Satyajit Das: The Unravelling – Part 1: Economic & Financial Furies

Yves here. Satyajit Das has weighed in on a topic that I also plan to address, namely the widespread sense of complacency in the face of the massive economic (and in the case of the US, social and political) demolition Trump has unleashed and is continuing to pursue. Because the businesses most immediately exposed, small to mid-sized enterprises, don’t have dedicated statistical reporting, commentators are relying on anecdata and proxies, like the collapse in container volumes in West Coast ports, and the resulting swan dive in truck bookings.

One of the effects of habit and “drunk in the streetlight” behavior (giving more weight to widerly available quantitative information, particularly in financial markets, is the propensity to see the accelerating crisis as similar to historical ones, such as financial crashes or the Covid supply chain shock. It isn’t. Due to globalization, extended supply chains, the corporate vogue for concentrating sourcing among comparatively few suppliers (because bargaining power) and many businesses employing “just in time” or other lean inventory practices, an unknown but undoubtedly substantial amount of production takes place in tightly coupled systems. From Richard Bookstaber, who popularized the concept during the runup to the financial crisis:

Tight coupling is a term I have borrowed from systems engineering. A tightly coupled process progresses from one stage to the next with no opportunity to intervene. If things are moving out of control, you can’t pull an emergency lever and stop the process while a committee convenes to analyze the situation. Examples of tightly coupled processes include a space shuttle launch, a nuclear power plant moving toward criticality and even something as prosaic as bread baking.

In financial markets tight coupling comes from the feedback between mechanistic trading, price changes and subsequent trading based on the price changes. The mechanistic trading can result from a computer-based program or contractual requirements to reduce leverage when things turn bad.

It may seem odd to apply the concept of tight coupling to trade and supply chains, since they are not particularly fast moving. But what matters is the speed of progression of activity versus the time it takes to intervene. And the relevant time frames also depend of the nature of intervention required to solve the problem. For instance, with the Trump tariffs, many companies were able to hold off immediate damage via stockpiling. But that’s just a band-aid. Once they burn through those reserves, the next intervention is to restructure their supply chain so as to end or greatly reduce dependence on foreign suppliers, particularly ones in China. Common sense, confirmed by numerous tales in the press, is that there are no or no readily implemented remedies. Some intermediate goods suppliers are lucky enough to have little China dependence might be able to push through price increases. But the media is also featuring accounts of vendors telling customers that they have to work out new prices for their products in light of the tariffs, and having all their order backlog vaporize.

This process is already far enough along that even in the exceptionally unlikely event that Trump were to drop his tariffs scheme tomorrow, a lot of companies will still have suffered serious damage. They will have lost orders since Liberation Day, and getting them back would take time. The longer Trump persists (and he seems incapable of desisting), the more the loss of productive capacity avalanches across the economy. As firms shutter or cut back, in classic, “For the want of a nail, the shoe was lost” compounding effects, the loss or shrinkage of businesses harms customers who similarly may have limited alternatives and have to cut back, as well parties that once got income from those enterprises, from employees to landlords to insurance providers to equipment lessors.

Mind you, that assessment is solely based on the impact of the tariffs. So apologies if we are overlapping with Das, who provides a wide-ranging and therefore sobering tally of the ways life as we recently knew it is starting to come apart, from misguided US sanctions and now Trump tariffs to whistling past the graveyard of climate change and COVID costs. The piece is worth reading alone for the last estimate, which for the US is on a par with the damage done by the 2008 financial crisis. Rounding out the list are rising international hostilities, and with them, defense spending, as the “rules based order” which sometimes was able to prevent worst outcomes, is also fracturing due to US high-handedness and self-dealing.

One mild sour note is Das not distinguishing between the debt of currency issuers like the US versus currency users like France or countries which are formally currency issuers but are not monetarily sovereign by having significant dollarization or other foreign currency exposure, typically via bank or other private sector borrowings. But with Team Trump being deficit obsessed, as well as destroying real economy productive capacity, MMT lessons are pearls before swine.

