Friday, October 10, 2008

A Loser Guy on Steroids

You often hear explanations about the state of our economy involving analogies about anabolic steroids (artificial growth hormone). I think it is a good analogy, but I will attempt to take it one step further, and relate the taking of steroids, and the specific medical implications of that, to the specific economic implications of the political and financial system that America has had over the last 30 years. With this strange exercise, I will ultimately try to portray the United States as a regular guy, but one who is deeply in debt, and addicted to steroids.

First, let me briefly explain a few things about steroids. Bodybuilders and athletes take them in order to increase their muscle mass. It is incredibly effective, because it turns your body, bio-chemically speaking, back into a teenager who can grow half an inch per day. When you take steroids, your body is flooded with male growth hormone, and if you lift weights, your muscles grow rapidly. As we all know, male hormones have a few other effects on the body, such as aggressiveness, which is eventually increased in the steroid-popping male. After having taken steroids for a while, our guy has large muscles, and an erratic temperament. This is pretty much as good as it gets for the guy, because after having achieved the superficial success of big muscles, things only go down the hill.

The whole problem with taking steroids is that you’re flooding the body with male growth hormones. This is telling the body that it does not have to produce any of growth hormone itself, and for that reason it stops doing that. Our guy starts losing his hair, and eventually his reproductive health starts to deteriorate. He is losing his potency as a male altogether, but still looks on the outside as if he is very strong. If he does not stop taking steroids at this point, the whole process can hit reverse, and he can turn into a freak. The reason for this is that the body stops producing male hormone, while it still produces female hormone (which males also have), so the guy’s body slowly turns female (if you have seen the movie “Fight Club”, there is a guy like that in it). Steroids can turn a man into a muscular freak with a high-pitched voice and female breasts.

In terms of economics, what you need to understand before we move on is something simple that people used to understand very well:

The real economy IS the economy!

Products and services of the real economy are things like cars, chairs (products), haircuts and cab rides (services). Products and services of the “financial economy” are things like derivatives, 401(k)s (products), “wealth” planning and investment advice (services). The financial economy is, largely speaking, a fictitious economy that only exists because the real economy exists. In a way, you could describe it as a parasite of the real economy. The most harmful products of the financial economy are the derivatives, because they are so far removed from reality that their true essence can rarely be grasped. In this complex form, they have been combined, amalgamated, merged and distorted, into ever more complex things. I will try to describe how simple derivatives work with an example:

Imagine that you want to sell your car for $10,000, so you put an ad in the paper. The next day, a guy calls and says the following:

- I’ll buy your car, but I’d like to pay you with a derivative. It’s worth $10,000 now, but it’ll probably be worth much more in the near future. The deal is that a bunch of my friends and I think that the price of cars, like the one you have, will go up, so we’re buying up a huge amount of cars, and we’re going to let the sellers of the cars get a share in the profit once the prices of these cars go up! As soon as the price goes up, you can sell your derivative to someone else and make a bunch of money. That sounds great doesn’t it?

It sounds pretty fishy, right? I think most people would hesitate in selling their car under those circumstances. It sounds like a pyramid scheme simply because it is a pyramid scheme. I’ll tell you for whom it was good enough: the U.S. Congress. For years, Greenspan was telling politicians (who didn’t understand what the hell he was saying, but wouldn’t admit to it) how great these derivatives were. Nowadays, almost all Americans own them in one way or another in this giant pyramid scheme. For years, derivatives artificially made it look as if the economy at large was doing great because the financial economy was made to look incredibly good with the help of derivatives. We can now begin to see the similarities between derivatives and steroids.

When all the derivatives started flooding the market like hormones in the body during the 90s, the stock market started to shine. What actually happened was that a lot of cash was made available, because it had grown artificially, just like muscles on a pill-popping bodybuilder. A bank didn’t actually have to give up money from its reserve (deposits from ordinary people) in order to give a person a loan, and that is the essence of what is called securitization. It just means that someone else is taking over your risk.

During this time of the shining stock market, there were a few downturns in the economy, like the tech crash, but that was a specific bubble related to new inventions, so it was not directly related to the kinds of problems we see today. In general, the financial economy appeared to be doing great until late last year.

Then the signs started showing, and our guy (meaning the American economy) started getting temperamental. The stock market started swinging wildly, and initiated its great downturn that we still see today. It seemed that things were no longer they way they had appeared. Financial products, such as people’s 401(k)s, suddenly started losing value. Value fell out of the portfolio like strands of hair from the bodybuilder’s head. Unbeknownst to the bodybuilder, he has already caused irreparable harm to his body, and his perceived beauty and masculinity is in a downward spiral.

Vanity started the entire process, and the guy attempts to deal with his new problem by taking more steroids and buying beauty treatments like plugs for his hair. This can be compared to the Federal Reserve lowering interest rates and coming up with different plans (such as the bailout) to try to help the stock market. It is all meant to preserve the status quo, even though that cannot be done. The bodybuilder has forever lost his potency because he has overdosed on male growth hormone. He has become infertile and impotent. From an evolutionary perspective, he is useless.

The Federal Reserve, has, just like the bodybuilder, also lost its potency. The reason for that is that the American economy has overdosed on the financial equivalent of steroids: derivatives and loans from abroad. The result of this is an infertile real economy and an impotent Federal Reserve.

Our freak of a guy is walking around confused, talking to himself in his high-pitched voice about glorious days gone by.


Lisa said...

Do you think these financial stocks purchases that Paulson has just announced will be of some help in loosening up credit or slowing up the Market slide? Or is this just a move to try and lessen fear, with no real effect on the fundamental problem. Also, is the pyschological factor in all this really even relevant? I mean, if our economy has been built on a house of cards, and is destined to fall, how does public confidence (or lack thereof) make any difference?

Jacob said...

Yes, I think it will do something to help. At least, it's a step in the right direction for the first time. The biggest problem right now though, is that none of the banks trust each other. Because of the lack of regulation, there is no way for the different actors in the financial market to find out who's good and who's bad. Because they don't trust each other, they don't lend to each other. Maybe we should mandate some kind of public presentation of all the assets that the banks have. Then we would know once and for all who has to go down.

The lack of public confidence helps to drive stock prices down, but that's only one of several problems right now.