The appearance and intensity of uncertainty is in direct proportion to the counter efforts intended to sow content and maintain the idea of control. It amounts to the financial equivalent of a “show of force.” Yet, how often do such forceful demonstrations actually provide comfort? More often than not, participants in that uncertainty interpret the need to show force as itself directly related to the hidden dysfunction or imbalance. That was certainly on the minds of the FOMC throughout 2007 and 2008, as policymakers attempted to straddle a position that offered some reassurance, taking care not to do “too much” that might frighten further.
It is only human to think that if “authorities” are implementing grand strategies aimed at order there must be the potential for grand disaster – it is a symmetry of psychology. And there is a lot of truth to aiming for the correct balance, but only if you presuppose that such balance would have any effect at all on the overall trajectory of pre-crisis or crisis. In fact, a true pathology of crisis shows the opposite, that the idea of control is an illusion (which, by the way, some policymakers actually know this).
In other words, once imbalance (rot) beyond a tipping point has been set into a complex system, it moves into a critical state to undergo a phase shift all its own, totally detached from the relatively minor inputs that authorities might make. The system will achieve its own balance, through phase shift, regardless of any attempts beyond that point – and phase shifts in finance are almost exclusively violent.
While we can map out 2007 and 2008 in these terms easy enough, these observations are equally applicable and even comparatively simple to see in more contemporary settings. My post earlier today on the “fear of missing out” is one example, as rationalizations about market behavior amount to a kind of attempt at a control input. We can also make the same observations about China as it progresses beyond what I think can be rightly called criticality.
The current mainstream narrative continues to push this idea of the PBOC “punishing” hot money speculators, thus offering an explanation for the yuan’s recent descent. I find this idea wholly unpersuasive as it leaves a whole host of factors untouched. My counter has been a dollar shortage narrative that I believe is far more compelling and comprehensive (explained here). To many, this seems to be a distinction without a difference, as it all amounts to the same in the end.
However, there is a vital division here between these two competing theories that sets up inside the pathology of crisis. The “hot money” explanation conforms to the illusion of control. The dollar shortage is the opposite, and more than suggests conditions beyond any ability of control.
Again, rationalizations play a prominent role in all of this. In 2007, after the Bear Stearns hedge funds were shut down and the eurodollar market froze, stock markets around the world rallied because central banks had begun to mobilize, often taking on exactly this form of reassurance. That was true particularly in September 2007 as Northern Rock became the first victim of an honest bank run. Yet, there was no immediate crash or collapse – it took another year for that to transpire.
That is what crisis looks like, an ebb and flow along these partially obscured fault lines. Cracks appear, central banks react, and everyone goes home and sleeps better that night. Only more cracks continue to appear, often deeper and more sinister, yet no immediate complications are evident. So uncertainty creeps in, but that is countered by the central bank dance of balance between wanting to reassure without frightening further. But the central case is that the continual inability of any central authority to put a full and complete end to the appearance of “cracks” is evidence of both this implied impotence and system criticality.
There was a run on a small Chinese bank today, reported by Reuters, that is on its own unimportant (particularly given the minute scale of the bank and the “run”). In this wider context, however, it shows a repeated rebuff of the idea of control. The Reuters article itself attempted to answer this seeming conundrum:
Why Yancheng investors suddenly lost confidence in the security of their bank deposits is not clear, given that the Sheyang bank is subject to formal reserve requirements, loan-to-deposit ratios and other rules to ensure it keeps sufficient cash on hand to meet demand.
Bank failures in China are virtually unknown, as Chinese banks are considered to operate under an implicit guarantee from the government.
Finally, money market interest rates have eased since February, and traders say liquidity in the interbank market — where banks like Sheyang can tap short-term funds to meet depositor demand — remains relatively relaxed.
Everything should be fine, yet it isn’t. Add those three factors together and it sounds like formidable defenses, not just in this individual bank case but systemically. The illusion of control permeates, yet it isn’t monolithic, is it?
That last paragraph, I think, demonstrates this more than anything else (though you can’t help but notice that the appeal to static ratios and reserve requirements inside a dynamic situation is obviously misplaced on its face). Liquidity in interbank markets is also not monolithic, a fact that should be prominent here. Central banks apply policy in such a manner, but despite any indications at all there is absolutely no way to tell what the liquidity conditions for Yancheng are right now. If we know anything it is that fragmentation can appear and fester without any obvious outward acknowledgement. The fact that Reuters reports a minor “run” here at all certainly contradicts the idea that all is well, even if all these assorted static figures lead you to believe it should be.
Erosion is a very slow process that can be utterly misleading in exactly this regard. Liquidity, however crafted and inserted, cannot solve solvency. The sheer scale of Chinese financial ascent assures broad misallocation and thus ultimately criticality. It is more a force of financial gravity than anything else, and that will not be denied by any input, central or not. The cracks are small at first, but as they continue to appear you can only be assured of helplessness.
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