By Satyajit Das, a former banker and author of numerous technical works on derivatives and several general titles: Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives  (2006 and 2010), Extreme Money: The Masters of the Universe and the Cult of Risk (2011) and A Banquet of Consequence – Reloaded (2021). ). His latest book is on ecotourism – Wild Quests: Journeys into Ecotourism and the Future for Animals (2024). 

Part 1 of this two-part series looks at the factors which may make a new financial crisis inevitable. Part 2 will look at the transmission of shocks, resilience and the capacity to respond to contain a new emergency.

 

A new financial crisis is close. The surprisingly durable era of hyper-financialisation faces its most severe test to date from a confluence of economic and financial conditions allied to rising geopolitical and environmental pressures. The lack of resilience and limited capacity to respond are compounding factors.

Investors and policymakers are remarkably complacent reflecting their experience of rapid recoveries from previous reversals which ultimately proved profitable opportunities to buy assets. This confidence is unjustified. Excessive optimism underlies high risk thinking. Fyodor Dostoyevsky thought that “it takes something more than intelligence to act intelligently.”

Trumpian Economics

The primary catalyst is the new US administration actions, which are rooted in victimhood. Apparently the European Union was created with the purpose of “screwing the US”. In his 2 April 2025 statement announcing reciprocal tariffs, President Trump declared “economic independence” lashing out at “foreign cheaters… and…scavengers” who had taken advantage of America. The answer is tariffs – a beautiful word in the limited Trump vocabulary – which will restore America greatness, bring back manufacturing, lower inflation and even make income taxes redundant.

Channelling Alice in Wonderland’s Humpty Dumpty’s “when I use a word …  it means just what I choose it to mean”, the White House spokesperson stated that tariffs are “a tax cut for the American people” – something hitherto unknown in economic circles. Other administration officials claimed that the tariffs would be a $600 billion tax rise, about 2 percent of GDP and one of the largest in US history increasing the federal tax share to over 19 percent of output, above the average since 1975 of 17 percent. This decrease in individual and business income  combined with the Elon Muck led DOGE job cuts and other austerity measures will be economically contractionary.

Internationally, if implemented, the tariffs may trigger a trade war as other nations respond in kind. Irrespective of the details, average tariffs rates are going to rise, perhaps to levels of the 1930 Smoot-Hawley Tariff Act which led to a sharp contraction in global trade and worsened the Great Depression. The exposure now is greater because global trade in the 1930s was lower. US imports then were 3 percent of GDP against 13 percent currently.

The US administration’s economic advisors believe that foreigners will absorb the tariffs to maintain access to US markets, the largest in the world. They rely on the 2016 experience when a strong dollar partially offset the impact of tariffs. But, in one of many policy inconsistencies, the Trump administration wants to weaken the dollar whose strength is reducing American export competitiveness.

Other Trials

The international monetary system is in crisis. There are around 28,000 sanctioned entities or individuals in Russia alone. There are sanctions on Iran, North Korea and China as well as the usual African and Asian suspects. The US has used these measures to gain extraordinary extra-territorial powers. Secondary sanctions are especially pernicious. If a third party deals with a sanctioned party, where it has no prohibitions on such transactions, then payments in dollars flowing through the American payments system creates sufficient nexus making it liable to prosecution for breaching US sanctions endangering any US assets.

Following its invasion of Ukraine, the US and Europe froze $300 billion in Russian overseas assets, including central fund reserves. The legality of these actions is uncertain. Moscow has retaliated forcing Western businesses to sell Russian assets at a substantial discount (50 to 60 percent) and pay an exit tax on the proceeds (15 to 35 per cent). Foreign firms have suffered over $170 billion of losses as a result. Banks from countries like Russia have been excluded from the SWIFT international payment system.

One measure under consideration to devalue the dollar and address America’s unsustainable public debt is to forcibly convert some US treasuries into one-hundred year (century) bonds or perpetual (no maturity date) securities with low or zero coupon. This would constitute a technical default. If such a measure is even seriously contemplated, then investors would accelerate sales of holdings of US Treasuries and dollars. Foreigners own around own $7 trillion of US Treasuries, $5 trillion of US corporate bonds and $19 trillion of US equities. The result would be large interest rate increases, falls in the value of the dollar and chaos in money markets.

