Belmont Club

The White Swan

The Associated Press says that the European Central Bank is considering the purchase of Italian government bonds to help that country get lower rates on the market. The Italian crisis, together with the US credit downgrade, has raised the possibility that stocks will continue to fall when the exchanges, according to the Telegraph. “The hope is that central bankers and world leaders can agree co-ordinated action to avert a new global financial crisis before trading begins in Asia.”

But Der Spiegel, a German news magazine, said it was doubtful that Italy could be rescued. At 1.8 trillion Euros in size, the Italian debt was simply beyond the ability of the current system to protect. Meanwhile David Axelrod, a former White House political adviser, claimed that S&P’s downgrade was based on poor math. It was a nod, he said, to political pressure. “The fact of the matter is that this is essentially a Tea Party downgrade,” he declared. “That clearly is on the backs of those who were willing to see the country default.”

Paul Ryan on the other hand, said the administration was derelict — and still derelict — in its handling of the debt problem. “The president’s February budget deliberately dodged the tough choices necessary to confront the threat of runaway federal spending. It was rejected unanimously in a Senate controlled by his own party.”

The math is scary, yet simple: In the years ahead, spending on programs such as Medicare, Medicaid and the Democrats’ new health-care entitlements is projected to skyrocket relative to the size of the economy, even as federal spending on everything else is projected to decline (see the nearby chart). …

The CBO’s latest Long-Term Outlook in June estimated that total tax revenues would have to double by mid-century in order to finance our current spending path. Health-care costs rose about 8% in 2011 and are projected to rise by 8.5% in 2012. At this rate, taxes would have to rise again and again just to keep up with health-care spending. Is it any wonder that the president and his party are afraid to produce a budget that requires such ruinous levels of taxation? …

Even the president seems to understand that the status quo of these programs is unsustainable. As he put it during a press conference on July 11, “If you look at the numbers, then Medicare in particular will run out of money, and we will not be able to sustain that program no matter how much taxes go up.”

Unbendable Curves

Shortly after the 2008 financial crisis the Telegraph wrote an article on Naseem Taleb and his concept of the Black Swan.  But he described another kind of bird in his menagerie of contingencies, the disaster in plain sight. The White Swan. Taleb argued that policy makers lived in a world imprisoned by their own conventional wisdom. It was:

a fantasy world in which the future can be controlled by sophisticated mathematical models and elaborate risk-management systems. Bankers and economists scorned and raged at Taleb. He didn’t understand, they said. A few months later, the full global implications of the sub-prime-driven credit crunch became clear. The world banking system still teeters on the edge of meltdown. Taleb had been vindicated. “It was my greatest vindication. But to me that wasn’t a black swan; it was a white swan. I knew it would happen and I said so. It was a black swan to Ben Bernanke [the chairman of the Federal Reserve]. I wouldn’t use him to drive my car. These guys are dangerous. They’re not qualified in their own field.”

Like Europe the US seems locked into a course which inertia cannot change and yet which ultimately will lead to ruin. In the history of politics the choice has often been between rationality and ruin. Alas, ruin usually wins.

Update: The WSJ Journal reports that the ECB has now moved on step closer to a last ditch effort. “European Central Bank officials on Sunday evening will weigh whether to purchase government bonds of Italy and Spain on a massive scale, according to people familiar with the matter, a move that would mark the most dramatic, and controversial, escalation of their nearly two-year effort to stem Europe’s unfolding debt crisis.”

The crisis has now moved online. “Sunday’s meeting, expected to begin in the early evening via a video conference, promises to be contentious. The 23-member ECB board was already divided along north-south lines on limited purchases of Irish and Portuguese bonds at the ECB’s meeting last week. At least three central bankers from Northern Europe, including the ECB’s powerful German contingent resisted the move, the people said.”

CNN reports that Timothy Geithner is will attend a teleconference meeting with G7 finance ministers. “The talks expected to occur before Asian markets open for Monday trading follow Friday’s downgrade of the U.S. credit rating to AA+ from the top rank of AAA. It was the first time in history the nation was rated below AAA.”

Events are now moving faster than the stately pace of jet travel can keep up with. The first markets to open provided a gloomy prognosis for Monday’s opening bells in Europe and the US. “Middle Eastern markets that were the first to open since the downgrade were sharply lower on Sunday. Israel’s market temporarily halted trade at one point and finished down more than 6%, while the Dubai Financial Market (DFM) General Index fell more than 5% for its biggest drop since January.”

The debt crisis in the United States, including the downgrading of the U.S. debt rating by a major agency, had a negative impact on the first day of the trading week in the Middle East. Stock markets in Dubai and Egypt dropped about four percent, and the effects were even worse in Israel. VOA reports:

The Tel Aviv Stock Exchange delayed its open by 45 minutes to avoid panic but it did not help. The market plunged by seven percent in response to the downgrade of the debt rating in the United States.

“It is a powerful shock,” economist Yaakov Sheinin told Israel Radio. He said U.S. President Barack Obama and the Federal Reserve should do something to calm world markets.

Bloomberg reports that “The $2.9 trillion municipal bond market is preparing for “hundreds and hundreds” of downgrades after Standard & Poor’s lowered the U.S. one level to AA+, the first-ever reduction for the country. … The aftermath of the U.S. downgrade and possible municipal rating cuts may further deter investors from buying local government debt … Investors withdrew about $861 million from U.S. municipal- bond mutual funds in the week through Aug. 3, according to Lipper US Fund Flows. It was the second straight week of outflows and the biggest since April.” I guess Axelrod is really going to start calling the Tea Party names now.

Further Update:

The ECB bit the bullet. “(Reuters) – The European Central Bank will intervene decisively on markets to protect Italy and Spain from an accelerating debt crisis, a monetary source said on Sunday, indicating it would buy government bonds of the euro zone’s third and fourth biggest economies.

The agreement of the bank’s policy-making Governing Council marked a watershed in the ECB’s fire-fighting after modest bond buying efforts last week failed to stem contagion to the currency bloc’s larger economies.”

Now the question is: what happens if this doesn’t stop it. Can anything kill Godilla? Is it possible? Is it …

The actions of the finance ministers suggest they know that a potential perfect storm is brewing. And they are battening down the hatches and pretending they can do something, but deep down I think they know they can only hope for the best. One of the cliche moments in the old movies was when the protagonists turned to each other after observing the onset of the enemy and said, “well, this is it.”

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