Guest Post: Financialization's Self-Destruct Sequence

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

Financialization's Self-Destruct Sequence

We are in the latter stages of financialization's self-destruct sequence.

Like all systems that follow an S-curve of growth and decay, financialization cannot return to its growth phase. I addressed the impossibility of reflating asset and credit bubbles in Let's Pretend Financialization Hasn't Killed the Economy (March 8, 2012).

But there is another dynamic at play: a self-destruct sequence triggered by central bank and Central State efforts to reflate asset and credit/leverage bubbles. All central bank and State policies aimed at driving capital into risk assets boil down to reflating phantom assets purchased with debt by issuing more debt that is based on newly issued phantom assets.

Phantom assets purchased with debt cannot be reflated by issuing more debt that is based on newly issued phantom assets. Piling more debt/leverage on a sandpile of phantom assets (CDS, bonds that cannot possibly be paid back, empty condos in the middle of nowhere, etc.) only heightens the probability that the unstable pile will collapse.

The implicit Central Planning campaign to trigger "mild" inflation is part of the self-destruct sequence. Central planners metaphorically fight the last war, or at best the last two wars, and so they remain blind to any dynamics that did not exist in their case studies.

In the 1970s, central bank easing and Central State stimulus sparked a nasty bout of accelerating inflation. This reduced the weight of debt because wages inflated along with goods and services.

Now that labor is in surplus globally, wages are not keeping pace with inflation. This completely changes the dynamic of "mild" (3%) inflation: as the purchasing power of earned income declines, servicing debt becomes more burdensome. Inflation only renders debt less burdensome if wages rise at the same rate as the cost of goods and services.

In a decade of "mild" inflation and stagnant wages, households will experience a very real-world 30+% decline in their income. Meanwhile, their debt payments remain unchanged.

"Mild" inflation in an era of stagnant earned income will crush households, forcing liquidation or renunciation of debt. What happens as debt service costs rise as a percentage of real net income? There is less cash for consumption, and so the consumer-dependent economy spirals down. Credit is poured into the banking sector, but little trickles down to high-debt, stagnant-income households. This is deleveraging writ large.

What happens when central bank financial repression--lowering the yield on cash to near-zero--causes pension plans to fail and savings to earn negative real returns? Households must save more income to compensate for the destruction of yield by Central Planners.

These mutually reinforcing dynamics feed the self-destruct sequence's inevitability. Add up the self-destructive forces: declining purchasing power, negative real returns on savings, rising debt based on newly issued phantom assets, and promises unbacked by real assets or based on declining national surpluses.

As Central Planning reflation of phantom assets fails, the credibility of the Status Quo institutions that promised success will crumble. I have described the dynamics of Heightened Expectations and the Collapse of Credibility and discussed The Keys To Understanding the Collapse of the Status Quo: Credibility and Expectations.

In the euphoric blow-off top phase of financialization, expectations of security and wealth were raised by political Elites anxious to mask the systemic looting of national wealth by financial/political Elites. Promises were even easier to issue than paper money.

But issuing promises, credit and leverage did nothing to expand the national surplus or the resources that ultimately back the promises and credit.

We can characterize the sudden, explosive convergence of fantasy (phantom assets and promises) and reality as Snapback! (October 9, 2008). The entire project of Central Planning (central banks and States) is to "extend and pretend" the Status Quo in the hopes that the gargantuan divergence between fantasy and reality will magically close as the result of "aggregate demand" or a new business cycle, or some other version of renewed "animal spirits."

But "animal spirits" require trust in the transparency and fairness of markets and Status Quo institutions. As markets are rigged and manipulated to manage perceptions and enable vast skimming operations to continue, the credibility of the markets, politicos, State oversight agencies and the financial sector is eroded.

As central bank/State reflation of phantom assets fail, the credibility of the entire political/financial Elite and the institutions they control will be irrevocably lost.

Financialization's self-destruct sequence has been triggered, and there is nothing anyone can do to stop it. The workings of the machine are opaque, and the interactions complex. We cannot know when the sandpile will collapse, or what the proximate cause of the collapse will be, but we can know that the unstable pile will collapse under the weight of the system's illusory assets, fraud, collusion, embezzlement, corruption and corrosive dependence on artifice and lies.