Despite the challenges, there is now serious interest in reducing the role of the dollar through alternative payment systems and broadening reserve currency options. Increases in the gold price, in part, reflect central bank demand to reduce their dollar reserve exposure. The ‘sell America’ shift, already under way, will cause serious disruption and instability.

The climate crisis continues to accelerate. The UN’s World Meteorological Organization recorded 151 unprecedented weather events in 2024. America’s NOAA’s National Centres for Environmental Information (probably slated for closure by the Trump administration) logged 27 individual US weather and climate disasters with at least $1 billion in damages, costing was approximately $183 billion. The global cost is probably five to six times this and significantly underestimates the true cost. This will require budget sapping spending. Global climate adaptation costs estimates range from $1.7 to $3.1 trillion annually by 2050, as well as $38 trillion by 2050 to tackle the effects of committed climate damage. This is additional to spending on emergency relief and migrating energy systems away from fossil fuels.

The pandemic never went away with new variants of the SARS-CoV-2 virus regularly emerging. The cost of long Covid (lost quality of life, reduced earnings and medical expenses) in the US alone, which affects up to 30 percent of people infected, is $3.7 trillion. This equates to roughly $11,000 per American or about 17 percent of pre-COVID US GDP and rivals in aggregate the cost of the 2008 Great Recession. The global long-term losses will be larger. New pandemics, such as avian flu or an easily transmissible mutation of haemorrhagic infections like Ebola, cannot be discounted, especially as governments are scaling back spending on disease control.

A Bloody Peace Dividend Reversed

The geo-political environment is unfavourable. The relative prosperity since the early 1990s owed much to the ‘peace dividend’ following the end of the first cold war.

While there were bloody and costly wars in the Middle East, Afghanistan and Africa, limits to great power rivalry allowed globalisation of trade and capital flows. Nearly 4 billion consumers and 1.5 billion low wage workers, some highly skilled, entered the international economy. Relocating production to cheaper locations reduced costs lowering inflation. Cross-border capital flows from countries with high saving rates and trade surpluses lowered interest rates allowing cheaper and larger borrowings. Corporate profits benefitted from expansion of markets and lower costs. Even a flagging Chinese economy is the largest driver of economic activity currently contributing around 30 percent of global growth.

Reduced defence spending funded lower taxes and other government spending. Europe was able to redirect €4.2 trillion in funds over 30 years.  UK  defence spending fell from around 4 percent in the 1980s to around 2 percent by 2021. USmilitary spending declined from 6 percent to 3 percent of GDP.

Today there are expanding hot wars in Ukraine and the Middle East. Ignored conflicts in Myanmar, Congo, the horn of Africa and the Sahel continue. Confrontation in the Far East and the South China Sea is possible. A new cold war between the US and its allies and Russia and China has commended. Geo-political flux means higher defence spending requiring diversion of funds. Europe plans to spend up to €800 billion on rearming. Additional global spending may reach $3 trillion per annum reversing the peace dividend. It also means a retrenchment of globalisation. Higher levels of disruption are probable with implications for commodity prices, especially for energy supplies and prices.

The Western rules based international order, which its proponents invoke when it suits their agendas, is disintegrating. International bodies, such as the United Nations and the International Criminal Court, have lost authority and credibility. America and its allies acquiescence in the Gaza genocide and Israeli territorial expansion will have long-term consequences. A return to earlier asymmetric warfare against Western citizens and assets is possible. If the mighty do as they please, then the weak will fight back with available means.

Within countries, the rule of law is fractured. The US administration’s assertion of executive power and disregard of judicial authority threaten a constitutional crisis. Western liberal democracies are increasingly ungovernable. They are normalising autocracy, adopting techniques associated with once criticised authoritarian states such as undermining the checks and balances of an independent judiciary, public service and press, persecuting political opponents, and surveillance of citizens.

