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  • Posted June 13th, 2024

    Predicting financial collapse (and what to do about it)

    Predicting financial collapse (and what to do about it)

    What happens if there’s some sort of financial collapse that means your savings and pension are wiped out? The commons is all about building a community-owned economy that can provide the essentials of life (including pension) whilst reducing our reliance on the money economy / finance sector, and moving towards not needing it at all. This includes self-provisioning, as well as bringing essential sectors such as land, energy and food into common ownership. But how likely is financial collapse? Matthew Slater, blogger and co-author of the Credit Commons white paper, looks into it:

    The failure of our system of money and debt is inevitable and possibly imminent, according to numerous unofficial narratives likely to be labelled ‘disinformation’. Some financial collapse narratives focus on the danger of leverage, or on possible triggers of the next crisis; others on how neoliberal policies are constructing a system that exacerbates social tensions and will explode in revolution; others on the inherent unsustainability of exponential growth on a finite planet. Are such stories just fake-news-clickbait, agitprop, or even psyops? What can we learn from them?

    This essay is not to warn or convince you about the risks to participants in that system: chapters 1 & 2 of Jem Bendell’s recent book, Breaking Together, do that well enough. This essay attempts to digest the diverse narratives out there, to share an analysis that is guiding my own decisions, and hint at the direction of possible useful action for others. I am not a financial advisor, and I do not advise you to look to finance to save you.

    In the context of the unfolding collapse of our whole civilisation, speaking of a financial collapse as distinct from everything else breaking down, could be misleading. Financial history recounts moments when channels of trade become temporarily blocked, called credit crunches. These events could be mostly isolated within the financial world, but they could also have many triggers and knock-on effects in adjacent systems. There can also be unpredictable interactions between stressed systems. Nonetheless, it is my intention to focus on the financial system, and how it breaks or is likely to break down. To get everyone on the same page I now present a mini-play which shows the elements or the fundamental dynamics of a financial crash.

    The Loss of Confidence” a play in 3 acts.

    The stage is set in societies that legitimise debt as a source of profit. The curtain rises on Confidence, leveraging up debt, and receiving multiples of interest coming off that debt. The more leverage he applies, the greater risk he runs that one day he won’t have the cash when someone wants to cash out. He’s making too much money to think about the future. He pirouettes on the edge of the orchestra pit. “Didn’t he fall last time?” you whisper to the economist sitting next to you. “Don’t worry, this time it’s different.”, he replies. Just then, up in the gods a butterfly farts, there’s a clash of cymbals, the music stops, and Confidence has vanished with all the money. Was it a Confidence trick?

    In the interval I must inform you that the lost money is not lost like when you drop money down a drain. Nor was it ever owned like money in your bank account. When they claim to have lost money what they mean is that their assets are worth less, like when a house price falls but to the residents, it is the same house. But while you can live in a house, you cannot live in a mortgage. The value of the mortgage to the bank is only what it could be sold for. Without a functioning market the financial companies have no idea what they are worth, whether their debtors will be able to pay, or whether it is even worth paying creditors who might already be insolvent. No money has been lost, only buyers’ confidence that assets will continue to rise in value. Common folk call this “counting your chickens before they are hatched”.

    Act 2 opens on the courtroom, overwhelmed with petitions and counter-petitions from parties who can’t or won’t pay. All those contracts were supposed to be unambiguous so as not to involve the court. But much of the financial innovation that has happened since the last crisis, has never been tested in court. It will take years, decades, to work out this mess, but restarting the engine of trade is a matter of national security. The financial system needs quick decisions more than it needs justice. The decision is how to distribute the losses between creditors and debtors. The lobbying is intense. Private conversations are had. The minister of finance turns out to have questionable loyalties. Some creditors take a haircut. Some debts are restructured. Precedents are set. Confidence limps back on the stage and the market grinds into motion.

    Act 3 brings us back to the trading floor, but activity is lacklustre. The creditors who had to mark down their assets can’t lend as much as they used to. The debtors who rolled over their debt have no surpluses to invest because it’s all going on interest payments. The creditors refuse to lend into such a moribund economy. But, over time, the debt burden eases, especially if it can be helped with a little inflation. Confidence limps, then struts and finally begins to pirouette as the curtain falls. The show plays eight times a week with a Saturday matinee.

    Economists call this show ‘the business cycle’ or when it becomes a problem for them, ‘boom & bust’. They have different theories about how to mitigate it. But 150 years since it was first noticed, I’m ready to believe that the fluctuations are somehow intrinsic to the system.

