One of the reasons people can tell a paradigm shift is taking- about to take place is the sense underlying the day to day reality … that important parts of the functioning world are irretrievably broken or lost.

Despite the +50% rise in equities since March and the non- stop spewage of ‘happy talk’ from media bobble- heads, politicians and economists, it is hard to shake the backdrop of foreboding.

Consider that prior to 2007 and the collapse of Bear- Stearn’s two derivatives- laundering hedge funds the earning capacity of America’s middle class had stopped growing and was, in fact shrinking. This was when consensus indicated that the US economy had finally pulled free of the whirlpool associated with the ‘dot- com’ collapse and the resulting washout of yields.

Without income increasing it was hard to see how the massive increase in debt was ever going to be repaid; the flush of new debt into assets created paper collateral ‘wealthiness’ but access to same required even more indebtedness or an exit from the ‘casino- marketplace’ (an oxymoron?) which would also mean lessened income. Looking at individual earning power and the lack of yield available to those not speculating in exotic derivatives with massive leverage it is easy to see where the crisis that began to emerge with the Bear- Stearns funds collapse was one of insufficient income or a crisis in earnings.

At the same time, the reason for the collapse of Bear’s funds and then Bear itself was not the inability of its borrowers to repay debts. Bear did not loan to individuals, it peddled derivatives and made a margin on transactions, its ambit was Wall Street paper to Wall Street participants; insofar as most Wall Street paper is bad from the get- go (think of options, a large percentage of these ‘bets’ are always out of the money) it was a set of unfortunate circumstances that ended in the run of Bear clients out the door that put that venerable company under.

Looking deeper, it can be seen that the money cost for Bear and others upstream from that firm in the morgage derivative food chain had made it increasingly difficult to originate new paper to ‘wash out’ the bad, the consequence to Bear’s balance sheet was noted by its clients and the first out the door were not rewarded but at least recovered their accounts. All this leaves the question open – and unanswered – whether any of Bear’s clients were ‘covered’; were their investments ‘hedged’, their lending to Bear insured by Credit Default Swaps. If so, it is hard to see where anyone would have lost money, but accounts were closed and without clients, a business will eventually have to fold.

From this sketch it is reasonable to pin the cause of Bear’s decline and fall and the crisis that emerged from this on the unravelling of the complex web of securities and derivatives that Bear and other investment banks and insurance companies traded in, moreso than the mortgage loans upon which these derivatives were based.

Orbiting both these two metaphysical concepts is the unhappy relationship between main street American production (and overseas production as well) and energy use. America’s energy problem began in 1970 when domestic oil production peaked @ 11million barrels per day. As was predicted by M. King Hubbert, US production steadily declined, even as new fields in Alaska were put into production. Diversifying into foreign imports, the US was blindsided by the embargo that cut 10% of those imports in 1973. What was the outcome?

In America it was to remove pricing authority from the Texas Railroad Commission and hand it to the market. In import- dependent Japan, the outcome was to inflate asset bubbles in stocks and real estate with cheap money. In Europe, previously ambivalent rival nations agreed to begin to explore a common currency. After another round of oil shortages in the early 1980’s following the overthrow of the Shah in Iran and its subsequent war with Iraq, the US followed Japan and used a large increase in sovereign borrowing/spending and cheap money to inflate its own asset bubbles in stocks and real estate.

The object of this bubble creation was to create enough asset/collateral value to act as a hedge against any increase in input costs, whether of labor, energy or taxes. Parallel actions to reduce taxes, reduce the bargaining power of unions and bring ‘efficiency’ to energy productions made the bubble creation very effective.

Supporting the bubbles in all manifestations was a massive increase in leverage and so it is often seen that the leverage itself along with the accompanying risks – that the leverage in question could never be serviced by earnings or the debts repaid – was a source of great and increasing danger. This observation reflects the importance of energy prices relative to finance; that stess in one market is the spur for a risky form of hedging in others. Beginning in 1999, after a near- fifteen year run of extremely cheap petroleum prices, oil doubled in one year and began a bull market run that continues to the present.

If one is to look at the long term run of oil prices beginning in the 1970’s there in 1998-99 when oil was in such great supply relative to demand that it was almost free; 30 cents a gallon of high- quality crude, with prognosticators predicting $5 a barrel crude or lower. This changed almost overnight; in dollar terms, Peak Oil took place at the end of 1998 and the beginning of 1999:

Since then, the relative ability of the oil industry to pace increasing demand has been unaffected by the resultant increase in investment in production. It is clear that the energy crisis that was predicted by Colin Campbell and others as the consequence of Peak Oil began sooner than expected, in fact has been the backdrop in front of which all the other financial and economic dramatics have taken place.

It can be said that what we are experiencing currently is less a finance crisis but an energy crisis.

Furthermore; since 1985 there has been the rise of China as both a manufacturing and commercial power; it has been the recipient of many American jobs as the price of energy, management, domestic labor, and capital has not left sufficient profits particularly when a wholly domestic producer of any good or service must compete with another that has previously sent its production overseas. The balance of the cheaper labor is the difference between business survival and not; with rapidly rising energy costs as well as oil- feedstock costs for all businesses that make use of them, the sweeping of US jobs to China then India and Mexico have had the result of sweeping as well the same or greater numbers of US business retail customers at the same time exposing those now diminished consumers with the fatal recourse of adding to their burden of debt.

It can then be said that the effects of China business as well as China currency and credit flows/trade and funds imbalances both into and out of China and into and out of US government securities has been a great part of the current decline both for us and for our trading partners.

The loss of worker earning power. The collapse of the derivatives markets. The energy crisis. The effects of China production and finance. Each of these inputs have had a serious effect on what is taking place in the world’s economy. Each effects the others. Yet the question is raised; what really caused the current crisis and how come all those economists on the government/business dime missed it?

This means Greenspan, Bernanke, Paulson, CNBC, Paul Krugman and the New York Times … etc. Only Taleb, Roubini, Schiller, Schiff, Mish and Ludlum … got it right.

When Isaac Newton described his observations of gravity, the interactions of two bodies are pretty straightforward; the force of gravity is inversely proportionate to the mass of the two objects and their distance from each other.

Add one more body and the interactions become far more difficult to describe. Where does this leave post- crisis economics (or pre- crisis economics, for that matter)? Much print has been emitted over the past several weeks over the inability of most establishment economists or policy makers to accurately prepare for what many would seem to be an obvious and increasing hazard.

The real question parallels this one; why cannot economists or the current (smart?) Administration come to terms with the situation as it exists now, full of far more hazards; with oil over $70, the dollar falling, both stocks and bonds sending contrasting signals, real estate values still declining, unemployment surging, tax receipts falling, businesses failing? Perhaps the problem that economists are seeking to unravel are too complex for the tools that they have become accustomed to using.

This is what Wikipedia says about the Three Body Problem:

Here’s more:

One of the many outcomes of ‘natural’ three (or n body) problems is the unpredictability of outcomes, of perterbations and chaos. Using statistical methods it may be possible to map likelihoods of variation sets to cause ‘outliers’ that in the case of the economy would represent various money- panics or ‘Minsky Moments’.

Unfortunately, current economics is too unlike science for its practitioners to do more than stand on the sideline and lament. The interactions are too complex as well as being too fluid to admit to static analysis. Data is contradictory; perhaps this crisis means the end of models that are too often solutions in search of questions or predetermined outcomes looking for rationalizations.

It would make more sense for economists to stop using statistical regressions by themselves (or worse, simple accounting strings) and look at n body or (n ≥ 3) interactions while measuring for tendencies toward perterbations; in other words, more powerful math tools.