Provisional
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Essays | May 9, 2007
save to del.icio.us Thin Paper Line
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A recent study
funded by the Pentagon concluded the U.S. Army was stretched to its
limit, a “thin green line” as the media have taken to calling the
controversial conclusions of this report, referring to James Jones's
1962 novel The Thin Red Line. The novel's title is derived from
an old Midwestern saying that “there's only a thin red line between the
sane and the mad.” War, accurately portrayed in his book and the 1998
movie, seems to stretch that line almost to the breaking point, as any
combat veteran would know.
Our thin
paper line is the world's financial and monetary system – in
reference to the paper-based nature of world financial markets. It's
what separates global economic prosperity from catastrophic financial
depression.
If energy is
the world's blood supply, its complex monetary system and sophisticated
financial markets make up the world's nervous system. It is becoming
increasingly apparent that there exists only a thin paper line between
the sanity of economic stability and the madness from a breakdown of the
world's nervous system.
The world is
awash in paper assets: stocks, bonds, mutual funds, IRAs, 401(k)s,
pension funds, insurance policies, currencies, options, futures, swaps,
derivatives, commodities, bank deposits and money market funds to name a
few, the values of which each day are measured by the prices and terms
to which buyers and sellers have agreed.
Perhaps the
best example is in your wallet. Pull out a dollar bill. It is worth
$1.00 only because we currently agree that it is worth a dollar,
which is because we currently agree on the amount of goods or value of
services that we are willing to exchange for that piece of paper. Back
in the day, U.S. currency represented a specific amount of gold or
silver for which the paper certificate could be redeemed. The U.S.
abandoned the gold standard in 1933 and silver in 1968, although in the
1900s only silver certificate dollars represented a like amount of
silver actually held by the U.S. Treasury to back the currency. Today,
nothing backs up the value of a paper (fiat) dollar save our
collective belief that it can be converted into its face value of
goods and services.
And how
significant are the world's paper-based financial markets? The word
“trillions” immediately comes to mind, as in hundreds of trillions of
dollars. For example, the face value of interest rate and currency
derivative contracts, financial products that didn't exist 20 years ago,
now top $200 Trillion. $17 Trillion in credit-default swaps, an even
newer development. And that's only some of the esoteric stuff. Start
adding up the value of global stock markets, bank deposits, government
and corporate bonds, insurance contracts, and such, and maybe we're
talking about a number that begins with a “Q” as in quadrillion,
and it's all paper.
So as we
painfully are made aware from time to time, our paper-based financial
markets represent the largest confidence games known to humankind, and
are subject to negative repercussions of tsunami strength arising from
what may seem only as pebbles falling into a pond, now at the speed of
light, the pace at which the electrons of the technological
underpinnings of our economic system traverse the globe.
It's the
“butterfly effect” of chaos theory illustrated, in which seemingly
minor, inconsequential events have major, widespread, profound effects,
such as: “a butterfly in China flaps its wings and tornadoes break out
in Oklahoma.” When applied to financial markets, it's more like: “a
second cup of coffee results in currency trading losses in Singapore
which causes a major London bank to fail, ultimately unemploying and
bankrupting thousands of workers in America whose employers' loans and
personal loans were called after stock market and real estate markets
crashed.”
Our financial
markets are so tightly wound, so finely tuned, so fragile, that only the
hint of trouble sends the buyers packing. Look at every
stock-market downturn, correction, retreat or crash in the last hundred
years and never was there a shortage of sellers – only buyers - which,
of course, is true of a correction in any commodity: bonds, gold,
real-estate, Beanie-Babies, you name it. And when it comes to our
nation's treasury bonds, we need those buyers.
China and
Japan, in particular, and other foreign-country “investors,” now own
more than half of this country's privately held treasury debt – more
than $2 Trillion, thanks to our insatiable appetite for imported goods.
The United States now is the largest debtor nation in the world. We
need our foreign investors to keep our economy afloat – perhaps
someday, if not already, more than they need us to buy their cars and
consumer electronics and baskets and cookware and sporting goods.
Imagine if
China, Japan and the Middle-East announced they merely were thinking
about scaling back their purchases of U.S. Treasury obligations which
they now buy with all the dollars they receive from us in payment for
imports ($310 billion, half of the 2004 total annual trade deficit). Our
bond markets would crash, resulting an immediate surge in interest rates
(bond yields), a stock-market sell-off and a drop in the value of the
U.S. Dollar compared with other currencies. And that would be only the
first domino to fall.
What if China,
who historically has been very friendly to our new favorite enemy Iran,
and today perhaps more so as a necessary source of oil, suggested to the
United States that it would not be in our economic interest to be the
Middle-East bully or to aid Israel if attacked by its neighbors? And if
we ignored China's thoughtful advice, what then?
The impact on
global financial markets would be immediate and catastrophic. Values of
all paper assets would evaporate in runaway deflation, while real assets
such as gold and commodities (but not real estate) would soar in price
until it became evident that no “paper” currency in any amount would be
sufficient to exchange for a “real” asset. At that point, like the
Weimar Republic of pre-Nazi Germany, paper assets become worthless and
barter – real assets for real assets – takes over.
We may believe
with misplaced confidence that other nations would not harm themselves
by harming us financially. It's an updated economic version, if you
will, of the Cold War concept of why neither the United States nor the
former Soviet Union would be first to turn the missile launch keys
because of the likelihood of the “mutual assured destruction” of each
country. We cannot, however, assume that these other nations would play
be the same, outdated rules that governed the half-century after World
War II.
The debacle of
Hurricane Katrina last year has offered a glimpse of the tenuous threads
that comprise the fabric of easy life in the United States, and how
quickly “civilized” humans descended into a survival mode that
encompassed lawlessness and violence under the cover of unaccountability
and self-preservation.
Perhaps we
should be glad some state legislatures have seen fit to insure that our
guns cannot be illegally confiscated by law enforcement during a period
of declared emergency. We may need them for our protection and
self-preservation if if the thin paper line ever is
stretched to the ripping point.
(Thin Paper Line originally was
published in February 2006, and has been revised with new
data.)
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