Three key things are happening, I wrote.
The first is the so-called credit crisis – really a crisis in market-based assessment of credit risk.
The second: colonialism is over. Economic, too.
Here is the third: when the economy will exit this crisis, we will have adjusted to a different state, hopefully a more stable one, by most measures a “lower” one for most western economy citizens. The process will be different from a cyclic swing from boom to bust and back.
This statement is certainly the most speculative of the three, a projection of what is happening more than an interpretation. It stems quite naturally from the two previous statements.
What in the crisis of credit risk assessment mechanisms makes it so uniquely disruptive to drive a permanent adjustment rather than a contingent swing? It’s the fact that these mechanisms as have now collapsed evolved as an extension to finance of the communication-intensive and computation-intensive mechanisms that successfully enabled globalization of markets for tangible assets. These mechanisms have allowed markets for tangible assets to extract from the knowledge of individual market players a vast quantity of information that helped us all deal with the equally vast amount of uncertainty global markets must present to any one player, however resourceful.
Applying these effective mechanisms to the financial market, a meta-market if there ever was one, has implicitly driven us all to neglect the second order effects that theory and practice have long proven are specific to the financial market, and are the ultimate justification of its special regulation. When the assumption proved wrong that what had successfully managed uncertainty in markets could apply to the meta-market, we found we had lost our tools to assess risk, or rather had been lacking any for a long time.
Can this assessment be a natural delusion caused by the fact I am observing the cycle from within, missing the cyclic component? Sure. What would prove we are still in a cyclic downturn? New tools for credit risk assessment in a global credit market including multilevel derivatives. Most importantly, evidence that these tools indeed can manage uncertainty as we thought the failed ones did. Until that happens, the world we will live in will need different financial regulation to cope with the newly discovered degree of uncertainty in the financial market. The end net effect will be more difficult access to more scarce credit. For good.
A very similar reasoning applies to the end of colonialism: the imbalance of power that helped nimbler “western” economies outperform and exploit others has now been reduced significantly: We now see Japan in stagnation was really the first truly western economy to get there, rather than a truly non-western economy revealed by its failure to pursue western growth,
The most likely outcome is a truly multi-polar world, with western economies having to come to terms with the greater relative power other ones have acquired. The net effect will be a higher cost of international trust and safety (defence, negotiation) and most importantly forfeiting much of the western privilege the former unbalance allowed.
To undo this, and bring us back to a cyclic contingency situation, our western economies will need to come up with a new trick to sustain geographic power unbalance. Feels even less likely than new tools to assess credit risk in the global financial market.
Here’s why I think things have indeed changed for good.
Now for the good news. Our earlier ways have likely been so far from being sustainable that a chance to change them, however difficult, is bound to be welcome. That is indeed what makes this crisis, more than cyclic ones, too precious to waste.
Originally posted on http://gmindshare.spaces.live.com.