The immediate concern is a sharp shock in economic activity and income as well as breakdowns in supply chains with resulting disruption and higher prices. A full-blown trade war alone between the US and its trading partners could cost $1.4 trillion with serious consequences for interconnected economies. The other factors combined with an aging population and slow productivity improvements will drive long-term stagnation.

Jenga Games

In parallel, the global financial system is now dominated by debt and speculation. It is a precarious Jenga game where progressive removal of safeguards have created a more unstable structure vulnerable to even small disturbances.

Central to this fragility is global borrowings, much of it by governments since 2008, which has reached around $315 trillion (330 percent of world GDP) up around a half from around $210 trillion a decade ago. Debt is temporary capital. Inability to meet interest and principal commitments threatens financial distress. Where true risk capital, like equity, is a soft bed, debt is one of sharp nails.

Debt should ideally be serviced from cash flow generated by the spending. But household borrowing primarily funded consumption. Corporations borrowed to finance share buybacks or mergers and acquisitions rather than investment in research and development and new production facilities. Investors used debt to leverage purchases of existing assets to increase returns. Government borrowed to finance recurrent spending.

The productivity of debt is measured by the Incremental Capital-Output Ratio (ICOR), the ratio of investment to growth. High ICORs signify low productivity of capital or low marginal efficiency of capital. Global ICOR is currently around 4 to 5 meaning an additional $4 to $5 dollars of debt is needed to generate $1 of additional GDP. The US, Europe and Japan are probably around that average. This compares to an ICOR ratio of around 2 in the 1950s. China’s ICOR is around 9, up from around 3 in 2007.

Over and above explicit borrowings, the financial system has significant embedded leverage, where financial engineering increases loss intensity for a given event. Digital or binary options (which if triggered have an agreed fixed payout independent of price movements) allow sellers to trade-off large losses in the event of a remote event occurring and a larger premium received. Junior securities in a securitisation have similar leverage to corporate financial distress. In the case of a few defaults, an investor diversified across an entire portfolio of loans would suffer small losses. If they are invested in the riskier equity or subordinated debt tranches that bear first losses in a securitisation of identical obligations, then the same number of delinquencies would result in large losses or the entire investment being wiped out. These techniques disguise often sizeable exposures to a particular market move or financial event.

Questions of Quality

 

Valuations of stocks and real estate are elevated. There is a systematic decline in the quality of public and private securities.

The creditworthiness of borrowers has deteriorated. Amongst sovereigns, only Australia, Canada, Denmark, Germany, Luxembourg, Netherlands, Norway, Singapore, Sweden, and Switzerland are AAA rated currently by all major credit rating agencies. There are only two AAA rated corporations – Johnson & Johnson and Microsoft.  Corporations now target a bare investment grade rating (around A/ BBB) adjusting their balance sheets with more debt to lower their cost of capital making them more vulnerable to economic slowdowns.

The majority of highly rated securities are asset-backed securities (ABS) created by securitising mortgages and corporate, usually non-investment grade, loans.  The high rating relies on subordinated securities absorbing first losses on the underlying asset pool based on models using estimates of future default rates, losses given default and correlations between defaults, none directly observable. There are no known cash losses on AAA rated ABS but a weak economy and rising defaults will reduce subordination levels driving ratings downgrades and wider credit spreads with consequential falls in value.

Securitisation structures, that proved toxic in 2008, have re-emerged under new branding. Outstandings of CLOs (collateralised loan obligations) and SRT (synthetic risk transfer) are around $1 trillion each. While advocates argue that they are less egregious than the earlier models, they remain untested in a serious downturn.

Public equity quality has declined. There is significant concentration risk with the US now constituting over 60 percent of global equity indices before its recent declines. 26 stocks, primarily technology firms, account for half the entire value of the S&P 500 index. Many companies have no earnings or barely enough to cover their interest bills.

