

In 1981 Jane Fonda, Kris Kristofferson and Hugh Cromyn were in a so-called financial thriller about the collapse of the world monetary system due to Arab oil monetary fears and self-preservation. Apart from the fact that I was younger and Jane Fonda was in it, the movie’s theme has haunted me for years. Looking on the web there are a few others like me, and if you do a search there is an interesting juxtaposition on youtube between the movie and the U.S. recent financial crisis. I don’t subscribe to the economic/political views of the producer’s of that video, although there is truth in everything. My prior post on contagion clauses reflects my view that in any crisis the most important element is time.

This brings me to the so-called pareto principle of 80/20; that which is important and worthy of attention is in the 20% cohort. In fact, the 20% group may be too large, as which is catastrophic, is often 1% or less, is most important, and is remote (or at least unpredictable). Life intervenes before the catastrophe, so other choices are made in lieu of catastrophic planning. When the catastrophe comes, there is little time to react; obligations in place often accelerate the catastrophe; those who have knowledge of the subject and are most capable of responding often have conflicts in doing so; rules must be broken; and the solution is generally to bide for time, by rolling things over long enough until normalcy returns.

I read in the papers each day about the financial crisis. In Europe apart from it being a political-fiscal crisis which needs time to resolve, sovereigns and the capital markets are in a dance of debt with no one who wants to cut in. Sovereign debt is Tier I capital for banks under Basel regardless of quality. There is no legal cap on country borrowing (although there is an economic cap), so the dance can continue.

In the U.S. the foreclosure problem is also a dance between the government (including Fannie/Freddie) and the banks and the secondary markets. They hope to run this out as long as possible to permit the capital base of the banks to improve and so continue the no effective interest borrowing from the Fed without corresponding macro usage of the funds (this would be Cat planning if they were not rewarding their internal and external stakeholders, even on a deferred basis). While there is some haircut due to unpaid interest, more often the obligations are being deferred through a balloon payment. In a low interest, volatile investment market the opportunity cost is relatively low, compared to a true haircut by the banks. When the interest rate/investment climate changes there will be a lot more foreclosures. The government is pushing State Attorney Generals to come on board, at the same time that the Obama administration’s low hanging fruit proposals don’t stand a chance in Congress. Look for 2013.

A number of years ago I spoke on a panel at a Reinsurance conference, where my topic was emerging issues in reinsurance. Reinsurance is insurance of insurance companies, and is one of the ways insurance companies finance themselves and protect their balance sheets. It impacts the premiums you pay. The issue I wanted to bring up was currency. In part because currency is hedged outside of reinsurance and in part because these were mostly property & casualty insurers, they did not understand why I wanted to talk about this. Since then the Euro crisis ensued, which has aggregated interest in the U.S. dollar in the short term. My talk was more long term, particularly for long tail risks. Given that China may become the dominant economic country, and that the Yuan could be the world’s currency in the future, long term commitments in dollars needed to be qualified. To get there there is likely to be a basket of currencies as in Singapore.

China’s domestic market will grow, making it the more dominant consumer economy on a mass marketing basis-  contrary to the pareto principle. As such, U.S. wages and its standard of living will decline, as the benefit of globalization is macro rather than micro. In order for China to sustain this they need to continue to follow their labor, rather than capital oriented economic policy unless that choose a more totalitarian political policy based on economic disparity. As U.S. companies have belatedly learned, every country supports their own and they will not share as much in China’s rise, unless they have know-how to share. Accordingly, the US will not be able to rollover debt to China.

The rollover period continues, but it is coming to an end.