Gillian Tett: “Was October 2008 just a dress rehearsal?”

A lot of investors I know lamented the loss of Gillian Tett. As the Financial Times’ capital markets editor in the runup to the crisis, she had provided very insightful commentary on some of the more arcane goings-on in the financial markets. I’ve had reason to look at her older commentary (circa 2004-2005) and some of it is freakishily prescient. But then she got promoted, she went to work on her book, and her writings were less frequent and just not as crisp.

Well, we may be getting the old Miss Tett back, and we all should be careful what we wished for. This article is very much like some pieces she wrote in January 2007…..and she says we’ll know better if the “reflate the economy by creating an asset bubble” strategy will work in 6 months.

Um, first we have the ugly 6 month parallel. The real break in the credit markets started in July 2007….6 months out from her January 2007 pieces.

Second, she indicates that most observers recognize the rally is not the result of fundamentals (duh!) but the result of excessive liquidity chasing assets. She adds this:

Now, some western policymakers like to argue – or hope – that this striking rally could be beneficial, in a way, even if it is not initially based on fundamentals. After all, the argument goes, if markets rebound sharply, that should boost animal spirits in a way that could eventually seep through to the “real” economy….

Yet, what worries me is that it is still very unclear that that pile of damp wood – aka the real economy – truly will catch fire, in a sustainable way.

Tett is being way too cautious. Someone tried this very experiment once and it was a complete disaster.

In 1985, the US bilateral trade deficit with Japan had gotten so bad that even the “free markets” oriented Reagan administration felt it had to do something about it. The result was the Plaza accord, a coordinated currency intervention to push down the greenback.

It was narrowly too successful and broadly a failure. The dollar fell further than anyone wanted it to, over 50% versus the yen. In fact, two years later, another coordinated intervention, the Louvre accord, was implemented to drive the dollar back up.

Even though US imports from Japan fell, US exports to Japan barely budged. The trade barriers were structural. But the Japanese now had a very pricey currency, and their exports to other countries fell also.

So the authorities figured they’d try to stimulate consumer spending via asset appreciation. Notice how Japan’s problem then is analogous to China’s now: an economy that depends on exports with insufficient consumer spending (of course, one problem in Japan that everyone seems to forget is the small size of their homes. How can you consume a lot if you have restricted living and storage space?). The idea was that the wealth effect would lead people to spend more and raise the level of domestic growth, offsetting the fall in exports.

We know how that movie ended.

Asset bubbles beget more bubbles unless the authorities shrink the financial sector. Tett’s colleague Wolfgang Munchau wrote earlier in the week:

This is exactly what the economist Hyman Minsky predicted in his financial instability hypothesis.** He postulated that a world with a large financial sector and an excessive emphasis on the production of investment goods creates instability both in terms of output and prices.

While, according to Minsky, these are the deep causes of instability, the mechanism through which instability comes about is the way governments and central banks respond to crises. The state has potent means to end a recession, but the policies it uses give rise to the next phase of instabiliy….The world has witnessed a proliferation of financial bubbles and extreme economic instability that cannot be explained by any of the established macroeconomic models. Minsky is about all we have.

His policy conclusions are disturbing, especially if contrasted with what is actually happening. In their crisis response, world leaders have focused on bonuses and other irrelevant side-issues. But they have failed to address the financial sector’s overall size. So if Minsky is right, instability should continue and get worse.

From Tett:

Earlier this month, I received a sobering e-mail from a senior, recently-retired banker. This particular man, a veteran of the credit world, had just chatted with ex-colleagues who are still in the markets – and was feeling deeply shocked.

“Forget about the events of the past 12 months … the punters are back punting as aggressively as ever,” he wrote. “Highly leveraged short-term trades are back in vogue as players … jostle to load up on everything from Reits [real estate investment trusts] and commercial property, commodities, emerging markets and regular stocks and bonds.