We also know that self-serving vested interests will continue their pillaging until the destruct sequence's final implosion brings the entire rotten edifice down in heap of empty promises.

In a word: Snapback!

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diogeneslaertius's picture

snapback's a ...stack gold bitchez!!!!11!

Getting Old Sucks's picture

Yup, and hide it well for our children or grandchildren.  They'll tax the shit out of us in our lifetime unless we can barter it.

Doubleguns's picture

No need to attack the gold just cut off social security and medicare. They no longer will have to pay those taxes. Big problem solved for them. You can live off your gold instead of them. Seems a fair trade.

donsluck's picture

So your answer to financial collapse is social collapse?

ATM's picture

You will get both. You aren't going to see a financial collapse without a social collapse right along with it.

And stopping payments into Medicare and SSI will do nothing to stop the collapse at all. the debt is far too great as it is. We cannot tax enough to stave it off. The taxes are irrelevant at this point. Collapse is cming both financial and social.

IndicaTive's picture

"Collapse is cming both financial and social."

The social collapse is leading the race to the bottom. At least where I live.

old naughty's picture

Financial, social, and...The tapestry of our existence.

Even the MIF can't stop these from self-desctruct !

No need to page Tom!

Zap Powerz's picture

Junk silver works well for that.  Just sayin.

MacGruber's picture

The absolutely critical point to this article is that wage inflation must working alongside of consumer inflation. I've tried to explain this to people for YEARS, but no one can quite grasp the concept. The real irony is that Greenspan and others promoted the destruction of their main inflation lever, namely organized labor. Without collective bargaining its nearly impossible for entire classes of workers to petition their employer for higher wages when a loaf of bread doubles in price. Inflation of consumption goods today merely becomes another tool to extract the last dollar out of the pockets of those that work for a living (non-capital holders) to capital holders.

Add to the death of collective bargaining a highly slack labor market, and you have a recipe for total wealth destruction among workers. By extension, wealth destruction equals zero consumption, and before you know it you're in a death spiral never before experienced in capitalist history.

ATM's picture

I'm scratching my head trying to figure out where which unionized workers have lost collective bargaining power other than Wi's government workers who should never have had collective bargaining in the first place.

Collective bargaining is supposed to pit two groups with stakes in the gae. Public union workers collective bargain with whom exactly? Politicians? What the fuck do they care if those workers make more than others or get better benefits? In fact they sure as hell want to give them outsized pay and benefits because it buys votes for the givers and the politicians get to do it not with their own money but get to do it with taxpayer money.


CH1's picture

I'm scratching my head trying to figure out

Don't sweat it, ATM. The collectivists have been here all day.

Guess Cas Sunstein is trying to Nudge us.

TrumpXVI's picture

I think MacGruber's point has merit.  His point being that with unionized labor's share of the workforce down to around 11% there is no longer that force acting to generate upward pressure on wages and correspondingly, inflation.  Without getting into an argument over whether or not labor should have collective bargaining power or not, the fact remains that unionized labor has been pretty well gutted as a political and economic force.  This reality is anti-inflationary and definitely acts contrary to central bank efforts to re-inflate the economy.

MacGruber's picture

Thanks Trump, that was my only point. I'm neither for or against labor unions. But while we're on that topic - I'm for the concept that people should be able to extract their fair share of the value they add to a product in the form of compensation, but I'm not for the corruption that union power usually ends up wielding. Unfortunately corruption always seems to arise whenever there is power and money at stake.

I will say however in relation to the WI union statement that its interesting to me that its always the lowest of the public workers that are villified when the government bloats. Maybe ATM should save up some of that anger for the people that are really fleecing the country like multinational contractors in cahoots with your local congressman. Those that "win" no bid contracts that are many times larger than state human resource budgets.

Do what you like, but I will always defend the rights of people that work for a living over those that collect economic rents for doing nothing. Even worse are the trolls that booklick for the uber wealthy that aren't wealthy themselves. Those that have bought into the status quo belief that if you "work hard enough" (wtf that means) maybe just one day you'll be uber rich too... so better protect your future forest. It could happen, but according to the census the odds are 10-1 against.

forexskin's picture

unionized labor can't compete in a world where labor arbitrage defines the least common denominator. i understand the arguments pro and con union, but the comment about public unions out of control because politicians don't have any incentive to balance negotiations, in fact the incentives lead to vote buying - no one thinks that is moral - well that comment is right on.

public unions give the entire union movement the worst possible aspect.

