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Imagine you are in a space ship hurtling toward a black hole.  You might try to turn the ship around and fire the engines full force.  The problem is that the blast from your engines only adds mass to the black hole, making its gravitational pull even harder.  What do you do?  Fire the engines harder to try to hit escape velocity?

That may sound like a silly analogy for our ecnonomy, and it is definitely far from complete.  But as the brilliant John Mauldin discusses in his “Thoughts From the Frontline”, the black hole of debt is posing some very unusual economic problems.  This “singularity” is, simply put, a place where the normal equations that describe the universe of economics no longer apply.  What can we do when everything we know no longer works?

With that analogy in your head, consider that the life of the creation of debt “singularities” is likely one of the strongest driving forces of the long “supercycles” or K-Waves.  These are the patterns of “secular”, or long lasting bull and bear markets that come together in one big cycle lasting 50-70 years.

Mauldin cites one of his favorite economists:

Hyman Minsky, one of the greatest economists of the last century, saw debt in three forms: hedge, speculative, and Ponzi. Roughly speaking, to Minsky, hedge financing occurred when the profits from purchased assets were used to pay back the loan, speculative finance occurred when profits from the asset simply maintained the debt service and the loan had to be rolled over, and Ponzi finance required the selling of the asset at an ever higher price in order to make a profit.

The process of moving through business cycles appears to followers of this analysis to be an increasing appetite for debt.  “Hedge” debt is taken out even by cautious entrepreneurs in difficult times, but may appear to have lower returns than speculation.  As investors gradually stop worrying about debt they eagerly chase return, moving gradually into something like a big Ponzi scam.

That’s when the black hole forms.  That’s when the rules break down in a singularity.

Back to the spaceship struggling to break out.  Anything that increases debt only adds to the problem, making it necessary for us to have even higher velocity to escape.  In this analogy, economic growth is the velocity that will get us away, but it has to be done carefully.  Debt that is clearly an investment, or a “Hedge” in Minsky’s terms, is very different from the other kinds of debt.

Then again the best shot we have is to somehow deflect ourselves around the black hole and “slingshot” to safety.  Mauldin thinks it’s still possible, and so do I – but it will be difficult.

The US still has the chance to pursue what I call the “glide path” option. We can reduce the deficit slowly, by say 1% a year, while aggressively pursuing organic growth policies such as unleashing the energy and biotechnology sectors, providing certainty to small businesses about government healthcare policies, reducing the regulatory burden on small businesses and encouraging new business startups, creating a competitive corporate tax environment (a much lower corporate tax with no deductions for anything, including oil-depletion allowances), implementing a pro-growth tax policy, etc.

I hope we can forgive Mauldin for sounding a bit like a politician here, but there’s a good chance that what we need to do is this simple.  And listening to the debate between Presidential candidates right now tells me that there is very broad agreement.  So why doesn’t it happen?

Once again, we are stuck arguing about the hard part, which is serious deficit reduction, before we get to the stuff we generally agree on.  Focusing for a moment on what we have in common is almost certainly going to be where we have to go from here.

Back to the spaceship.  Imagine the crew arguing among themselves and fighting to grab the controls, breaking down any chain of command and fighting each other rather than the problem.  You know what will happen to that group no matter what.  Even if escape is unlikely in the best situation, we know that such a crew is definitely dead.

14 thoughts on “Singularity

  1. I happened to have read that Mauldin piece–the first one I’ve read though for some reason I’ve been getting his emails for a while. He is entertaining but I think his prescription, which you cite above, is bullshit. There is not an iota of evidence that–for example–the “regulatory burden on small businesses” is causing the US economic problems. On the other hand, it is quite true that the burden of health care is one of the biggest barriers to entrepreneurship. But fixing this would require the sort of fundamental change that seems politically impossible in this country. The Repugs, far from wanting to lift this burden, want to turn back even the mild reforms they have labeled “Obamacare.”
    Maybe I’m judging him too soonm but Mauldin seems just another rich Repug advocating for himself and his clients…..