“Oh, I am sure the banks’ public relations people will talk about the subdued atmosphere in banking, but don’t you believe it,” he continued bitterly, noting that when money is virtually free – or, at least, at 0.5 per cent – traders feel stupid if they don’t leverage up.

“Any sense of control is being chucked out of the window. After the dotcom boom and bust it took a good few years for the market to get its collective mojo back [but] this time it has taken just a few months,” he added. He finished with a despairing question: “Was October 2008 just a dress rehearsal for the crash when this latest bubble bursts?”

I daresay this missive reflects some element of hyperbole. But I have quoted it at length because the question is becoming more critical. Six months ago, the financial system was in deep distress, reeling from a meltdown. Now despair and panic have been replaced not simply by relief – but, in some quarters, euphoria. Never mind the high-profile rally that has occurred in the equity markets; what is perhaps most stunning is the less visible rebound in debt and derivatives markets, as risk assets have displayed what Barclays describes as a “stellar performance”

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    1. Cullpepper

      Anyone care to lay it on the line and propose what market events will signal the collapse of this new bubble?

      Dollar collapse?
      Treasury bonds down-graded?
      Trade tariff wars?
      Beanie Babies selling for $10,000?
      A Chinese company buys Gillette Stadium?
      (The next) oil war erupts?

  1. rosethorn

    The analogy of Japan in 1984 to China today is worth careful consideration. Japan responded to reduced exports caused by revaluation negotiated in the Plaza Accord with inflationary policy which created a real estate bubble. When the bubble blew up, Japanese authorities responded with even more inflationary policy…deficit spending, rock bottom interest rates, and quantitative easing. None of which was sufficient to avoid two “lost decades”.

    Today, China must respond to reduced exports to the US due to consumers having run out of savings and credit. China is pursuing inflationary policies, which is clearly driving asset price bubbles. The rest of the story…look to Japan.

  2. gruntled

    Japan, China, the US, and the rest of the World… They’re all like drunks looking for the car keys under the street lights. No one seems to have the imagination to do anything else. But clearly the keys ain’t where they’re looking. God help the Main Street!

  3. Michael Fiorillo

    “The world has witnessed a proliferation of financial bubbles and extreme economic instability that cannot be explained by any of the established macroeconomic models. Minsky is all we have.”

    To help here, I’d recommend Marx, Karl, a 19th century political economist and philosopher.

      1. rootless cosmopolitan

        Vinny G.,

        I suppose you refer to Lenin’s/Stalin’s Soviet Russia and what happened in Soviet Union, in the Eastern European Countries and in other places after WW II? Whatever happened there, how horrible it ever was in parts and at times, it doesn’t falsify Marx’s [bf]economic analysis of capitalism[\bf]. These are two very different topics.


        1. Michael Fiorillo

          I should have been more specific. I was referring to Marx’s unsurpassed analysis of capitalism’s inherent instability.

          Regarding his prescriptions, well, we could argue about how distorted they were (or weren’t) by his followers, and the historical pressures they faced. But let’s not.

          My point was, or was intended to be, that Marx’s insights into the plate tectonics of capitalism – a system that he paradoxically had an appreciation for – should be given the acknowledgement and respect they deserve.

          1. Yves Smith Post author


            My understanding is that Keynes DID admit he read Marx. Like most proper economists, he trashed Marx’s labor theory of value, but much later came upon his work re instability and was very complimentary of it.

          2. Costard

            Marx’s criticism of markets was directed at the predominant mercantilism of his day. Since our own society is more mercantilist than capitalist, and modern industries are just as planned, endorsed and subsidized as any in history — why on earth should he be wrong? But let’s call the devil by its proper name, eh?

            Regarding the “instability” of markets (I can’t resist): please provide a single example of a human, a society, a government, a solar body, a molecule or a universe to which the word “stable” might be categorically applied. The most stable things in the world are lies and deceptions, which is why people are generally liars, and which is why neither truthful individuals nor free markets can be tolerated for very long.

