Look Out Below

I’ve been humming It’s the End of the World As We Know It for the last couple of days, and having 2008 flashbacks. Although a much attention has been on the US, the real epicenter is in Europe–though the US will not be immune, and is in poor shape to withstand the shock.

Europe is experiencing, I think, its Wile E. Coyote moment. It has been levitating over the chasm, for a lot longer than Wile E., actually. But with Italy and Spain in dire straits, and Greece, Ireland, and Portugal well-known basket cases, economic gravity is about to reassert itself.

Runs, be they on banks, currencies, countries, or romantic (but unnatural) supernational groupings, are coordination games, with multiple, self-fulfilling equilibria. The global games literature shows the role signals that agents get about the economic circumstances of the bank or currency, etc., play in sparking runs. Small changes in these signals (which are noisy representations of the fundamentals) can induce discontinuous changes in behavior by millions.

To some–like the old goat who is the Italian prime minister–the discontinuity of these changes demonstrate that “the market is wrong.” The abrupt shifts are no doubt disorienting to politicians and policy makers. But it’s not like there isn’t precedent–and it demonstrates the dangers of trying to skate by and avoid making fundamental changes that would appreciably reduce the likelihood of wandering into the run risk zone.

It may be well too late, coming as it has in a week when US government debt (the official stuff, not counting the countless zillions in government liabilities that aren’t in the calculation) breached 100 percent of GDP, but one would hope that American policymakers are taking serious notice. One would hope–but hopes like these are made to be disappointed, I fear. Europe is playing Ghost of Christmas Future. We should take heed, but probably won’t. The debt deal charade, and the hyperbolic reaction of the left to it (e.g., Rep. Doyle’s lament that the evil Tea Partiers have left the government without “any money to spend”, give or take $4 trillion) and the impending election mean that nothing serious will be done voluntarily before 2013.

Too many are taking solace in the fact that interest rates on US debt remain low–and indeed, are going lower as money flees Europe. But the European experience shows, yet again, that these things can turn on a dime. Or a trillion or two.

The aftershocks are being felt everywhere. Japan is playing beggar-thy-neighbor with its currency. Moreover, these events put a particularly interesting twist on Putin’s recent tirade before a Nashi audience about the parasitical US.

One consequence of the market shock has been a steep decline in the price of oil. Brent crude is down about $10/bbl in the last two days. A sustained economic downturn would put further pressure on the price.

Putin’s electoral strategy is to use oil rents to promise all sorts of goodies, including both guns and butter–a huge defense procurement binge and higher social spending. It is likely that this would be reversed post-election, as even with $120 oil these promises are unaffordable. Putin thought he was in fat city with turmoil in the Middle East and emerging market growth propping up the price. But now he realizes that–yet again–his grandiose plans are hostage to things outside of his control.

No doubt, like me, he is having very unpleasant flashbacks to 2008, when his dreams last came crashing to earth due to economic turmoil in the US. You know it just makes him hysterical to realize that he is at the mercy of the US. That his fate is driven largely by a country and a society he despises.

Put differently: if the US is parasitical (and there are certainly parasitical aspects to US policies, although the main host is productive Americans), then Putin and Russia are little more than parasites living on the bigger parasite.

No, Vladimir. There will be plenty of pain to go around. You no doubt will rage at the injustice of it all. But few will listen, as they will have their own problems to deal with.

• Become A Funded Futures Trader