    I find it helpful to remember that this event, which is framed as a collapse, is not a collapse of real wealth. What actually collapses is the volume of trade. The ‘real wealth’ is reallocated during the debt-default negotiations, and by that score there are both winners and losers. A financial collapse is not a Bad Thing for all parties. Anyone who comes out of the negotiations with money, is in pole position to buy up all the distressed assets cheaply, ready for the next cycle. Those parties are not troubled in the least by the business cycle.

    The play tries to show that the high leverage of our financial system already makes it structurally vulnerable, at least to entomological methane emissions. What it doesn’t show is the range and diversity of shocks the system needs to cope with. Currently, for example, much of the world (BRICS) is trying to move out of the dollar hegemon and create a new marketplace. The boomerang sanctions against Russia, and Europe’s switching to more expensive energy, and many other events are rocking global finance. It is hard to imagine any kind of collapse without financial collapse.

    The play might also suggest that because crises are cyclic, they are predictable. They are not, but some writers put out predictions as if they want to be credited for predicting the next crash. They might point to some chart which peaked in 2008 and is even higher in the present day – “Look! We should have crashed already”, they imply. But looking back, we didn’t. This is because the financial system is constantly evolving, and a single stat like ‘debt to GDP ratio’ does not have a constant meaning over time. The builders of the system can intentionally shuffle things around to mislead those who depend on isolated indicators. Between the crashes of 2008 and 2020, I witnessed an evolution. The earlier event was extremely dramatic. I remember banks being vilified, suggestions that it was some kind of a heist, austerity policies being announced, Queen Elizabeth’s Question, and it formed the basis of political discourse for a whole election cycle. The Covid bailout was almost as large. They did it before the market crashed which reduced its impact, but it still involved massive transfers of money with minimal accountability. The story was out of the headlines within a fortnight. The perfect crime!

    Conventional collapse narratives

    Here is a smattering of stories you may have seen in recent months, especially on alternative media:

    • The market for real estate, which is fuelled in large part by credit, is vulnerable to rising interest rates. High rates slow the market and cause house prices to fall, possibly below the value of the mortgage, at which point banks start wanting their money back (as in 2008). The recent collapse in demand for office space in many major cities is also being pointed to as a real estate bubble about to burst. Example.
    • It’s not only mortgages. In the 2010s when interest was near zero, very little return on investment was needed to borrow money. But now interest rates are back up, many of those investments are struggling to keep up interest repayments, and a wave of default seems very possible. This hazard has been increased by central bank policies of buying huge amounts of bonds issued by corporations, which created a buoyant secondary market for junk bonds (as explained in chapter 2 of Breaking Together).
    • Tech stocks since the pandemic have become overpriced. Stocks are important to many people because their pensions are invested in them. Example
    • During the pandemic, while some corporations were bailed out, others were allowed to recapitalise by issuing bonds which weren’t always scrutinised. Rising interest rates are tipping many of those businesses over the edge and their bonds are defaulting. Can we be sure that the rest of the system is sufficiently insulated? Example
    • For structural reasons, the Chinese economy might be about to collapse. Example. As it seems to be either a major supplier, customer or financier to almost every other country, the consequences would be multidimensional and unpredictable.

    A formula is emerging: if you can identify that a particular market is overpriced, then any perceived threat to that market could start a selling spree, and, since the shadow banking system is like a secret layer of wiring behind the circuit board, we have no way of mapping or guarding against possible contagion and a repeat of the events of 2008.

    Novel collapse narratives

    Other stories focus on novel risks, often exogenous to the financial system, whose probabilities and impacts are not well understood.

    • The declining availability of cheap energy that was identified by peak oil theory (‘cheap’ means energy which does not require a lot of energy for it to be accessed) means a rise in energy prices, which will absorb financial surpluses and kill investment. And Bad Things happen when capitalism can’t grow.
    • The decline of the US Hegemon and the reserve status of the US dollar is leading to increasingly drastic behaviour as USA snarls, snatches and clutches at its purchasing power. Many countries in the US ambit are circling the plug-hole.
    • The banking system could be hacked, especially by AI.
    • A recent book called The Great Taking puts the case that financial elites have nearly finished constructing a legal system which means all our financial assets will be confiscated during the next crash. Note that this is presented as the Great Depression on steroids rather than as the end of anything.
    • Major conflict in Europe, the Middle East or Taiwan could collapse confidence in national economies, currencies, and lead to a variety of capital controls, with uncontrollable ramifications for a hyperconnected global financial system.
    • A simultaneous failure of grain harvests caused by increasingly frequent freak climate events will lead to high food prices, such as to kill demand in the rest of the economy.
    • Future climate change impacts are being systematically underestimated by the insurance industry which will necessitate a very large correction.

