Big Shorts & Failed States
If you don’t think a movie about finance can be a hell of a lot of fun to watch, then you haven’t seen The Big Short. It’s based on the true story of some crazy finance guys who made a fortune betting against the stock market before the 2008 crash. They sailed straight into the gale-force headwinds of the “prosperity forever” psychology, because they had seen fundamental weaknesses in the market that most people missed.
The 2008 crash was the first time I had ever heard of the verb “to short” something, in a financial sense. It means to put yourself in a position to profit if the thing you’re “shorting” fails. It is to gamble on failure. In this fascinating, anger-making piece in the current New Yorker, Nick Paumgarten writes about investors shorting this or that during this current pandemic-driven crisis. Excerpt:
I asked Mohamed El-Erian, the longtime co-chief investment officer at pimco, the world’s biggest bond fund (he now advises Allianz, pimco’s parent company), about the confidence of the Fokkers and the would-be Teppers. “It’s idiotic,” he said. “Well, I shouldn’t use that word. This notion of a V, of a quick bounce back to where we were before—people don’t understand the dynamics of paralysis.”
He said, “This is much bigger than 2008. 2008 was a massive heart attack that happened suddenly to the financial markets. You could identify the problem and apply emergency remedies and revive the patient quickly. This is not just a financial stop. This is infection all over the body, damage to virtually every limb and organ. The body was already so fragile. Those of us who have had the privilege of studying failed states have seen this before, but never in a big country like the United States, let alone a global economy.”
He went on, “In the financial crisis, we won the war but lost the peace.” Instead of investing in infrastructure, education, and job retraining, we emphasized, via a central-bank policy of quantitative easing (what some people call printing money), the value of risk assets, like stocks. “We collectively fell in love with finance,” he said. Apparently, we’re still in love.
Last Thursday, amid news that another 6.6 million Americans had lost their jobs, the Fed announced the infusion of an additional $2.3 trillion, including hundreds of billions to purchase corporate debt, ranging from investment-grade to junk: big dirt. Stocks surged anew. The Fed was propping up risk assets again, at a scale that dwarfed the interventions of 2008, and the bankers were back, hats in hand. They get paid like geniuses, and yet, every ten years, they need bailing out.
Notice the words “failed states.” He’s talking about the US as a failed state. All nations, really. And notice that what the central bankers are doing now is massively larger than the 2008 intervention, which at the time beggared belief. I think that most of us really haven’t come to terms yet with the immensity of what’s happening, in part because we have nothing to compare it to — almost nobody alive today can remember the Great Depression, except as a child. During the Great Depression, the unemployment rate topped out at 25 percent. Nobody knows whether it will get that high in this crisis, but consider this: in the 2008 crash, 8.8 million Americans filed for unemployment; today, 22 million have done so already, and this thing is not nearly over.
Moreover, back then, there were villains: reckless people — bankers, regulators, politicians — pushing easy money. It is somehow easier to cope with psychologically if you can blame somebody, and say with confidence that if ____ and ____, and especially ____ had done their jobs, we wouldn’t be in this mess. Today, the villain is a virus. True, they great global villain in all this is Xi Jinping and the Chinese Communist Party — never forget that. And it is also true that almost no national governments prepared adequately for this crisis. Donald Trump’s maladministration has been particularly lacking, but many other leading industrial countries haven’t fared significantly better. My point, though, is that this is far more like a natural disaster than a man-made catastrophe, as in 2008. I’m not sure psychologically if that buffers the shock better — that, and knowing that the economic pain is necessary to save lives.
Paumgarten ends his piece by saying that truly, nobody knows anything. Nobody knows how bad this is going to get. Everybody’s talking about the astonishing collapse in oil prices today: futures contracts on West Texas Intermediate crude, the American benchmark, went into negative territory, signaling that oil producers will have to pay people to store their oil. With the economy crawling at nothing, and with most people staying home, we’re not burning oil. When it costs more to produce oil than leaving the oil fields alone, they will cease production. In a state like Louisiana, where I live, it is hard to wrap one’s mind around what will happen without oil production, on which so much in this state depends. You might think, “Woo-hoo, cheap gas!”, but the cost of that cheap gas is economic catastrophe for millions. How will the state fund the public health system? The public universities? Road-building? And on and on, throughout every sector of the economy.
And that’s just one industry.