Manipuflation's picture

Interesting point you raise concerning wage inflation and consumer inflation.(I assume you mean monetary inflation)  There is one problem that would need to be addressed however and that would be the tax bracket creep where you end up losing what you thought you gaining due to higher taxation rates.

Huh, it's almost like it's intended to work that way...

Shelby Moore III's picture

The point of the article is that centralization (declining degrees-of-freedom and entropy) is a futile exponential S curve trending against the overriding and fundamental 2nd Law of Thermodynamics (that governs every process and manifestation in the universe), which says entropy is always trending to maximum.

Centralized bargaining and unions is a collectivist's perspective, that can't understand the fundamental science of nature. Nature wants to always increase the # of possibilities, thus centralization will always fail. Centralization must grow exponentially, because that is the only way it stays ahead of the 2nd Law. And saplings grow to Oak trees, but they eventually rot and never grow to the moon (because resources are not infinite in finite time, another way of stating the 2nd Law).

DOT's picture

Your point about decline in available resources (including time) reminded me of the modeling of Cusp Catastrophes. It also provides a rational basis for why the "plateau" seems to be quite long. You can not see what is coming if you look in the wrong direction. I have even 'felt' that things have been going sideways  for years.

DOT's picture

The government will give you a raise ! 

Coming soon: new minimum wage law

                   new middle income adjustment act

                   new upper middle income sharing act

                   new rich bastard excess earnings tax



Yeah, I know, none of it is "new".

Michael's picture

Fortunately for the sheeple, there's no fail-safe.

Auto destruct on Star Trek

GoldandSilverTrain's picture

The system needs to self destruct before something else can take its place. Stock markets move from undervalued to overvalued and back down again. Unfortunately we need to move toward more totalitarianism before we will move toward freedom, peace and prosperity once more. -portfolio tracker & analysis of gold and silver stocks

ATM's picture

Praying for a benevolent dictatorship but it won't happen.

Zap Powerz's picture

Its a fucking shitting thing, but its true.

HardAssets's picture

We don't 'need' to move into a dictatorship.

We may very well end up doing so, however.

People's ignorance makes them slaves.

Quackking's picture

Interesting, and I don't know if anyone else has already posted this: Apparently there is in fact something new under the (game theory) sun which bears on this: Zero-determinant strategy. See the MIT Tech Review synopsis.

monad's picture

Works too. See Rod Blagojevich struggling to produce enough anal leakage to get through the Joliet day, every day, while his former accomplices clean out all the vaults.

Mr Lennon Hendrix's picture

Bill Gross, the guy holding the shitsoaked MBS bag, wants you to buy....gasp...."housing", "land", and "hard" asshats!  Oh my!

Tirpitz's picture

Risk on trades are in, again, lately.

Currently GDX, GDXJ, SLV, PPLT, FXE and INTC charts look quite bullish for a quick trade.

Mr Lennon Hendrix's picture

The Brokerage FIrms analysis teams would tell you gold and precious metals, and their miners, are a risk on trade, but when I look at the ten year graph all I see is a bull market.

Lost Wages's picture

Bill Gross himself doesn't stand to lose much except future income. He's clocked his dough. It's all the 401Ks, pensions, etc. that are invested in his fund that will get bit while he skips merrily tra-la-la to the bank. He has basically taken all those people and put them in Bernanke's line of fire. It's all up to Janky Bernanke now whether anyone has a future after slavery. Everyone was calling for sub 1% interest rates just a week or two ago. Expectations subverted... but for how long?

techstrategy's picture

You are one of the few people that get the negative reinforcing loops (which are now effectively closed loops) which assures the outcome and the path (it will NOT be hyperinflation as many around these parts believe, although gold will unquestionably be a/the preferred asset class).


Stay gold, Ponyboy.  Stay gold...



ATM's picture

It starts as deflation but it will surely end in hyperinflation. 