    • My comments were based on reading this while listening to the debate – the prescription seems very much in line with what both Obama and Romney were talking, with different emphasis here and there.
      Is there a big regulatory burden on entrepreneurship? I have yet to hear a good specific example, but I do wonder if employment regulations and especially the overhead per employee costs (some of which probably come from regulation) can’t be managed far better than they are. But as you say, we can’t even get a real health care system together, the best way to cut overhead per employee and create jobs.
      Mauldin is a Republican, no doubt, but he seems to “get it”. If they were all like him, I’m sure a deal could be crafted – but of course those in power are not and we’re really screwed. The thing about Mauldin is that even when I disagree with him he makes me think, which is all I really ask. I do think the idea of an “economic singularity” where all the fundamental laws of normal activity break down is an excellent way of looking at this Depression.

  2. If it was obvious I think it would have been done a long time ago. Maybe I’m wrong about that but there are a lot of details when you talk about things like regulation and pro-growth tax policy. There is a lot to fight about not that its a good idea to just fight.

    • Fair enough – we do have a lot to fight through. So let’s get at it and fight the good (real?) fight! I’m good with that. If we can keep our eyes on the prize and make something happen we should be able to do this right. Call me a dreamer, again. 🙂

  3. I read the Mauldin piece and while it rambles a bit his point is that some economies like Greece and Spain are already in the black hole. I think that makes sense and the ‘normal’ rules do not apply to them. As for us avoiding it we do have some growth but it is so weak that our debt (public and private) is going to crush us. But cutting off spending now will send us into a real depression and I think John said that. He is right. Maybe distinguishing between the kinds of debt would get us on the right path but it is going to be hard.
    Its good that you introduce us to other people who are thinking about this even if I don’t agree with them entire or match their optimism.

    • There is reason for optimism, if for no other reason than if you don’t think we can manage the debt and grow out of it we might as well default now. I think it’s at least worth trying before we contact oblivion.

  4. No qualms about today’s blog.

    Just wanted to make a point that modern life seems to have created a great desire for debt at the private household level as well. Conversely people like purchasing financial instruments that are basically loans to other entities, with some expected rate of return.

    Take home mortgage refinancing. When you refinance the home owner loses equity and substitutes debt. The banks do that as a normal part of their business. The bank gives out a loan at a lower interest rate. That makes no sense. But then it is cut throat competition for your indebtedness.

    An article in the Wall Street Journal said that the Chinese are getting an appetite for a higher level of household debt. That could be good for the US–we could save more as a society by lending to them. I’m not sure about about the details of their consumer financial system, but I think they may allow more foreign money into their system.

    • Interesting point about China, yes.
      A while ago, probably the first time I mentioned Minsky, I had a graph showing that total US debt was over 400% of GDP. A quarter of that is Federal, another 15% is State and local, but the rest is private. I never did find a breakdown, but I’m pretty sure that at least half of private debt is in households, which is to say quite a bit more than the Federal debt. As much as I love deficit hawks we should remember this the next time one says “You wouldn’t run your house or your business this way!” Um, yeah, we kinda do. 🙂
      But yes, refinancing just turns “good” debt into something more like “not so good” debt in the long run. And when there was a bubble it became “ponzi debt” pretty quickly in many cases.
      Will keep an eye on China – and the rest of the developing world and their appetite for debt. Many other growing nations could see their tendency to use cash for everything fall away as they get used to good times – such as Brasil, Malaysia, etc. Would be an interesting trend.

  5. Debt is definitely the black hole that will suck us in if we don’t do something. Look at Greece, they are totally screwed now. Maybe the ‘normal rules’ don’t apply to them but someone has to figure out what rules do before the whole country shuts down. This is how fascists come to power. That may not be a problem with a country as small as Greece but Spain has a history and who knows? Maybe France or even Germany is not too far down the road.

    • An excellent point. Developed nations do not go quietly into the dark night. Once none of the normal rules apply, well, it seems no rules apply. Very good. We should be far more worried about that than we are.

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