    I will unpack that last one to highlight the kinds of unknowns we are dealing with. It comes from Steve Keen, who was able to warn about the US housing market being overpriced prior to 2008, although his predictions continue to be defied by the ever-escalating Australian housing market. His recent paper, Loading the DICE against pension funds, shows that climate risk has been underestimated and underpriced across the board, and therefore prices of assets like pensions, which are more exposed to longer-term risks, are priced too optimistically, i.e. without considering tipping points and other hard-to-predict things which are left out of many models in order to make them appear more ‘certain’. So climate events which are out of the anticipated range could lead to these assets being suddenly re-valued, triggering a huge financial crisis.

    A report by Finance Watch puts it this way: “the theories behind these economic models rely on backwards-looking data, make assumptions about economic ‘equilibrium’ and use damage functions that are not suitable for modelling an economy disrupted by climate change… Yet, the climate scenario analyses conducted byfinancial supervisors all use these models.”

    Financial collapse

    A similar argument is put forward in a University of Exeter paper, The Emperor’s New Climate Scenarios which also focuses on insurance. It says “Damage functions that are used to estimate the economic impacts of climate change exclude many of the risks we expect to face, such as those impacts from tipping points, or societal consequences such as involuntary mass migration.” 

    This is really damning. In Breaking Together, Jem discusses how and why many tipping points are left out of climate models and the conclusion of the IPCC. Here we see that those modelling techniques that we know to be deficient and over-optimistic are being used to make long-term financial projections. If finance is really about managing risk and creating a more secure future, the insurance industry is going off the rails by using those projections.

    Though I appreciate all the work that went into these reports, identifying possible triggers doesn’t leave me feeling informed or empowered. When the financial system is so highly leveraged, a crisis can result from any trigger, endogenous or exogenous. Educated guesses about the trigger and exact timing can only help people who are highly invested and trying to sell at peak prices. A more rewarding question is what exactly about the financial system makes it so risky?

    Risk, reward & government

    Risk is an essential part of economic life. You invest now to get rewards later, and those rewards always come with the risk that for whatever reason the project will not reach fruition. Financial tools are all about dispersing, delaying, dampening, dumping, deflecting and directing risk and reward between savers and investors. Capitalism has a nice ethic, that those who bear the risks, deserve the rewards, and finance determines the details of that, sometimes with the opposite effect. The game is to make the least capital yield the most surplus, with the greatest reliability. But if you actually constrain yourself with ethics about risk bring proportional to reward, you are likely to be trampled underfoot.

    Generating/extracting the most profit from the least capital assets is a knife edge. In ‘normal’ times of economic growth, a simple act of plundering like ‘trimming fat’ from the productive asset itself and counting it as profit, goes unnoticed or is applauded. There sometimes comes however, a cold night when that extra bit of fat would have made all the difference. If just one asset has been stripped of insulation, it might live from the warmth of the others, but if all assets have been stripped, a single event could destroy the lot.

    I realise I’m writing about ‘the market’ in a very abstract way. That is because the market is no longer a square in the centre of town, but pervades our collective life. It consists of anything that has a price and can be sold, including land and labour. The market is a field of surpluses and shortages, trying to balance each other out. Just as the sound of Krakatoa exploding in 1883 was communicated thousands of miles through the medium of air, manifesting as a rumbling sound, economic shocks are communicated through markets, manifesting in price movements, broken supply chains, debt defaults and unemployment. When the Ukraine war kicked off, the only noticeable impact I felt (in Italy) was when the price of sunflower oil shot up. Similarly the current inflation and unemployment could be caused by mismanagement of finance, or could be signals of a malaise beyond the financial system.

    When debts can’t be paid, there are two logical solutions: either the creditor marks down the debt, essentially forgiving some of it, or the debt is restructured, which means repayment is delayed – or a combination of those.

    But there is a third, increasingly common solution to financial crises. Governments are not supposed to save gamblers from their own recklessness, but somehow they are responsible for keeping the market liquid in a crisis. When a creditor is so enormous that its insolvency would have national security implications, the public purse might compensate the creditor, even if that means hardship for citizens for years afterwards.

