Sunday, March 4, 2012

Shark-fin Soup

One of my greatest professors – quite possibly the greatest – was Dr. Bruce Craig at Ball State University’s Human Performance Laboratory. Armed with the Gospel of Arthur Guyton he guided his graduate students through the labyrinth of neurophysiology with maddening precision and monotonic poise that conveyed complete command of one of the world’s most complex electrochemical systems. And to this day, there are few facts that he imparted that I would not be able to recite if I was under even the slightest duress. Under extreme pressure, I could regurgitate it all (including his not-so-P.C. quips that offended the more sensitive of his students). So it was, as I trudged through the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union which was heralded as a significant step forward for the stabilization of the Eurozone, I found myself wishing that at least one policymaker or economist would have been a classmate of mine with Dr. Craig.

Allow me to explain using a simple lesson in neuromuscular physiology. Most reflexes are dumb. Now, before you rush to judgment about this dismissive assessment, allow me to clarify. They are mindless, as it were. There a few things you learn about reflexes (and how they work) that support the empirical truth of this statement. When a stimulus triggers a receptor it causes a nerve membrane to go from its resting state (a -70mV charge) to an activated state (a +100mV charge). But, here comes the dumb part. That “all-or-nothing” stimulus goes racing up the nerve to the spinal cord where it executes a hardwired response – hyperactivating certain muscles and rendering others flaccid. At no point does the brain kick-in and say, “Hey, let’s think about whether our response is actually helpful or whether it might do more harm than the thing we’re avoiding.” No, the brain plays no role whatsoever. It just hangs out and hopes that nothing too catastrophic happens. Like the nerves that stimulate them, the muscles go through the same “all-or-nothing” response and respond with unmodulated, unconsidered, unconscious action. Tragically, having been thus activated, the whole system goes into a refractory state where the ions that flipped the switch on have to re-equilibrate during which time no movement can be effectuated. Now, if your reflex, let’s say, had you punch a shark in the nose to get it to swim away and it worked, you’re in luck. If, however the shark decides to chase you, well your myoneural refractory period will get you well acquainted with the digestive juices of a shark.

And here’s the kicker: the Member States of the European Union just punched a proverbial shark in the nose. The stimulus in this case was the on-going contagion that has rendered the Greeks, Italians, Spanish, and Portuguese as at-risk states (with debt to GDP ratios of 142%; 120%; 60%; and, 93%, respectively). In the treaty, 60% debt-to-GDP is the resting nerve state over which the reflex of this treaty is activated. But, as if to evidence the absence of a cognitive involvement to attenuate the reflexive error of the theory of this treaty, the Member State that fails to get its fiscal house in order is subject to a variety of penalties adjudicated in the Court of Justice. However, assiduously absent from this treaty is any sanction for the Member State(s) who aids in the reckless indebtedness of a State by PURCHASING debt issued by the violating state. During the week where the Chinese continued to alter their purchasing of U.S. debt realizing that our investment-grade status is not likely to re-emerge with the impotent policies of the present administration – to say nothing of the sheer madness coming from the leading contenders to make the Obama’s join the ranks of the jobless and homeless in 10 months – it’s particularly noteworthy to see the European leadership fail to lead. The Chinese know that part of fiscal discipline includes NOT BUYING what is toxic. It would seem obvious that this lesson should be self-evident to a Europe awash with banks that don't have Tier 1 capital courtesy of bad sovereign debt.

The central problem that this treaty fails to address along with all the other ‘trained-economist-proposed’ solutions that preceded it is the fundamental problem of decoupling credit from productivity. In the name of efficiency, our central bank and capital markets’ impulse that leads to capriciously setting interest rates on debt issuance based on political winds rather than actual economic productivity is the curse from which we can’t seem to escape. Uncorrelated returns – a necessary corollary to enterprise-ignorant debt – is the malignancy which, if supported by mindless purchasers will insure on-going fiscal malaise. We may stimulate. We may artificially manipulate interest rates. And like the stupid spinal reflex, we’ll get a twitch. But also like the reflex, without cognitive engagement in which rates and productivity are linked, we’ll continue to create debt instruments that are fundamentally unsubstantiated. And, as long as buyers can consume these debt issues without consequence, the crisis of confidence will spread its malignancy across the markets. So, get used to the digestive juices of sharks ‘cuz there’s some sharp teeth sneaking up behind us.

1 comment:

  1. Your reflex parable applies in a whole lot of other geopolitical contexts...good analogy!


Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave