The Greek Stress Test & The Reality Of Incremental Changes
by Daniel R. Amerman, CFA
With the Greek banks closing, capital controls being imposed, and the unwillingness of the European Central Bank to expand its emergency liquidity assistance program – the stability of the global financial system is officially in play. Nothing is set in stone yet, but a looming Greek default and potential economic catastrophe in Greece is setting elements into motion on a global basis that have the ability to impact many things.
Unfortunately, some of the potentially most important changes will be invisible to the general public, because of the way information is usually presented by the media –which could be likened to an "on/off" switch. That is, either the Greek crisis triggers a collapse of the global financial system, meaning the light switch turns off (which is possible), or order is preserved and the light switch stays on (which is much more likely).
Let me suggest however that when it comes to maintaining our own financial security, a far better framework for making decisions is to reject the overly-simplified on/off switch and to recognize that what we're really looking at here is a "dimmer switch". Where reality isn't the light simply being either "on" or "off", but rather moving around somewhere in the middle. And it's subject to incremental changes as the dimmer slides up or down, with the light levels fluctuating by potentially even small amounts.
Now the most dangerous consequence of accepting the false paradigm of an on/off switch is to wrongly conclude that if the switch doesn't get turned off – if financial catastrophe is avoided with the current crisis in Greece as the current example – then our lives will not be affected on a global basis.
Because the reality is that any movement of the dimmer switch – even with no financial catastrophe – is still enough to potentially change each of our lives for decades to come.
Just a little downward movement on the dimmer switch can decrease the chances of our achieving the future standard of living that we hope for – or even just basic financial security in the years ahead.
The chances that we maintain a job, or that our collective children and grandchildren have not only jobs but the kind of careers they hope for, may move incrementally downwards.
The chances of a future financial crisis where the switch does go all the way down to "off" may increase in terms of probability and move forward in time.
So the price of successfully containing the current crisis may be that while the light switch remains on – the light level moves down at least slightly and perhaps even significantly. And if we are to have effective personal defenses against potentially diminishing light levels, then we have to clearly see and understand this distinction.
The Dimmer Switch In Action
What is an example of a dimmer switch in action? For many people, all we have to do is look around at the world today as well as at most of the last decade.
The light switch nearly clicked "off" in 2008 – but it didn't. So, if we if view this from an "on/off" perspective, then it was victory! The light remained on.
But while the light did stay on, the level of light dimmed greatly. It was after all very expensive to save the economy from total collapse, and the national debt exploded in the United States and other nations.
Through the creation of massive sums of money which were used to force interest rates to record lows, markets were put on life support – and stability maintained.
At the same time, however, retirement accounts were devastated, and standards of living in retirement have plummeted for those who rely upon interest payments to pay for their lifestyle. Even as unemployment rates soared (as measured by workforce participation rates) and remain at near historic highs even today. Even as the middle class shrank in size, and median incomes fell in inflation-adjusted terms.
So while the light has remained "on" throughout, the price of containment has been a pulling down on the dimmer switch to the extent that it's transformed markets, jobs, income and standards of living for many millions of people around the globe.
Yet, the common narrative is to disassociate the light switch from the level of light. We are increasingly told that essentially, happy days are almost here again. The central bankers are the heroes who saved us all. The markets are roaring and wealth is being created at a fantastic rate (asset bubble issues aside). Never mind the national debt, or the legions of the long-term unemployed, and don't worry that interest rates that have been deliberately and openly forced below the rate of inflation – you can invest with confidence.
And for those who question that narrative? As explored here, the simplified dichotomy of the "on/off" switch means there is only one place for them to go, and that is the gloom and doom camp of eternal pessimists. A marginalized and delusional group who has been continuously proven wrong – because the light never did turn off.
Or so the narrative is commonly presented, as people are effectively given the choice between the easy path of fitting in with the comfortable mainstream, like supposedly everyone around them, or the lonely path of the somewhat disreputable fringes thereof.
There is good reason for why false dichotomies are used in what could be called "perception management", which is that in practice – they can be highly, highly effective. Again, all we have to do is look around us to see this.
Greece & The On/Off Switch
We do have an artificial and therefore inherently unstable financial system right now, as recently explored in this article. The atmospheric energy is there, and Greece appears to be heading down a path that is quite capable of setting a major crisis off. But will such a larger crisis actually develop?
The immediate questions are contagion and liquidity. In the coming days and weeks, does the time come when investors in a given market – which could include the bond or stock markets in the United States – decide to head for the exits in sufficient numbers that a liquidity crunch develops?
And if it does – will the current defenses be sufficient to handle a developing stampede for the exits? In seeking an answer, let's quickly consider some of those defenses.
A return to or increase in quantitative easing is the likely first level, with ever more money being created for the purpose of market stabilization.
If liquidity issues develop, then the central banks may create the money to loan to banks and other financial institutions so that they don't have to sell their securities, much as what happened in 2008.
The Europeans may resort to their Outright Monetary Transaction program, which would effectively make them the market when it comes to European government bonds.
As recently suggested by the IMF and explored here, central banks around the world could even become market makers on a global scale, creating however much money is needed to buy every stock and bond for sale.
