Crises are Hard to Predict

April 26th, 2011

Glenn Reynolds links to a piece by Megan McCardle about what a crisis looks like. Megan writes that the failure of the Chinese to continue buying American bonds would be devastating, and contrary to some predictions, would not happy gradually, but would happen suddenly. If this happens, we’re screwed:

“The real issue starts, not when China starts selling our bonds, but when China stops buying our bonds. As soon as that happens, we’re in big trouble. . . . A lot of people tend to assume that there will be warning signs telling us that we need to get our fiscal house in order: China will slow down its bond purchases, interest rates will gradually rise. But in fact, the lesson of fiscal crises is that the ‘warning signs’ we’re watching for often are the crisis. Unless interest rates increase (or debt buying decrease–which is really the same thing) in a very gradual, orderly fashion, then by the time your interest rates rise, it is already too late to do anything easy; your debt service burden forces you into dramatic fiscal measures, or default. . . . People are willing to lend at decent rates, until suddenly they’re barely willing to lend at all.”

Reynolds adds a very insightful comment:

Yes, looking around the world it’s obvious that when things start to fall apart, they tend to do so very rapidly even when that happens after a long period of apparent stability. And yet that always seems to come as a surprise. What we’re seeing now are the warning signs. . . .

No doubt, a future failure of China to buy our bonds is quite a black swan. Experts can’t predict it today (if the powers that be listened to Megan McCardle we would be taking a different monetary path). When it happens, it’ll come as a huge surprise with devastating results. Afterwards, experts will try to take remedial measures to make sure it won’t happen again. You heard it here first. Though, I hope the U.S. still has freely available Internet access when we default on China’s bonds so I can blog a “See I told you so.”

I am reminded of an episode of the Simpsons, titled Bart the Mother. In the episode, Bart nurses what he thinks are bird eggs, but in fact are the eggs of a lizard that steals a bird’s eggs and leaves her own. These lizards are a huge nuisance. However, the lizards eat the pigeons, so people are happy. But, soon the lizards over-populate and become a nuisance. So how to get rid of the lizards? Well Springfield will import Chinese Needle Snakes, which will eat the lizards. But what happens when the snakes become a problem? Well Springfield will import snake-eating gorillas, of course. But what about over-populated gorillas?  Well, “when wintertime rolls around, the gorillas simply freeze to death.” Sometimes I feel that government policy mirrors this episode. Solve one problem with a second problem, and when that problem becomes too big, impose a third problem, and so on, ad infinitum. Though, we will not have some cold winter to kill the final problem.

Here is the transcript, a conversation between Principal Skinner and Lisa:

Skinner: Well, I was wrong; the lizards are a godsend.
Lisa: But isn’t that a bit short-sighted? What happens when we’re overrun by lizards?
Skinner: No problem. We simply release wave after wave of Chinese needle snakes. They’ll wipe out the lizards.
Lisa: But aren’t the snakes even worse?
Skinner: Yes, but we’re prepared for that. We’ve lined up a fabulous type of gorilla that thrives on snake meat.
Lisa: But then we’re stuck with gorillas!
Skinner: No, that’s the beautiful part. When wintertime rolls around, the gorillas simply freeze to death.