"A thing long expected takes the form of the unexpected when at last it comes." ~Mark Twain
Many would say that we are in the midst of revolutionary times. "Change," it would seem, is being forced upon the world in ways many did not expect. Subjective slogans and unfulfilled campaign promises, however, are not what ail the world today. No, the ongoing financial crises exposing the soft underbelly of our modern State—the Leviathan—trace even back to the good book from which Thomas Hobbes drew his original title.
I once thought my own interpretation and outlook for the future was somewhat of a "fat-tail" event—purely within the realm of possibility (at least, in my mind) though still an extremely unlikely outcome in the near to intermediate future. However, things are moving quicker than I had anticipated and I believe we are all in for a surprising twist.
All Tied Together
The spreading financial panic throughout Europe and into other parts of the world has put our leaders into crisis mode. In times past, economic or financial turmoil was relatively manageable to contain. Not so today. Our highly interconnected world is now almost entirely based on a structural design and technology comparable to the human brain. The world has never experienced this before, and now, with the pervasive spread of data and information, centralized systems of authority are faced with a brave new world of opportunities and challenges.
In general, the spread of knowledge is a great benefit to society; however, in times of distress certain types of information can become quite dangerous. This is the reality of those who attempt to maintain confidence in the system and prevent panic, chaos, or worse. Those most at stake in this process are national governments and the various central banks—the many heads of the Leviathan, if you will.
Government + Bank = Modern State
Given the immense interconnectivity between the global financial system and the economy, the need for the many heads of State and Bank to coordinate monetary and policy actions to maintain financial stability and economic confidence has never been stronger.
Banks hold and finance large amounts of government debt and economically-sensitive instruments. If forced to sell in lieu of a bank-run or other emergency, yields rise, therefore causing the cost of financing that debt to become more expensive for governments. This is the problem facing many countries in Europe currently. Financial and economic uncertainty has put a massive strain on their ability to finance budget deficits cheaply, necessitating the need to cut spending and raise taxes, furthering the cycle of economic contraction.
Even more important is the fact that banks in one country hold large amounts of debt of an entirely different country. Like unseen strands of a spider's web, bank-runs developing in one region connect to another bank hundreds of miles, or even continents, away. Economic uncertainty in Greece, for example, is quickly transmitted to Spain, Portugal, and elsewhere. Of course, if the problem spreads widely and quickly enough—something central banks and global leaders are doing all they can to avoid—there is the obvious potential for global financial crisis.
Triffin Dilemma
The argument that Europe’s problems are largely the result of trying to achieve a monetary union without a fiscal and political one highlights the inevitable merger of government and banks. The European Central Bank controls the monetary policy of the European Union whereas the individual governments of each country set fiscal policy. European leaders believed, perhaps naively, that creating a monetary union among the various disparate nations and economies of Europe would help facilitate the future emergence of an EU superstate. So far, this hasn't happened. Major economic crisis might be the catalyst for such a grand unification, however.
Keep in mind that the dynamics at work in Europe are merely a regional expression of a similar global process. As the European Central Bank faces the difficulty of managing a cohesive monetary policy that affects each economy in the Eurozone differently, so does the Federal Reserve largely control the monetary policy of the many differing nations around the globe. Like in Europe, the issue, of course, is that the USD cannot serve both the economic self-interests of the United States and largely differing global economies simultaneously—a problem referred to as the Triffin dilemma. A country that issues its own currency will simply print money to pay off its debts rather than reduce spending—a situation that will benefit the debtor at the expense of other nations
As Charles de Gaulle pointed out in 1965:
"The fact that many countries, accept as a principle, dollars being as good as gold, for the payment of the differences existing to their advantage in the American balance of trade, this very fact, leads Americans to get into debt and to get into debt for free at the expense of other countries. Because what the US owes them, it is paid, at least in part, with dollars they are the only one allowed to emit. Considering the serious consequences a crisis would have in such a domain, we think that measures must be taken on time to avoid it. We consider necessary that international trade be established as it was the case before the great misfortunes of the world, on an indisputable monetary base, and one that does not bear the mark of any particular country."