So if we return to our latest global stress test in process – which may or may not become a full-fledged crisis or global instability event, then if we view it from the false dichotomy of the on/off switch, the most likely result (although far from guaranteed) is that the light remains resolutely on.
As negative events unfold, if they do unfold, the central banks of the world will use unconventional monetary policies to contain the damage.
And the way it is likely to be ultimately presented is that the crisis is over, the system held, let's all move along – there is nothing to see here.
Greece & The Dimmer Switch
On the other hand, when we allow for the dimmer switch of incremental adjustments that often impact reality – understanding that total state changes are rare but incremental changes occur all the time – then we see a completely different picture.
The very act of increasing the degree of central banking interventions in a number of different ways impacts reality. It does indeed affect investment returns. It makes it more likely that fixed income investors will receive lower investment returns for years to come and even decades to come, as one of a number of incremental factors over that time period.
All else being equal then, the light remains "on" throughout, even while the dimmer has shifted down somewhat, let's say going from point A to point B in the above graphic. That means less income for most fixed income investors, it means a somewhat lower standard of living over the years to come for savers, and it means reduced financial security over that time.
At the very same time, the continuance of major governmental interventions will tend to create an inefficient economy where economic growth is less than it should be, which would also tend to pull us down from A to B.
Again – this is flat-out impossible to see so long as we view things only in terms of the on/off switch, as most people do. Because the switch is clearly on. The crisis quickly recedes in the rearview mirror and is then forgotten about.
But if in fact we have a lower growth economy at the same time that we have more extensive central banking interventions, then it becomes ever more difficult for the central banks to find a place where they can exit. Because the stability of the markets is ever-more reliant on the dysfunctional interventions.
So lower real economic growth means less real resources available to support price gains in stock markets on a fundamental basis. It also means lower real resources available to fund public benefit retirement programs such as Social Security and Medicare in the future, and it means that the future is a little bit bleaker for our collective children and grandchildren. All of which also act to pull us down from A to B when it comes to the realities that may govern our future lives.
The Dimmer Switch & The Redistribution Of Wealth
There is a second and more nuanced level of understanding when it comes to the "dimmer switch", which is that if the switch does slide down from point A to point B as a result of the interventions used to contain crisis – this is not a straight-up loss in wealth. Rather, what is created is a redistribution of wealth.
If we see the dimmer switch, and we understand that the methods used to contain crisis can impact investments in a persistent and powerful way, then we can also see that should the crisis be "successfully" contained, that this may then result in an extension of the length of time that interest rates remain unusually low.
The simple, surface level take-away is that savers and retirees are going to feel more pain for a longer period of time.
The more refined understanding is that interest rates are a redistribution of wealth. And if the dimmer switch moves from A to B, then investment strategies which benefit from low interest rates will prosper, while those which are hurt by low interest rates will do worse.
Similarly, another price for containment can be a reduction in the economic growth rate. Because this increases both unemployment and the national deficit, then per the economic theories that determine current governmental policies, the appropriate response is to increase the differential between inflation and interest rates, by increasing the rate of inflation while keeping interest rates very low.
Again, when viewed on the simplified surface level, this is just plain bad news. After all, 1) higher inflation rates combined with 2) lower interest rates for 3) an extended period of time is a three way recipe for a poor outcome when it comes to many investment strategies.
The more refined understanding is the recognition that inflation and interest rates are both redistributions of wealth, and that double negatives can be turned into double positives. Which means the identification of the movement downward on the dimmer switch from A to B becomes valuable and actionable, as it facilitates the creation of a double positive outcome.
Through no fault of their own, most of the general public will always have a dual blindness when it comes to both crisis and the price of containment. If a crisis arises but is contained, they are unlikely to understand the pervasive cost of that containment, and how it could affect their own lives for years or decades to come.
Even if they do understand the cost in terms of feeling its effects, because the costs of containment are usually viewed as pure negatives, they may not think there is much they can do about it.
This is where two levels of vision can make all of the difference. The ability to see the dimmer switch. And the ability to see the redistributions that happen when the dimmer is moved up or down. Quite simply, the ability to see each with clarity can change everything, when it comes to the current potential crisis as well as what else may come.
What you have just read is an "eye-opener" about one aspect of the often hidden redistributions of wealth that go on all around us, every day.
A personal retirement "eye-opener" linked here shows how the government's actions to reduce interest payments on the national debt can reduce retirement investment wealth accumulation by 95% over thirty years, and how the government is reducing standards of living for those already retired by almost 50%.
An "eye-opener" tutorial of a quite different kind is linked here, and it shows how governments use inflation and the tax code to take wealth from unknowing precious metals investors, so that the higher inflation goes, and the higher precious metals prices climb - the more of the investor's net worth ends up with the government.
Another "eye-opener" tutorial is linked here, and it shows how governments can use the 1-2 combination of their control over both interest rates and inflation to take wealth from unsuspecting private savers in order to pay down massive public debts.
If you find these "eye-openers" to be interesting and useful, there is an entire free book of them available here, including many that are only in the book. The advantage to the book is that the tutorials can build on each other, so that in combination we can find ways of defending ourselves, and even learn how to position ourselves to benefit from the hidden redistributions of wealth.