Shelby Moore III's picture

Global hyperinflation is impossible. (click link)

Whereas, cooking the frogs in inflation creep is sufficient.

cougar_w's picture

Central Planning: Always solve the last century's problems first.

HardAssets's picture

Central 'planning':  isn't about 'planning' or solving anything. Its about robbing you.

It was the same in the old Soviet Union where the party big wigs road around in black limos and got all the Western goods they wanted - - - and its true in the West today.

falak pema's picture

current central planning is to cover the elitist asses of Oligarchs who got it ALL WRONG as the ANNOINTED John Galts of Reaganomics. The best and brightest of the supply side, power to "the happy few" age.

The roads to serfdom are numerous, some begin in republic and end in despotism; others begin in despotism and end in anarchy.

Rome was the original model and is now in DC/WS.

i-dog's picture

What abject nonsense you write - day after day.... !!!!!!!!!!!!!!!!!!

Heroic Couplet's picture

Good. The more bankers, hedge fund managers, and day traders destitute, broke, unemployed, and on food stamps, the better off the world will be. Got a complaint? Let's total the dollar amount Phil Gramm is responsible for and then take your complaints to Phil. If deregulation started in the private sector, then the losses can stay in the private sector. Good riddance.

spinone's picture

As long as OPEC only takes dollars for oil, no worries.

Marcuz Aurelius's picture

This is how nature tends to function: ( the in the article projected graph is asymptotically stable, but since it is a man made construct. We know how that construction built upon quicksand is going to end up. :-) I always have to laugh a bit when nature itself proclaimed by scientists/academia to have a high entropy value (leaning more towards chaos/randomness) and utilising stochastic modelling to explain these certain phenomenon. And yet something that we have "invented" has a life-cycle shorter then 7 years. 2012 has once again confirmed and elucidated that we understand little of creation because we are the contributor to financial and socio-economic Entropy we are the cause of these "anomalies". Let's restore the balance, by educating ourselfs and children (the future) outside of this maniacal educational system.

bankruptcylawyer's picture

bullshit. this whole thing was never meant to be stable. eventually the u.s. 'collapse' will bring on the REAL collapse of china , they will starve, a revolution will happen and then the will the real wwiii will stand up ? AFter china is dueced off with some emps' and nukes. rinse , cycle and repeat with russia. one world government by 2096. 

be there or be square.

fahugwahgads baby. 

Shelby Moore III's picture

China already collapsed (see also the German port collapse, the collapse of the Baltic shipping index, the collapse of electricity demand, etc), but the official statistics (ahem lies) have not yet. China is warning that 2nd half of 2012 will be worse.

I think China must officially be admitted to have collapsed before the USA does.

China's GDP deflator (inflation) is understated and its nominal GDP is overstated. Thus, real GDP in China is at most 5%, and more likely below 3% or even negative. Gordon Chang says that China's GDP (the official lies version) has never outpaced official electricity growth, and its below 4.5% officially (much worse in reality).

Why do people put so much faith in a highly centrally managed economy? Hypnotized by the Bernanke put? They don't understand degrees-of-freedom and entropy. Thus, collectivist Europe and communist China will collapse first, USA to follow.

Flakmeister's picture

Well financialization enabled future demand to be yanked forward in the guise of intrinsic and reproducible growth...

Well bugger me with a fish fork, whocoudanode it would turn out like this...

Shelby Moore III's picture

Central banks are nearing *the inflection point* where printing is PULLING on a string.

catch edge ghost's picture

Who needs Animal Spirits when you got a SCOTUS?

dunce's picture

The accumulated wisdom of all the overpaid international bureaucrats in the area of Brussels is no greater than that of one of our perrenial bankrupt native American indian tribal councils. While it is possible that one of them wrote a book on economics, there is no doubt that they never understood one.

giovanni_f's picture

"The future is mistakenly charted as a downsloping red arrow whereas it should be drawn horizontally in green color and labelled 'plateau of constant prosperity'. The starting point should be about stage '3' to allow for some 'froth' in stage '4'. Stage '5' should be labelled 'green shoots or else...', phase '6' unexpected soft data but inflation contained'.

Ben Bernanke