The Curse of the Printing Press
Nearly fifty years later and we see the U.S.—once the largest creditor—is now the largest debtor nation in the world, financing a rather large and unsustainable trade deficit through excessive borrowing and currency debasement. One would think—as I'm sure de Gaulle did—that this system would've failed much earlier, however, the trick in its success is that the U.S. has been able to borrow and issue so much debt without any major economic problems—up until now. That is, the system works as long as foreign nations have confidence in the U.S. to remain economically sound. As long as we continue to consume the world's goods and make other countries rich, our promises to pay them back are also considered, as de Gaulle said, "good as gold." Thus, trillions in IOUs act as physical monetary assets—just like gold or cash—on the balance sheets of banks around the world. Can the U.S. pay it all back? Well, as the head of the U.S. central bank, Ben Bernanke himself admits:
"The U.S. government has a technology, called a printing press—or, today, its electronic equivalent—that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar [to create inflation and reduce its debt burden]... Of course, the U.S. government is not going to print money and distribute it willy-nilly—although as we will see later, there are practical policies that approximate this behavior… If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation."
Apparently, the man who controls both the U.S. and, in large part, the entire world’s monetary system feels no need in hiding the very thing de Gaulle warned long ago in the “serious consequences a crisis would have in such a domain.” Why? Because this is the dominant economic philosophy here in the U.S. and the rest of the Western world of exactly how central banks should respond to any crisis—print more money! As Ludwig von Mises wrote in Human Action:
"Credit expansion is the government’s foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous."
Of course, the attempt to continually prop up the economy or markets with easy money comes with a great price, as von Mises comments again:
"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
This is where the world finds itself today. Not after one single boom of artificial prosperity, but decades worth! The government and banking Leviathan is now so bloated with funny money that it can barely support its own weight. This is obvious. Everyone knows it. Does that mean that governments and central banks will give up and let the free-market take over? Of course not! They will do everything thing in their power to maintain control over the economy.
The Perfect Model
Consider the following statement made by Former Federal Reserve Vice Chairman and current Princeton economics professor, Alan Blinder:
"It would be a better world if the people at the Federal Reserve had perfect foresight and had a perfect model of how the economy works so they knew exactly what to do at exactly what moment, [but] that's a fantasy. Now, what it means is that they should try to keep learning; learn from experience, try to improve their forecasting methods, the models by which they understand how monetary policy works. They got to keep working and getting better..."
There is a widespread deception that the economy must be micro-managed. It cannot function on its own without the blessing and direction of those possessing divine knowledge of how it should run and be properly organized. Alan Blinder does not say that this “better world” is merely a fantasy because the Federal Reserve is incapable of producing it—no. It simply doesn’t have enough information or the right model yet for doing so.
This now gets us a little bit closer to where I am headed. The very foundation of modern economics—the imperfect model currently being used to understand and run the economy—is facing a rather large existential crisis. There is a “widespread recognition, both among economists and the general public, that economic theory has failed,” as George Soros recently stated at the Festival of Economics in Trento, Italy, going on to say:
"...the failure [of our current system] is more profound than generally recognized. It goes back to the foundations of economic theory. Economics tried to model itself on Newtonian physics. It sought to establish universally and timelessly valid laws governing reality. But economics is a social science and there is a fundamental difference between the natural and social sciences… Social events, by contrast, have thinking participants who have a will of their own."
I specifically chose to highlight Alan Blinder and Soros' comments because they summarize two of the most fundamental reasons why human governments have failed in exerting absolute control over society and the economy:
1) Lack of data, intelligence, or the right model
2) The free will of thinking participants, i.e. human unpredictability
The question I want to ask is: What steps do you think have and will continue to take to solve these two problems? How far will they go? Looking back at history it should be clear to us that in times of great desperation and turmoil, central authorities will do everything in their power to ensure self-preservation—whether it be war or otherwise.
