The joys of "stuff"

Last post, I was riffing on the story of how commercial banking got replaced by investment banking. I implied that it was bad that this happened, and the great crash of the last few years has largely confirmed this model. Unfortunately, I wasn't clear on the real ontological problem: "stuff" and money have become disconnected in the financial world.

Consider bank capital. What is it? Sophisticated investors, regulators and scholars fundamentally disagree about what should be counted and how to count it. So the fundamental building block of bank, and thus finance, regulation is something that bankers try to inflate, regulators cannot measure and investors just have to hope is real.

Meanwhile, equity markets have fallen from their "assured 11% growth" that was promised to your piemaker by a man in a sharp suit in 2004. I was told that day that betting against the NYSE was "betting against America!" Turns out I would actually have been betting against algorithms playing arbitrage games with exchange order books and Congressmen with insider information (h/t to Dan Carlin). To this day I'm not sure if the man in the suit was foolish or disingenuous, but his passion and intensity convinced me that he did not work in a rational market.

Normally, when money and "stuff" go their separate ways, there's hyperinflation. Indeed, the price of gold (~$1200/ounce as of this writing) would seem to bolster this claim. Unfortunately for large debt holders, the rest of the economy is extremely deflationary. Housing prices are such that homes financed after 2005 (give or take a couple years depending on the market) cannot even be rented at a high enough rate to cover the mortgage. Those same houses are now unaffordable to the people who would buy them until three years ago, and people with highly mobile careers (essentially the whole upper-middle class) have been taught the hard way that equity can be an anchor instead of an asset.

Meanwhile, globalization's march to ever cheaper labor helps ensure that there will not be too many dollars chasing too few goods. Quite the opposite, as imports continue to hold steady or rise slightly and the effective monetary destruction of housing debt defaults and write-downs (Planet Money's "pet" Toxie tells this story well). So instead, too few dollars wind up concentrated in the hands of relatively few people and companies with declining incentives to invest in the face of uncertain regulation and government action.

Clearly something has to give. The question is are we Turning Japanese, or going medieval? I'm not sure how the world's reserve currency can hyperinflate when the second largest economy intentionally devalues itself, and the other major currencies face similar (or worse) economic pictures.

Is there a brighter future? Quite possibly. The loss-making rentals I mentioned aren't so bad when the Mortgage Interest Tax Credit is taken into account. There is simply not enough oil that can be extracted at $70/barrel to keep up with demand for the next several years, and so there will be innovations in transportation and infrastructure. Where and how that happens depends on the policies of various countries, but we have the cash and expertise to take the lead in the US. Support your favorite climate legislation and encourage investment in "stuff."