There is over $12 trillion of private equity and debt investments in businesses, real estate and infrastructure encouraged by abnormally low costs of capital and abundant liquidity. The higher returns claimed necessitate additional risk taking, including greater leverage and lack of liquidity. Another concern is the lack of transparency, especially the valuation of these private investments which have not fallen as much as corresponding public peers. There are suggestions that private valuations, derived from successive funding rounds, transactions between private investors or internally between funds managed by the same asset manager, or models have deferred adjustments in anticipation of a recovery.

Recent transactions illustrate the dysfunction. In an interesting parallel to WeWork (a real estate business masquerading as a technology firm), CoreWeave is an equipment rental business that purchases Graphics Processing Units (GPUs) in-demand for AI applications from Nvidia and rents them to users. The business model is predicated on the current scarcity of Nvidia chips. Analysis of its operations reveals a reliance on sales to two main customers, a close relationship with Nvidia (an investor in the company), uncertainty around the rate of depreciation and obsolescence of the chips and significant borrowings. CoreWeave’s March 2025 initial public offering sought to issue shares totalling $2.7 billion at $47-55 each. The transaction only raised $1.5 billion at $40 per share of which $250 million was a last-minute order from Nvidia. Three investors took up 50 per cent of the offering. The underwriters had to allegedly intervene to avoid the shares falling below the issue price on its first day of trading.

The concern is that values of some private securities currently are overstated and may have to written down if markets turn down.

Bovine Gatherings

 

Investment and trading are focused on few strategies.

The preponderance of passively managed exchange traded funds (ETFs), which track major indices, have created homogenous, momentum following markets. Over-weighted, liquid, large stocks benefit disproportionately from forced buying by ETFs and other funds which track indices to some degree, who have no investment discretion increasing the risk of price bubbles. Passive fund managers, reliant on lowering costs, emphasise scale exacerbating concentration. Markets are dependent on flows from a few large passive products.

Active investors, whether guided by fundamental or quantitative analysis, are clustered around the same crowded trades. This is compounded by the prevailing ‘risk-on or risk-off’ approach – when perceived risk is low, investors purchase higher-risk investments reverting to safer investments if risk increases. This reduces the benefits of diversification as price changes across risky and safe assets are highly correlated.

Herding behaviour is evident with participants placing similar bets. Common strategies involve highly leveraged treasury basis trades (arbitraging small price differences between bonds and bond futures), carry trades (borrowing in low cost Yen or Yuan and buying higher yielding currencies or assets) and wagers on stability (selling options for modest premia against the risk of large loss).

The financial system is now a long inter-connected chain complicated by the rise of lightly regulated and opaque shadow banks. whose share of global financial assets in 2022 was around 47 percent, up from 25 percent in 2007-08, compared to conventional banks’ 40 percent. The majority of transactions are routed via a few large dealers, investors and central clearing counterparties for derivatives. All participants rely on near identical models to quantify and manage risks. What could go wrong?

Tinderbox

The line separating investment and speculation is ill defined. All periods of expansion thrive on large doses of easy money which provides investors with effortless and seemingly riskless profits. Recalling the post-US Civil War age of unfettered growth, Thomas Mellon observed: “It was such a period as seldom occurs and hardly ever more than once in anyone’s lifetime…. In which it was easy to grow rich. There was steady increase in the value of property and commodities … One had only to buy anything and wait, to sell at a profit; sometimes … at a very large profit in a short time.” The expansion of credit over the last four decades rewarded speculation and created a fake prosperity for some.

Such unsustainable conditions must like our revels end. As Fred Schwed wrote in Where Are the Customers’ Yachts?: “When “conditions” are good, the … investor buys. But when “conditions” are good, stocks are high. Then without anyone having the courtesy to ring a bell, “conditions” get bad.” That is now happening. The trigger for the final tumultuous phase of the unravelling is unknown. As Mao Zedong understood: “a single spark can start a prairie fire”. It could be a recession, credit losses, share price falls, failure of a trading strategy, a large corporate failure, fraud or a geopolitical event. The world today is a tinderbox.

© 2025 Satyajit Das All Rights Reserved

This piece draws on material first published at the Nikkei Asian Review and New Indian Express. These pieces are co-published by the New Indian Express Online and NakedCapitalism.com.