  4. Alison Adams

    There are, at the moment, no policy choices other than inflating a new bubble. Over time, the U.S. government has abrogated its most important social functions to the financial sector.
    Healthcare was off-loaded onto employer based healthcare insurance.
    Pensions and old age care has been dumped into 401Ks. The result is a bloated financial system and lazy politicians. Long money 401k funds vote with company boards and Insurance companies buy bonds.
    The political incentives to keep asset bubbles balloning is enormous.
    Voters cannot judge our politicians by the social goods they provide since they provide very little when compared to other developed countries.
    Politicians worry about keeping the financial sector alive and manufacturing new finanical products so that these issues, and others like homeownership for all, do not land on their desks.

  5. Skippy

    Our world financial markets are akin to a space ship moving at light speed with a 14th century ship rudder to steer it. All whilst the ships Capt’s are gorging them selves on the cargo, wistful dreams of making a killing once back at port, with lusty girls and castles to sire the offspring…go figure. Bloody hell economics is a forensic endeavor, sadly the killer keeps changing his method of operation and we are always one step too late.

    The main st. economy that 99% of people use to support their lives is now a stone tool and no longer needed by the other 1% or so they thought. Every body is happy on the side lines at the craps table when the roller is on a roll, best friends till snake eyes come up ha ha. then every one wants their money back…good luck.

    Skippy…people with fools pride will suffer the most, the rest will persist and get on with life, where ever that takes them.

    1. Vinny G.

      “All whilst the ships Capt’s are gorging them selves on the cargo, wistful dreams of making a killing once back at port, with lusty girls and castles to sire the offspring…go figure.”

      What’s wrong with that?…LOL


    2. b.s. burros

      Now look, a blast does not move at the speed of light but light from the blast does. You understand now? We are staying ahead of the blast in our image moving at the speed of light. Oh say can you see exploding star here

      /”blighted fingertips unfinished cigarette”/

      1. Skippy

        @Vinny..ha..ha..feeding the inner-child is a good thing if the dreams are benign, play time is very important and sadly over looked with adults.

        Still when a commander during armed conflict is more concerned with medals, promotion, the accolades of his peers, things never go well for the troops.

        @b.s. burros…I should of said useing the Alcubierre drive, also known as the Alcubierre metric…OK…lol

  6. gloppie

    Dress rehearsal? Yes ! But after the play, the Emperor will be naked. The sooner we get DJIA 3600, the better. The shakedown of the system is overdue.

  7. Rupert

    Listening and reading to you guys trying to figure out all this mess is like watching a lab full of Dr. Frankensteins stood around, scratching their collective furrowed brows and proclaiming ‘Well it all worked in theory!’ While we, the gathered ignorati, gasp in awe and wonderment at the monster that you all created, as it rips through our fragile livleyhoods.
    Thanks for nothing.

  8. Siggy

    Tett is an interesting voice. Thank you for noting that she may be returning to her earlier prescient form. I’ll read her more often now.

    Does anyone have a sense of what may set the current stock market rally back, something that will complete the purge of misallocated money?

  9. mechanic

    For the past 10 years or so years, I have often wondered how America could be so blind to the bubble economy. I guess that really is the definition of a bubble, an inability of market buyers to distinguish fair pricing and an irrational craving for the quick kill.

    As far as the so called “equity market”. With the entire financial system making their nut trading, there really is no market. Prices are set at the margin so the financial cartel easily pushes prices up in their control of the accumulate and distribute world.

    IMO, the market is overvalued but I still wish I had re-invested in March. Maybe it’s not to late. The stocks are up 4 % just in October while I’m making a puny 3.5 % on safe bonds.

  10. i on the ball patriot

    Yves said; “Asset bubbles beget more bubbles unless the authorities shrink the financial sector.”

    “Bubbles”, what a cute little euphemism for deceptions.
    “Authorities”, what a cute little euphemism for low life sell out puppets.
    “Financial sector”, what a cute little euphemism for gang raping scum bags.

