Bridgewater Daily Observations - "Economic Risks are Increasing as Thoughtful Leadership is Giving Way to Mob Rule"

Bridgewater Daily Observations - "Economic Risks are Increasing as Thoughtful Leadership is Giving Way to Mob Rule"

 

Economic Risks are Increasing as Thoughtful Leadership is Giving Way to Mob Rule

 

By mob, I mean a crowd of people operating in an emotional rather than thoughtful way.

 

Classically, in deleveragings bad economic conditions lead to emotional reactions, social and political fragmentation, poor decision-making and increased conflict.  When this occurs in democracies, the checks and balance system, which is intended to yield the best decisions for the whole, can stand in the way of thoughtful leadership and lead to ineffective "mob" rule.  This dynamic can lead to a self-reinforcing downward spiral – bad conditions lead to bad decision-making and bad decision-making leads to bad conditions. Frustrations increase, the established ways of doing things that were thoughtfully created to assure quality group decision-making come under attack and frustrations over the ineffectiveness of government creates the perceived need for someone to gain control of the mess – i.e., the "benevolent despot".  To be clear, I am not arguing against democracy or saying that this path is predestined.  What I am describing is a classic deleveraging dynamic that has been well recognized for many centuries (read Plato) and that is repeatedly observable to those who read history (e.g., it is why Hitler was elected and brought to power in 1933, at the low point of the Great Depression). 

 

In our opinion it is happening now and it should be taken into consideration when trying to figure out what is most likely. Rather than trying to resolve their disagreements through thoughtful discourse and sincere attempts to find the best paths for the country as a whole, people with different points of view are now typically exchanging insults and trying to grab power to beat and suppress their opponents. Tensions between the rich and the poor, capitalists and socialists, those in and out of power and different factions in each group are now intensifying in a manner that is classic in deleveragings. Politicians who are fighting for power in a political year are fanning the flames and are increasingly willing to do risky things (like shutting down the government) in pursuit of their missions and popular support. Watching the election dynamics is like watching two opposing teams in a game that will culminate on election night, with commentators reporting the score of how badly the red team beat the blue team, or vice-versa, and the winner gaining control of our country.

 

This growing populism will have important implications for monetary, fiscal and trade policies and will significantly increase the risks of a global depression.

 

Regarding monetary policy, the mob is at the gates of the Fed and wants to grab control while those on the inside are in disagreement about what should be done. Ben Bernanke and those who helped him save the country from depression are now under siege. This is happening at the same time as the Fed is virtually out of ammunition – i.e., its capacity to ease is very limited because it cannot stimulate private credit creation and because it cannot get money in the hands of people who will spend it. For these reasons it would not be prudent for us to bet on the Fed saving us as it has done in the past. The battle between the left that wants to tax the rich more and the right that wants to cut entitlement spending is at a fierce stalemate that is likely to intensify in scary ways (e.g., automatic across the board spending cuts kick in starting 2013 if a Congressional super-committee doesn't come to an agreement in November). For this reason we cannot assume that fiscal policy will be used to stimulate the economy the way it was used in the past.

 

Since there is high unemployment and growing anger, the "mob" is blaming the foreigners who "took their jobs," especially the Chinese who are "manipulating" their currency to "compete unfairly". And since politicians want popular support, they are navigating this issue to gain political benefit (e.g., to put the President in the position of having to choose between the political suicide of vetoing Schumer's currency bill and clashing with China) rather than to approach this difficult issue calmly and analytically to find the wisest path. As a result, trade flows and capital flows are increasingly being looked at by all sides as possible weapons in an economic war between China and the US. For these reasons, it would be naïve of us to see the risks of bad surprises in trade and capital flows as being no greater than they were

before.

 

Mobs are literally at the doors of bankers and others in the financial system, screaming to politicians to put these people in jail while the politicians who are seeking their votes are fanning the flames rather than reminding people that the legal system is the way these people should be judged. Since banks are levered about 15 to 1, it doesn't take much of a debt problem to cause them solvency problems, and since in deleveragings debt problems are big, there is significant risk that banks will run out of equity again and that the fury against them will intensify. For these reasons we cannot assume that the banks will be safe and that the government will bail them out.

 

While we hope that most people and their leaders will approach these difficult challenges calmly and collectively, we would not be meeting our fiduciary responsibilities if we bet on this happening.

 

Bridgewater Daily Observations, Friday, October 14, 2011

 

John Broussard

Assistant State Treasurer

Chief Investment Officer

State of Louisiana

Department of the Treasury

Ph:  225-342-0013

Fx:  225-342-9721

Email:  jbroussard@treasusry.state.la.us