it could possibly have not been so utterly obvious to all of us.
And there will be no answer.
Back to the present... I wrote that to summarize what most concerned me then, and concerns me now, about our economic environment - the debt that surrounds us. Debt that grows ever larger every day.
I think "unprecedented" is an accurate label for this thread. For although it is true that every time and every place and every people have had their economic challenges, their crisis's to be surmounted, it is equally true that those crisis's were mostly country or region specific. Japan has been in a depression for 20 years now. But it had the great benefit of enduring that time while the rest of the world has, for the most part, been carrying merrily along. That has served to substantially mitigate how difficult Japan's situation might otherwise have been. If you have to have a depression, it is certainly better to have one when all your trading partners are still there to buy your stuff.
The 1930's (actually, it's more accurate economically to speak of the entire inter-war period, from 1918 to 1939), in contrast, was one of the few examples of how things work when everyone walks towards the cliff together. That didn't end well.
It gets even more complicated when you consider that economic contraction and credit destruction - outcomes one might expect as the inevitable endgame in a debt-besotted society - are fundamentally deflationary. Whereas monetary stimulus and debt monetization - events already long underway in the sovereign sphere - are fundamentally inflationary.
Fire or ice. Which do you choose?
I don't have an answer. What I do know is that stocks have periodically sucked for long periods of time. The DOW took 27 years to get back to par, after crashing in 1929. The Nikkei peaked at over 39,000 in 1989. This morning, as I write this, it is at 10,900 and change.
Sovereign bonds have long been viewed as bastions of safety. But "Greece" is coming to nearly all of us. I commend This Time is Different
by Reinhart and Rogoff as an important treatise that, perhaps, shines a light on what lies in front of us.
Munis have long been seen as advantageous in a portfolio. Beyond their innate returns, their tax benefits are a strong draw in non-tax-advantaged accounts. Alas, they are a minefield. Stockton, San Bernardino, Scranton, North Las Vegas, and other towns and cities are but the tip of the iceberg. Whether by two generations of over-generous pension promises that are today underfunded, or simply by fiscal mismanagement, many municipalities today face very difficult times. I wouldn't touch their bonds with a barge pole.
So what the heck do you do?
Diversification has long been held to be the answer to reducing portfolio risk. But essentially all of the diversification models speak to the more or less conventional economic cycles that we've experienced over the last century. As I said in the other thread, they assume that the future will never be worse than the past.
Is that a valid assumption?
If you held a portfolio in Weimar Germany, your stock portion didn't do too badly during the early stages of the hyperinflation. Equities seemed at first to be a good place to help protect your wealth. But as the crisis deepened, stocks blew up, along with virtually everything else. The very economic landscape washed away.
In such an environment, hard assets like gold, art, real estate, and sovereign currencies not exposed to the debacle were the only things that escaped.
Is such an event beyond our ken? Is such a black swan not possible during the however-long retirement I anticipate? Has anyone ever floated a cogent explanation of how we might escape our current arc?
When I look at the numbers, starting at the top, at the sovereigns, then working my way down to the states and municipalities and communities and families, I am given great pause. The math suggests to me it will not end well.