    Deceptions beget more deceptions unless the low life sell out puppets grow some balls and eliminate the gang raping scum bags.

    Deception is the strongest political force on the planet.

  11. fresno dan

    “This is exactly what the economist Hyman Minsky predicted in his financial instability hypothesis. He postulated that a world with a large financial sector and an excessive emphasis on the production of investment goods creates instability both in terms of output and prices.”

    Yup. Examples include excessively low interest rates, the “committee to save the world” bailing the imprudent out, and private gain public loss.

    “What Does Collateralized Debt Obligation Squared – CDO-Squared Mean?
    A special purpose vehicle (SPV) with securitization payments in the form of tranches. A collateralized debt obligation squared (CDO-squared) is backed by a pool of collateralized debt obligation (CDO) tranches.”

  12. Fernando Philadelphia

    Today’s scientists have substituted mathematics for experiments, and they wander off through equation after equation, and eventually build a structure which has no relation to reality.
    – Nikola Tesla

    Needful to say, economists have followed physicists in order to gain respect as a quasi scientific field of knowledge. The economists have missed the empirical side of the scientific endeavor and keeping on doing, based on experience, what is contrary to the desired results. The Glass Steagall Act worked, it was taken away and a repeat occurred. That would be the empirical validation of its social utility as policy. Continuation of free market policies is simply blind ideology in contravention to the facts. As a the nation whose sole contribution to philosophy is pragmatism, it would seem obvious to fire the incompetent ideologues and replace them with what works. Or is getting predictable and acceptable outcomes too severe a price to pay in the face of sure metaphysical sinning by abandoning capitalism? If in fact we a have ever had such a system, but a mixed economy with periodic oligarchic struggles at various critical tipping points of massive political and economic change. How much pain do we have to endure before we change for the better. Where oh Where is the motivation to make us say and mean, “you make me want to be a better society”?

  13. Jesse

    I hate to be a nag but:

    “The banks must be restrained, and the financial system reformed, and balance restored to the economy before there can be any sustained recovery.”

    Nice essay Yves, and duly linked. But the power mongers will not listen to reason or they ladies. They will go at it until they wreck the bus, and unleash a terror.

  14. Haigh

    The “authorities” AKA “low life sell out puppets” could put a big damper on this if they would just let the “Financial Sector” AKA “gang raping scum bags” know that the next bailouts will be capped to foodstamps based on income/asset tests.

  15. plschwartz

    The decision to tie up Congress for a long time may tell us lots about Obama’s interest in financial reform.
    When he came in the financial industry was on the ropes and could not have withstood a concerted move toward proper regulation.But Obama is after all a Chicago politician and so he waited to strike til the iron was cooled. Why did it take ten months to get an executive pay freeze. How much data needed to be collected and how difficult was it to collect.
    A pox on both the Houses and the Executive too.

    One might do well to read Trotsky to imagine what might happen to a “half-measure” government if the Recession has another severe dip

  16. Michael Donner

    shrinking the financial sector is of course absolutely essential. since, in america and elsewhere in the ‘developed world’ we make fewer real things and are ‘manufacturing and creating more NOT real things…like innovative financial instruments (which a reader yesterday pointed out well that we did fine without until 1990 or so) it is obvious this must be radically changed.
    this also flies in the face of the idea of TBTF and TBTR. It appears that no real plan is on the table to move towards making real products that people and use and eat and away from innovative products taht are only ultimately counterproductive to say the very least.
    IF we can agree taht the financial sector must be reduced by half (say) then the conversation about TBTR is off the table and TBTF is obvious ….to us…apparently not to the ‘powers that be’.
    so, settling for and creating regulations for, say 26 TBTF companies seems counter intuitive at best as that cements into the system an ‘apparent’ agreement that the financial sector is fine in its overall size related to GDP….when it is clearly not FINE, healthy not useful.
    so, let’s focus on Tett’s concept of the need to reduce the size of the FIRE sector and its implications!