    What governments are supposed to do is regulate and police markets: making a level playing field, incentivising or punishing certain activities. They have specific financial tools for use in both normal times and crises:

    • Inflation, for diminishing the value of long-term debt, at the expense of savers, as well as encouraging money to circulate.
    • Quantitative easing, a way of exhorting the banks to lend by passing some of the risk onto the public.
    • Ad hoc tools, such as windfall taxes, tax rebates or as in 2022, when European governments switched from their cheap Russian supplier to more distant, expensive ones, and started subsidising energy bills.
    • A particularly exotic tool is ‘plunge protection’. When there is a fear that the market could tank in a dangerous way, central banks can semi-anonymously buy assets with ’emergency’ money to put a floor on the market: this perpetuates confidence and liquidity, and helps everyone get back to plundering.
    • Corporate bond-buying is a recent addition to the repertoire. It is a way for the public purse to bear the risk of lending to industries when commercial banks won’t.

    With government intervention, many crises are successfully delayed, dispersed, deflected or redirected before they even strike. But the litany of bailouts, quantitative easing and corporate bond buying since 2008 means that the public are constantly paying to sustain a crisis-riddled system [Footnote: this is a constant theme in Justice as an Option, Robert Meister]. I’m reminded of the ancient Minoans of Crete placating the minotaur by sacrificing their young to it.

    The public is paying for the perpetual crisis in the market not only through taxes, but through austerity, credit card debt, small business closures, local governments bankrupted – and in wider society: a ‘lost generation’ of young people with very limited prospects for a career or affordable housing, an increasing Gini coefficient, with rising stress in families, rising suicides, hatred of immigrants etc.

    After 16 years of ‘emergency’ policies that favour the financial elite, isn’t it fair to assume it is the new normal? As chronicled in the first half of Breaking Together, even without new financial crises, most people are finding resources harder and harder to access, standards of living are falling, and real growth of economic activity has stopped. What evolved as a growth economy, has hit the ceiling and is now, by definition, a pseudo-growth economy: no political rhetoric, monetary injections or technological innovation can change that. The rich are getting richer as they always do, but now the pie is shrinking, and that means only one thing for the middle and working classes.

    Procuring and protecting your wealth

    It’s not as if the marketplace was an easy place to frequent before collapse commenced. It has always been a shady place that rewards suspicion as much as it rewards tricksters. But neoliberalism has transformed a trading space into a Hunger Games, the macellum (the marketplace) into a colosseum, where the biggest and best-connected bosses thrive by lying to customers, price gauging, monopolisation, manipulating government, evading the law, squeezing their suppliers, brutalising their staff and gobbling up their competitors! Peace-and-freedom loving people don’t last long in such places.

    The ongoing decline, or even collapse in most people’s living standards is only possible because they are already way above sustainable levels. A large part of middle class wealth results from the structure of the economy which seizes resources and funnels wealth to them: infrastructure and knowledge contributed by the ancestors; mineral wealth being ripped out of the ground; goods and service created by, for want of a better word, slaves. Government then plays a huge role in shaping the distribution of all that wealth between groups like landowners, essential workers, creditors debtors and entrepreneurs. Government determines everything from public sector pay, taxes, bankruptcy laws, insurance mandates, etc. and so ensure that the wealth you have bears no relation to the wealth you actually create. So even though many people work hard, and wages always feel deserved, that is a psychological illusion I expect will be dispelled.

    The precious metal merchants however build on this spurious notion of ‘deserved wealth’. They place commentary in the financial news and sponsor YouTubers to play on the fear of people who have some savings. “Protect your wealth” they say, arguing, usually correctly, that the government cannot be trusted or that financial collapse is inevitable.

    I have serious problems with this ‘protect your wealth’ narrative. Firstly, it is not a solution for the public, only for those few who have spare capital to tie up in an unproductive assest. Secondly, even if everyone did have spare capital, all the gold ever mined amounts to less than 20g per person or $1500 per capita, silver much less. Thirdly, because when the gold price rises, the bearer increases his wealth without working, which means at the expense of others who do work. Fourth, a great part of wealth is not private but public, including architecture, parks, safe streets, health facilities, and not least, the medium of exchange. So finally, if the gold is in your vault while there is a shortage of money in the world outside your vault, then you are preventing other people from earning a livelihood. In short, this narrative is elitist, antisocial, and probably racist, especially if you consider where the gold came from. Investing in cryptocurrencies is similar, because it does nothing to address the scarcity of real resources. The magical money propaganda, or sales talk, about crypto doesn’t help people to remember that real wealth is any phenomena that sustains our lives, not the monetary instruments that we use to claim access to such phenomena. I also see a moral side to it:

    “If you can keep your wealth when all about you
    Are losing theirs – you will be a-damned, my son.”