As I mentioned in the beginning, the hyper-connected architecture of modern society poses a brand new set of challenges and opportunities to centralized systems of authority. The challenges of blocking certain types of information from spreading could lead, for example, to a massive bank-run or a communications channel for rioters and mass demonstrations. The opportunities, however, are also quite massive. Never before has so much information been available on what people eat, drink, buy, or listen to. Do you think all this valuable data isn’t being archived? Guess again:
"Under construction by contractors with top-secret clearances, the blandly named Utah Data Center is being built for the National Security Agency. A project of immense secrecy, it is the final piece in a complex puzzle assembled over the past decade. Its purpose: to intercept, decipher, analyze, and store vast swaths of the world’s communications as they zap down from satellites and zip through the underground and undersea cables of international, foreign, and domestic networks. The heavily fortified $2 billion center should be up and running in September 2013. Flowing through its servers and routers and stored in near-bottomless databases will be all forms of communication, including the complete contents of private emails, cell phone calls, and Google searches, as well as all sorts of personal data trails—parking receipts, travel itineraries, bookstore purchases, and other digital “pocket litter.” It is, in some measure, the realization of the “total information awareness” program created during the first term of the Bush administration—an effort that was killed by Congress in 2003 after it caused an outcry over its potential for invading Americans’ privacy."
In the past, and still today, economists working for the government or other agencies had to derive this information from second-hand sources through various surveys or retail data. Often it was outdated by months to a year given the time it took to collect, analyze, and develop into useable forms. That is no longer the case.
It is tempting to think that all this data gathering is for identifying terrorists, cybercrime, and other nefarious activity, however, tracking the collective behavior of both foreign and domestic citizens, I believe, is much more valuable for governing authorities and financial institutions than we might imagine. Are there restrictions in using this treasure trove of data for financial purposes? Will economically-useful information be fed directly to the U.S. central bank for understanding economic trends, consumer habits, or other relevant financial information? Would the government be willing to sell this data to private companies or investment banks?
Later on in the same article it is mentioned:
"Once the communications are intercepted and stored, the data-mining begins. 'You can watch everybody all the time with data-mining,' Binney says. Everything a person does becomes charted on a graph, 'financial transactions or travel or anything,' he says. Thus, as data like bookstore receipts, bank statements, and commuter toll records flow in, the NSA is able to paint a more and more detailed picture of someone’s life."
There’s one last thing I think we need to understand here too: This deluge of data isn’t being collected, analyzed, and graphed by people—this is a herculean task that can only be tackled by the fastest and smartest supercomputers in the world. You think IBM’s Watson who won Jeopardy against our best and brightest is smart? I’d put my money on the NSA’s “Thinking Machine” any day.
Whether we’d like to admit it or not, our world is becoming increasingly driven by automation. For those familiar with a topic I've discussed numerous times , high frequency and algorithmic trading, the idea of machines thinking and acting by themselves is simply part of doing business. Then again, it doesn't stop there. The technology and speed with which these rapid-fire algorithms pulse through the market is beyond the control of human regulators—certainly, a monumental shift in artificial versus human intelligence. It's one thing for a computer to beat the best human chess player or the undefeated champions of Jeopardy, but it is an entirely different thing when machines are now beating and outrunning humans in their ability to regulate or govern the financial markets! We are in completely uncharted waters now.
In Summary
The key issue facing the world today is the problem of global monetary policy and governance. It is widely understood that the present system needs to be revised given the uncertainty of the U.S. economy and the need to have a world reserve currency that, as de Gaulle famously said, "does not bear the mark of any particular country."
Unless the world disintegrates and takes a massive technological step back, the trend towards greater economic convergence through the global financial system is inevitable. We cannot expect the U.S. to be a superpower forever and yet, the health of the current system is highly dependent upon confidence in the U.S. economy. I do not believe, however, that it will be another nation that takes its place in conducting the world's monetary policy, nor in even setting fiscal policy either.
Ironically, the description that Thomas Hobbes gave in the 1600s of the ideal sovereign and all-powerful entity ruling over mankind takes on a completely new meaning now:
"Nature...is by the art of man, as in many other things, so in this also imitated, that it can make an artificial animal. For seeing life is but a motion of limbs...why may we not say that all automata (engines that move themselves by springs and wheels as doth a watch) have an artificial life? ...Art goes yet further, imitating that rational and most excellent work of Nature, man. For by art is created that great LEVIATHAN called...[the] STATE, which is but an artificial man."
I believe Hobbes was a man ahead of his time. He, like another famous writer long before him, envisioned a powerful beast emerging from the seas of humanity to rule over us. Today, our modern day scientists and mathematicians have breathed life into such an "artificial animal": synthetically human, virtually divine—a creature uniquely adapted to rule a world flooded with information.
by Thomas Homer-Dixon. The basic idea is that when the carrying costs of the society exceed its output, the whole contraption collapses.
