The ups and downs of diverted capital

I was recently reading an excellent book co-authored by David Suzuki called Good News for a Change:  How everyday people are helping the planet.  I highly recommend it. Us humans can be very thick when it comes to nature and our role in it.  This book is a great summary of where we are at, and what improvements are readily possible.

One of the key concepts I get from the book is a better understanding of our planet's water system.  It turns out that the earth's water system is very like the arterial system of the human body.  All of our capillaries, veins and arteries play a key role in efficiently moving blood flow around the body.  It is a perfectly designed, closed system in its inception.  Once challenges present from poor eating, lack of exercise or other abnormalices, various parts of the system become clogged, restricted and even completely cut off.  For a while the body will bravely innovate and find new ways to flow around the damns.  But ultimately there is a limit to what the system can accommodate, and eventually blocks in one area will lead to bursts in another.

The same concepts apply to our planet.  We humans can be demanding, obnoxious little creatures, we like to believe we can dictate our own rules on the natural order.  And so, we have repeatedly diverted water from its natural path, draining some areas, flooding others.  This has created prosperity in some target areas with waste land and devastation in many others.  Each time we block or divert the natural flow of water we are placing increasing stress on our earth's life support system. 

I cannot help but see this common thread in our world financial markets at present.  The low rate era of the past several years has encouraged great courage and innovation in the area of credit derivatives.  Wall Street has made billions taking capital from some pools and diverting it to many others.  These various players have played a pivotal role in directing the flow of capital around the world.  But now we must also recognize the downside.  In artificially flooding capital in consumer areas we have also created floods, imbalance and increasing devastation.  As PIMCO bond guru Bill Gross writes in his July Investment Outlook, Looking for contagion in all the wrong places,

 “derivatives are a two-edged sword.  Yes, they diversify risk and direct it away from the banking system into the eventual hands of unknown buyers, but they multiply leverage like the Andromeda strain.  When interest rates go up, the Petri dish turns from a benign experiment in financial engineering to a destructive virus because the cost of the leverage ultimately reduces the price of assets.  Houses anyone?” 

 “The right places to look for contagion are therefore not in the white-washed Bear Stearns hedge funds, but in the subprime resets to come and the ultimate effect they will have on the prices of homes–the collateral that's so critical in this asset-backed, and therefore interest-sensitive financed-based economy of 2007 and beyond.”

Our ability to consume goods has been on steroids this cycle aided and abetted by Wall Street.  Ultimately steroids are not healthy for our system. Kicking the habit will have some painful side effects on our economic system.  Many consumers will have to seriously restrict their consumption habits in order to regroup now that cheap money and unsustainable asset gains are at an end.  We will all have to suffer the consequences of financial distress on the marriages, health and families of our society. 

The good news for a change is that we don't actually need all the stuff we've been buying anyway.  We can learn to consume less, and enjoy health and family more. Consumers of our generation will once again learn (albeit the hard way) what others have learned in decades before us:  buying less and saving more are the road to a sustainable and richer life for our future.

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