Let’s say the government opens up the economy. Do you really think everyone is going to go back to business as usual with this virus still raging? I’ve written here before about Pastor Tony Spell, the Baton Rouge area Pentecostal preacher who has made a national name by declaring himself a religious liberty crusader. He denied at first that his congregation was at risk of coronavirus, and then said that if the virus came for them, that they would greet death as a “welcome friend.” Well, well, well: last week, the parish coroner ruled that one of Spell’s elderly congregants had died from Covid-19. Spell denounced the coroner as a liar. This past Sunday, attendance at Spell’s cavernous megachurch fell off from around 500 the previous Sunday to 130, according to police monitoring the situation. The pastor denounced police as liars, but the truth is more likely to be that most of Spell’s flock is waking up to the fact that this thing really can kill you.
So, how many people are going to return to bars and restaurants, even if they are allowed to do so by the government, if the risk of sickness and death remains? It’s simply false to assume that the only thing keeping the economy ground to a near-standstill is government policy.
Until and unless we have a vaccine, or at least more effective treatments for the virus-sick, we are going to be mired in economic disaster. Some states will fail. We should not assume, as we magically-thinking Americans often do, that God is going to protect us from history. For decades before his death in 2015, I joked with my dad that I wouldn’t sell the land he planned to leave me in the country, because I would want to have a rural place to live if everything fell apart. Well, for the first time ever, it doesn’t seem like a joke.
What would it mean for the United States to become a “failed state,” do you think? That our government will be unable to meet its obligations, and collapse? That’s what happened to the Soviet Union in the 1990s, which was a horrifically traumatizing time for its people. If you want to understand why so many Russians turned to Vladimir Putin at decade’s end, you have to understand how grueling it was for ordinary people to live through the ruins of Communism’s collapse. Putin consolidated his popularity by going after the post-Soviet oligarchs who enriched themselves amid mass poverty and suffering. Of course he became the biggest oligarch of all, as these figures always do in history. The point is that there is only so much “failed state” that people can put up with before they are willing to back a strongman who promises to put things to right. The kind of people Nick Paumgarten writes about in his piece are not going to be safe in the era to come if they are seen as profiting while the masses suffer.
Or maybe not. Russia still has oligarchs, after all. Maybe the post-pandemic economic future belongs to the smart guys who can figure out which side to short. The scary thing is that when post-Soviet Russia became a failed state, there were plenty of safe places to go, and to put your money: Western countries, which operated under the rule of law. What if the Western states fail this time? Nobody really knows. But given the facts on the table, you’d have to be blind not to see that possibility. And more: the opening quotation of my next book is this, from Solzhenitsyn’s introduction to the 1983 edition of The Gulag Archipelago:
“There always is this fallacious belief: ‘It would not be the same here; here such things are impossible.’ Alas, all the evil of the twentieth century is possible everywhere on earth.”
Civilizational order is a fragile, fragile thing.
UPDATE: Reader Lawbooks10 posts:
I continue to be amazed by the parallels of this situation to the First World War. I don’t think most people have wrapped their heads around the enormity of what all this means. I’ve been aware for weeks on an intellectual level, but I work in the oil and gas business, and even though I’m still employed right now, I just today started to really process the fact that my career is probably going to be vaporized. I’m likely looking at long-term unemployment. I continue to believe that this event is the 21st century’s First World War – this event is going to destroy all the assumptions that we have about the world, the future, how our lives will go – comfy middle-class lifestyle, college/career/retirement, etc. If my kid was a junior or senior in high school, am I going to send them off to college to take out debt, or pay for it myself, with this uncertainty? Lord no! And this event is going to accelerate all the pre-existing financial problems we had, with the federal debt and entitlement programs like Social Security, etc.
Not only will the economic fallout be catastrophic, but we lack the social cohesion and individual hardiness to weather it. My grandmother lived on a rural farm in east Texas during the Depression; her family was poor anyways. They didn’t expect to be materially well-off or comfortable. We do. So how we do come to terms with that changing virtually overnight?
I think basically everything is on the table. Here at home, social unrest, rioting, civil war, even the dissolution of the United States. Globally, the collapse of supply lines and trade routes, the largest human migrations in centuries (it will make the 2015 Syrian refugee wave look like a drop in the bucket), chaos in many parts of the world, collapsed states, conflicts over natural resources, etc.
It’s going to be very ugly.
My God, not two minutes ago, I was standing in the kitchen putting on some rice, thinking about a German miniseries I’m watching now, “Heimat,” which starts out in 1919, with the return of a village man, Paul, from the front. By the time the first two hours are over — the narrative takes you through to 1927 — Paul has cracked, and abandoned his wife and young children, and village. But you can tell from the opening scenes, when he arrives back in the village, that something very deep has cracked inside him by what he has seen at the front. Everything that made his life rational to that point has been vaporized. He came unstuck. I was thinking, “What if this is what has now begun to happen to us?” And then I sat down to approve comments, and read that Lawbooks has been thinking of the same thing.