  17. don

    At risk of grossly simplifying things, the Catch-22 (or internal contradiction, if you prefer), is this: surplus capital moves into financial assets – rather than productive one’s – because there is more than enough commercial products and capacity to produce those products than can possible be consumed – and I’m talking globally, here.

    Central banks and governments can step aside and allow the “shakeout” to proceed full bore – and thus risk the consequences, such as losing all legitimacy and be thrown out of office – or attempt to do about all that can be done: blow more bubbles.

    The global economy is dependent on bubble formation due to excess capital concentrated in the hands of a small minority, aligned with the political power structure, that has no other direction to turn to, unless of course a vastly new direction were pursued, namely income equality.

    Any chance of that happening?

  18. Bob Goodwin

    I will report that outside of the tangible asset bubble, that investing is scarce in America. My circle of entrepeneurs is reporting that venture capital is still at a standstill, and that energy infrastructure investment is still stalled. There is macro economic data to show that companies are not investing in labor growth, and no buildings are going up. Lastly, my sample of friends show they are all still hoarding their cash, with the exception of some participating in the tangible asset bubble.

    Not scientific, but the mood outside of Washington/NYC is still guarded.

    1. different gordon

      I am still reading that lending to the “real economy” (aka Main St) is very sluggish. According to the post, “…if markets rebound sharply, that should boost animal spirits in a way that could eventually seep through to the “real” econo…”. I don’t see how that could work even in theory without healthy lending to the creditworthy on Main St.

  19. reader

    please leave a link to sites when you quote if possible…for readers that care to read more…thank you.
    eg. the Gilliam Tett piece?

  20. Robert Dudek

    ** How can you consume a lot if you have restricted living and storage space?).**

    Go to a lot of expensive restaurants and build luxury tourist attractions within the country.

  21. emca

    A most thoughtful post.

    My own comments:

    While the size of Japanese households is certainly a problem in an economy hoping to incite domestic consumption, it is not the only one, nor do I think its the most culpable. From what I have observed, the Japanese have regard their own as more appropriate, if not better (quality wise and lifestyle matched), than is offered by any imports. This is particularly pointed in comparison of automobiles produced in Japan and the U.S. in the 1970’s Perceptually and actually domestic (U.S.) cars were junk, overly large and overly prone to failure, characterized by style for the moment, scrap for the future (sound familiar anyone?). There is is no way this U.S. product would ever be competitive in the Japanese market, open or not.
    (As an aside, my son is particularly negative on U.S. goods (he’s not Japanese), to the point I feel the need to pick-up the baton and argue the opposite, that it ain’t necessarily so. Fortunately most of the ‘stuff’ we own is from China, so the quality of domestic goods vs. those of Japan is moot and much bad feeling concerning ‘right’ or ‘wrong’ is avoided /happy face/.)
    (Another aside: the concept of order and what is necessary for a good life differs from here to there. Many a Japanese household frowns on the excessive display of clutter and relics in a typical U.S. domicile. The concept of ‘blank’ wall is totally foreign to the neo-Western being and sense of self, that it is immediately filled with shelves of bobble-headed John Waynes, pictures of all the children and Aunt Louise on her summer vacation in the year of our Lord, circa 1974, commemorative plates of Ronald Reagan’s inauguration, ‘real’ oil paintings bought off the Internet for $10, and a host of other bric-a-brac fated to anonymity and dust in the tireless pursuit of filling space. Strike it up the culture, but it sure doesn’t make for a consumptive society, as we enjoy (sic)here in the states).

    It might also be observed, the Japanese government has also had difficulties in getting its own populace to up the ante. This may be a critical difference in the ongoing Japanese experience (lost decade(s), etc.)and ours, Western abhorrence of lack of material to fill space in our lives and the ends to which we will go to mask that vacuum.

  22. LeeAnne

    “Does anyone have a sense of what may set the current stock market rally back, something that will complete the purge of misallocated money?”

    I’ll take shot at that: The stock market rally setback depends on a surprise waiting to happen. Smart money gets out of the way some time ahead of the inevitable rather than waiting for a stampede out the door.

