Ambling Towards A Crisis?

After 2008, there was a small community who always predicted repeats of The Financial Crisis. The problem the doom-mongers faced was the back side of “The Minsky Cycle”: actors react to a crisis by reducing risk and taking steps to avoid repeating the exact same crisis. That was done throughout the financial system (including Canadian regulators who changed their housing market policies, which was my worry at the time). However, memories fade — and new ways to spawn a crisis pop up.

Financial crises of varying strength have popped up on a frequency of (roughly) once per decade in the United States since the 1960s (when the lingering fear of the Great Depression finally subsided). The COVID recession hit at about a decade after the Financial Crisis — and so we had another crisis that stood in for a financial crisis. The question one might ask is whether the clock is ticking. Although I am fairly permanently pessimistic, I still lean towards a financial crisis being delayed.

Fiscal-Induced Crisis

The big risk on the horizon is a fiscal “policy” induced recession/depression in the United States — although the issue here is literally a lack of a fiscal policy. Turning off SNAP payments, a large increase in medical insurance premiums, and the cutting of pay to many government workers could easily lead to a collapse in demand. There is a general sense of unreality in Washington D.C., and it is unclear to me when the government shutdown will end. That said, panic among politicians will probably set in once reality starts breaking into their information bubbles.

Since restoring order can be done rapidly, it is perhaps too early to panic. The problem is that economic data is also not being published, and so we are flying blind.

AI Bubble

I have written very little on the topic of so-called “artificial intelligence” (AI) on the basis that I thought it was a cute technology that would find some niche uses — but not lead to a revolution in economic activity from a macro perspective.

However, a macro issue is the investment spending on data centres. If optimism about the future of AI fades, that spending could crater. Although this would have an effect on the economic growth, there are important distinctions between it and homebuilding (which is usually at the centre of modern financial crises, although business investment is sometimes involved). AI capital-spending is not that a labour-intensive a process, nor does it involve a large number of shaky borrowers.

Financial crises usually involve lenders panicking and withdrawing funding. The tech bubble popped in the late 1990s when people no longer wanted to fund the 3G/optical fibre buildout, which was a global fixed investment wave. (The financial media focussed on the dot-com equities, which were a macro sideshow unlike the 3G/fibre buildout.) The news flow I see suggests that the AI buildout is being funded by incestuous vendor financing loops within the tech sector (which was a feature of the 1990s tech bubble). Although a failure of those projects might make investors in those companies sad, many of the firms involved are still cashflow positive from their other lines of business. As such, there is no reason for a hard landing resulting from AI concerns alone, rather a sectoral recession. More realistically, the main risk from AI spending is that it would be just another large casualty of a wider collapse in animal spirits for other reasons.

Crypto/Stable coins

I was always skeptical about the theory that crypto-currencies were going to revolutionise money, and I see no reason to believe that I was wrong. The crypto ecosystem created a new set of private “monies” that circulate as a betting scheme, and the system as a whole acts like a “currency” for a virtual economy that has almost no useful legal products and services associated with it. The ecosystem does not collapse because there are illegal products and services that crypto provides, and there are people pushing real money into the ecosystem. As long as those inflows continue, the show can go on.

Stablecoins are economically distinct from pure crypto currencies (like Bitcoin) — most appear just to be unregulated money market funds denominated in real currencies. Money market funds in principle are safe instruments — they are a pass-through that allows smaller investors to buy money market instruments. Problems with money market funds show up when unit holders rush to liquidate due to credit concerns. This pulls away funding from entities that funded themselves in the money markets, and thus there is a funding crisis.

The beauty of stablecoins is that they are so unregulated so that it unclear to me whether some of the assets that they allegedly own on the behalf of stablecoin owners even exist. To the extent that the funds were going to fraudsters, there’s not a whole of productive investment being funded by them. This means stablecoins are just a zero-sum transfer from buyers to sellers, and so the multiplier on losses is limited. Furthermore, the entities that put money into stablecoins are risk-seeking, and do not fit the behavioural profiles of traditional money market investors.

Inflation Book

I have been puttering away on my inflation book. I was unhappy with it, but upon rereading, I think my concerns were somewhat misplaced. I am now doing clean up that was necessitated by the passage of time, but things look good.

The problem of course is that it is unclear for how much longer the BLS will produce credible inflation data, which undermines a major premise of the book (that inflation data is credible, it just might not conform to what people expect).

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(c) Brian Romanchuk 2024