Commentary

Game Theory

By Gary Tanashian

March 17, 2008

Remember the moment. This is the moment our kids' future - at least as commonly envisioned - went down the drain. Make no mistake, that future was already swirling around in a whirlpool headed for the pipes, but at this moment all pretense of sound macro policy management is falling away and the worst part is, it is all the result of a macroeconomic game that rewarded short term players and punished those who 'bought in' in any sincere way.

The President of the United States is touting the resiliency of the American people while urgently calling together da boyz in da workin' group, the SecTres parrots "a strong dollar is in the US interest" as yet another naughty player - Bear Stearns - is bailed out no doubt in large part by you and me in the final analysis. Carlisle Capital is imploding and amid all the currency-debasing macro activity we have the big guys at the world's largest bond fund demanding even easier policy, as if there is no risk involved as Uncle Sam tries to inflate himself out of this mess. 'Bond vigilantes' is a quaint term that used to apply to those investors who would drive up yields when the risk of inflation began to get out of hand. Since the global economy has depended on one bubble or another for some time now you could say the bubble in stupidity has been the longest running one at thirty years and counting.

Are politicians giving in to the greedy interests of the Wall Street power brokers simply to gain brownie points during election season or is there something more powerful at work here like say, desperation? The kind of desperation that can only come from being an insider to a short sighted - if you can call thirty years of fiat paper wizardry short - game of 'shuffle that paper'.

It goes like this: We have a starting concept called the 'productivity of the American people augmented by the sound policies of a long since retired Fed chief (not Greenspan)'. The concept is quantified, marked up and sold into the market as paper certificates of various denomination. This paper representation of inherent value is then split up several times over with each fraction again marked up and sold. This is all legal (and apparently moral) and is just Wall Street doing business.

But the real fun begins when risk players enter the game. Here is where the leverage and real financial innovation come into play. You see, systems have a way of building in abstractions and cementing assumptions the bigger they get and the longer they run. Hubris, denial, delusion... these are but a few of the interesting aspects to the game. The art is to subdivide your "investments", make new bets derived from old bets and talk a good game. Much like poker, there is a lot of bluffing going on here - and this is a vital concept to a winning strategy as well. Whereas in poker you try to show confidence in your manner, in this game you baffle them with fancy lingo that you are pretty sure they don't understand; you "baffle them with bull$hit" as the saying goes. Do you know the rules or are you a pawn? Yes, there are plenty of pawns in the game. In fact, they are vital to the entire concept. You see, someone needs to be the offload receptacle.

These paper calls on productivity have been so deeply bastardized that they are now not only worthless, they actually represent negative value, as in liability in the $Trillions. They are worth less, much less than zero. Whether or not you passively assumed some of this risk in your retirement account or via your conventional financial advisor you, me, our kids... we are all going to get the bill in the end. That's the inevitable outcome of the game!

There are winners and losers, but we all get to share in the clean up of the macro mess as politicians go the easy route in a short sighted effort to solve the problem with more of what created it in the first place; namely, credit and its shadow side, debt. Of course the winners - few though they may be - who have long since cashed out via the golden parachute will help with the clean up. But this is relative nickels and dimes to them and with a wink wink, nudge nudge they do their duty along with the rest of us all the while thanking their lucky stars for a system underpinned by so many naive pawns. The only rule these would-be winners needed to keep in mind is the one in the fine print at the bottom of the rule book:

* Don't forget, if you are the head of a major financial corporation - especially a leveraged lending institution - you must show quarterly earnings growth to keep the game going. This should be easy enough however as the pawns are pawns for a reason; they will take the sound economic growth story hook, line and sinker. Meanwhile you may string together a progression of strong quarters and have your board vote you bonuses based on short term performance. If things start to look dicey at any point and you have not yet implemented your exit strategy a wise move is to activate a standard David Lereah press release mechanism - pronto! Remember, most players do not bother to look into the details as long as they are being shown an apparently good economy and their stream of relative chump change remains intact.

And for heavens sake, don't get perp'd like these men!

Angelo Mozilo, Countrywide Financial CEO - Kevin Lamarque/Reuters photo

The above is not an exercise in sour grapes. It just is what it is; a look at the games to which the masses are just now figuring out the rules. We will get through this, but new rules are being made up right now and folks, you had better be in tune with them this time. Most readers of this website have long since cut their teeth in this line of thinking. They understand Austrian economics, money backed by more than confidence and they understand Wall Street's gamesmanship. But the great majority is just now waking up with a groggy "What the....? I can't concentrate on American Idol with this economy $#!% going on!" But there are positives happening out there as I mentioned in the most recent letter. To find them one might revise one's commonly accepted assumptions and expectations and look for pockets of productivity. The US manufacturing base will only get stronger relative to the paper edifice built during a three decade long game of 'shuffle that paper'.

Our portfolios are up 3.7% thus far in 2008. Not stellar, but I will take an annualized 15% considering the gore fest in progress in the markets and the economy. To this point in 2008 the game has not been about capital appreciation but rather preservation. With several markets - Euro and many commodities - in blow off mode, we begin to look for trades and/or investments rooted in productivity and value even as the public - so well informed by the fear stoked media - pukes them up. Wash, rinse, repeat... the game continues.

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