    Completing the purge of misallocated money is a different story since we don’t know how many more bubbles can be engineered and BTW be careful what you wish for because the end of the bubbles could bring about, rather than fair distribution of money, civil chaos and war. There’s a reason the US maintains a military larger than the total of the rest of the entire world while neglecting social services like secure basic health care at home. Oh, excuse me, our military is to protect ‘freedom.’

    1. gruntled

      The present rally reminds me of that famous quote from Prince of Citi:

      “As long as the music is playing, you’ve got to get up and dance. When the music stops, in terms of liquidity, things will be complicated.”
      Chairman and Chief Executive Charles Prince, July 2007

      I find it amazing that a somewhat different set of players on the same stage are playing the same game only two years later, hoping the end result will be different this time. The music will certainly stop again. Unfortunately everyone seems confident that they’ll still have a chair when the moment arrives, but we do know what actually happens.

  23. 273 light years away from home

    In memory of John F. Kennedy, who had the vision to put a race to the moon as the ultimate aim for the competition between the East and the West at the time, and by that has averted humain energies to exploration and productive pursuits and helped to build the USA technological advantage, despite of the dubious and controvertial human moon landing, we need the same vision and courage now, instead of computing who is winning and who is loosing among mankind. What the point of asking more than you can eat and live you life in peace and happiness, and during that take lives away from you own kind, bringing destruction to your own human race ?

    The law of the Universe is the same in a small family as in a large community. We have a problem with distribution of goods, and we fight to death among ourselves ?

    1. different gordon

      Vision and courage, and also a clever political move. JFK used the moon mission to create a civilian (ie. non-military) space agency. This was a clever move in an era when the USAF and the US Army were both running what amounted to separate, Service-based space programs. JFK stopped that and created a single space agency located outside the Pentagon. I think the generals were not happy, but they were politically stymied.

      Maybe such vision and courage today would lead to the creation of a civilian training and job agency which could offer younger, untrained Americans what so many of them have to find in the armed forces – secure temporary employment while acquiring skills.

      1. purple

        The younger generation is quite skilled. Algebra is now mandatory for 8th graders in California. Many take it in 7th grade. Only a few took it when I was in 8th grade, going to an top public school. One can go down the list.

        The problem is not skills, the problem is a de facto capital strike with regards to productive investment.

        1. tew

          The high school graduation rate in Los Angeles is around 50%. That city has around four million people. While it may not be representative, it’s not off the grid either. Those drop outs are not learning much of anything, algebra included.

        2. Scared Investor

          And why does the “de facto capital strike with regards to productive investment” exist? Because folks with capital to invest in productive assets are scared that Marxist Thug Obama will decide to redistribute their return on that capital.

  24. i on the ball patriot

    “Does anyone have a sense of what may set the current stock market rally back, something that will complete the purge of misallocated money?”

    … major partial purge event as aggregate perception curve impacts and sends aggregate deception curve slightly downward … about Nov 5.

    Purge completion is dependent on further increase in aggregate perception curve. Increase your personal perception by staying tuned to NC. Work for election boycotts and a rewrite of the constitution.

    Deception is the strongest political force on the planet.

  25. dd

    The issue is the end game and what it looks like. Hard to foresee the future; but there are enough guideposts. First and foremost the banks will not be restrained until there is utter failure; this will take time and as long as they function in Treasury distribution they will be protected as will the dollar so that gives us perhaps a decade.
    The easy tendency is always to corral the individual “entitlement” as opposed to the corporate welfare. It’s pretty easy to see means testing for SS and Medicare. Afterall the entire system will simply be backed by bad mortgage debt, phantom derivatives and taxation. The companion will be a debit chit system; and we’re moving in that direction as well. If labor will accept debit chits for their services that will go a long way toward recapitalizing banks in a return to feudalism with a techno twist and the ability of banking to garner multiple fees for every transactions.

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