    So far I’ve talked a lot about narratives – what the alt-media says – and found not much of value, so now I shall point to what I think are more constructive ways of thinking.

    Resources are running out, the cost of climate change is increasing; real growth has finished, and the financial system, even when tempered by government, cannot comprehend that predicament and allocate the remaining resources fairly. So, whether a credit crunch paralyses developed economies in one fell swoop, or whether the Gini coefficient on inequality continues its inexorable rise over the coming decades, the broader public faces a serious decline in its standard of living (as people have experienced in most countries of the world since 2016, as chronicled in Breaking Together).

    The only economists who are prepared to talk about this are the ‘Degrowthers”, but even they can be a bit squeamish. Their aim is to convince policymakers that economic growth should not be their focus and instead try to reshape society for wellbeing without GDP growth. Warning against mass poverty isn’t a friendly framing – after all, they have to ‘sell’ their message to elites, so degrowth focuses less on poverty and more on increased leisure time.

    Fortunately, I have the luxury of not trying to sell anything so I can be blunt. Whether the current financial distortion and decline becomes an outright collapse or not, the future for most of us is poverty, and, unless we fancy our chances at revolution, we should begin to reconcile ourselves to that.

    I first encountered poverty in London as a teenager. I was on a school trip, outside the hotel at night; I saw a filthy old woman crouched in a doorway. She was scratching herself and mumbling incoherently. She was utterly alone and ill and exposed; her deprivation was absolute.

    That nightmarish vision is just one manifestation of poverty – one that perhaps keeps many of us returning to the rat race. Poverty sounds scary, but the word describes the experience of billions of people, most of them in a better condition than this woman. Poverty isn’t always so ignoble. Many religious people, and some non-religious people, make a virtue of it. As I draw this essay to a close I want to outline more precisely how we are likely to experience a financial collapse and the kind of widespread poverty I think will result, even while the super-rich retain their technology and freedoms.

    A healthy market means a healthy supply and a healthy demand. In the industrial era poverty is always framed as a problem of demand – people don’t have enough money to buy stuff. But as the financial system breaks down we will see more problems with supply as well, as with the Russian collapse in 1991, when many people had (inflated) rubles but the shops were empty. Because financial collapse is experienced through the market, it is easy to point to other examples of market failure, when we want to contemplate our future. The crises in Greece 2011-2016, Argentina 2018, and Sri Lanka 2022, had different causes but similar effects. Cuts in government spending and lack of access to imports.

    Foreign goods will be the first to be sucked into the vortex of the collapsing market, ultimately rendering supermarkets, malls, and factories as deserts. Nowhere in the developed world will be immune because all production, including primary production depends on all other production. Even a humble pencil has a global supply chain. Global goods will still exist, because rich people will want them, but there won’t be enough of them for the middle classes, let alone the already poor.

    It seems to me that the safest asset is land, including housing. It probably always has been. That’s because land doesn’t need a market to be valuable, and can be used to enhance our lives in many ways, not least providing living space! Furthermore, the legal principles around land ownership are very old and run very deep, and so your ownership of (unmortgaged) land might be more secure than that of other assets.

    What will remain after the crash is your time, your skills, your relationships, unmortgaged land, any equipment you can maintain. Your post-capitalism well-being will depend on those.

    The sooner that peace-and-freedom loving people organise themselves outside of the Colosseum to provide their own essential items, the better it will be for them. Preparation cannot begin too soon. The word ‘preparing’ evokes wild-eyed ‘preppers’ with their baked beans, bunkers and bullets, but I have something more co-operative and convivial in mind, building new systems for food production, sharing resources, and maybe even for risk management and accounting! Breaking Together chapter 12 describes several examples such as Transition Towns, ecovillages and community economics in the slums of Kenya. I think of this collective preparation as ‘Prepping Together’.

    You could have gold delivered to your door, or crypto downloaded to your phone, but it won’t improve your quality of life much or quell your anxiety for long. Prepping Together – changing your lifestyle, becoming independent of the Colosseum and working directly with others is the only serious response available to ordinary folk.

    My thanks to Chris Cook, Dave Darby and Stephen Hinton for their feedback on this text. If all of this is pertinent to you and you are in or near Belgium, do look at this 3-day event I am co-organising in July.

    Matthew Slater

    This article was first published at jembendell.com.

    The views expressed in our blog are those of the author and not necessarily lowimpact.org's


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