Gyroscopic Forces

August 16, 2005

There has been much debate in recent months/years regarding the symptoms of Central Bank excesses - which excesses range from excessive expansion of the money supply, to excessive downward pressure on short term interest rates.

Some of these symptoms have been:

  • Equity Bubble
  • Real Estate Bubble
  • Debt balloon
  • Growing Current Account Deficit of the USA (other countries have been in surplus)
  • Growing Budget Deficit of the USA

Many economic commentators who consider themselves to be prudent and responsible - including in particular those subscribing to the Austrian (von Mises) school of thought - have been troubled by these symptoms.

Several fashionable arguments have been put forward in an attempt to explain why this state of affairs will/will not land up in catastrophe. The explanations have ranged on a spectrum from "Kondrat'eff Winter tells us that we are going to have an economic contraction as a result of debt implosion" (at one extreme) to "A Savings Glut is causing a downward pressure on long term interest rates, which are therefore explainable and not a sign of impending recession" (at the other extreme).

This, against a background of rising commodity prices, in particular oil, and a rising tide of terrorist activities - which some people are explaining as being largely motivated by dark forces of conspiracy to cause public opinion to coalesce behind society's incumbent leaders and focus on (and accept) the need for "emergency government powers" (and, incidentally, away from other worrying issues). By way of example: Today's headline (July 14th, 2005) on The Drudge Report read as follows:

If it is attacked by Washington during a confrontation over Taiwan... CHINA 'READY TO USE N-WEAPONS AGAINST USA'

Greater minds than mine have been wrestling with the various symptoms referred to above, and none has (to my way of thinking) put forward a plausible explanation to fit the facts - as to whether or not the patient (the world economy) is healthy, ill or perhaps terminally ill. Most commentators are talking about what "should be" as opposed to explaining what "is".

In casting around for an analogy which might fit the facts, the word "gyroscope" popped into my head and, for those people who do not know what a gyroscope is, the following is a brief description. (Source:

gyroscope (ji'r?skop') , symmetrical mass, usually a wheel, mounted so that it can spin about an axis in any direction. When spinning, the gyroscope has special properties. Many spinning objects exhibit some of these properties; the rotation of the earth about its axis gives it the properties of a huge gyroscope. Once a gyroscope starts to spin, it will resist changes in the orientation of its spin axis. For example, a spinning top resists toppling over, thus keeping its spin axis vertical. If a torque, or twisting force, is applied to the spin axis, the axis will not turn in the direction of the torque, but will instead move in a direction perpendicular to it. This motion is called precession. The wobbling motion of a spinning top is a simple example of precession. The torque that causes the wobbling is the weight of the top acting about its tapering point. The modern gyroscope was developed in the first half of the 19th cent. by the French physicist Jean B. L. Foucault, and its first notable use was in a visual demonstration of the earth's rotation. In the second half of the 19th cent., with the invention of the electrically driven rotor, its uses multiplied. It became possible to rotate the gyroscope's wheel at desired speeds without interfering with the precession. Large gyroscopes are used in ship stabilizers to counteract rolling. The gyroscope is the nucleus of most automatic steering systems, such as those used in airplanes, missiles, and torpedoes. It is also used in the gyrocompass, a directional instrument used on ships. Unaffected by magnetic variations, its spinning axis, when brought in line with the north-south axis of the earth, provides an accurate line of reference for navigation.

With the above in mind, a globalised world economy can be looked upon as a sort of gyroscope. The economic wheel spins around as a result of massive injections of liquidity. This liquidity funds consumption in the developed countries and finances production in the developing countries. As long as the gyroscope keeps spinning, it remains upright. If it stops spinning (or even if the momentum slows), the system will likely fall over.

What we appear to have is a symbiotic relationship between developed countries and developing countries in that it is in the interests of all components of the system that the gyroscope keeps spinning. If the surplus countries stop "recycling" their dollars into US Treasury instruments, the liquidity in the US will contract, and this will cause consumption to contract. In turn, this will cause production in the surplus countries to slow down, and the momentum of the gyroscope will degenerate. All participants in a globalised economy understand that if this happens the entire system could fall over - so the predisposition of all parties to keep the gyroscope spinning is high.

Another analogous word that popped into my head while I was ruminating over possible explanations was "homeostasis"

Again, for those who are not familiar with this word, here is an explanation (Source:

ho·me·o·sta·sis (ho'me-o-sta'sis)
The ability or tendency of an organism or a cell to maintain internal equilibrium by adjusting its physiological processes.
The processes used to maintain such bodily equilibrium.

In this context, if we look at the globalised community of nations as an integrated biological organism, "the organism" appears to want to keep adapting to maintain a condition of balance and equilibrium.

What appears to have happened as a result of Messrs Nixon and Kissinger initiating the re-establishment of relations between the US and China, is that the countries of the East have joined the world's community of nations, and the world's communities have coalesced into a single global organism.

The question arises: Is there anything on the horizon that can cause a destabilization of the gyroscope or an interference with the processes giving rise to homeostasis?

At face value there are signs that the system might indeed be at threat both from within and without.

Within the oceans of information/disinformation that is available "out there in the ether" there have been some nuggets of information regarding some significant developments which may be pointing to a future that has no historical precedent

Examples are:

  • The flattening of the US yield curve - which has confounded financial experts given that a decreasing differential between short dated and long dated yields implies an abatement of inflation in a world awash with money. (This represents "disconnect " of conventional logic)
  • The US Supreme Court case of Kelo vs City of New London, which holds the potential to destabilise Western Civilization at its foundations if it becomes a "point of departure" for the cancerous erosion of home ownership rights.
  • The emergence of a new form of "reverse auction" - whereby large retail organizations are pitting suppliers against each other in an auction environment where the price is squeezed down in a progressively lower bidding process. The natural assumption that this is a force for deflation may be a bit simplistic as the evidence seems to suggest that in an oligopolistic retail environment, the primary beneficiaries are the retail chains, whose margins are growing fatter.
  • The barely containable (simmering below the surface) threat of Avian Flu in Asia that, if it erupts, could have a major impact on all geographic regions of the world given that it is transmissible by migratory birds such as geese
  • The rather odd statistic that Movie attendances in the USA have been deteriorating for 18 straight weeks - evidencing (without explaining) a potential structural change in consumer behaviour.

If we look at the above in a bit more depth then, by way of example for those who do not understand the implications of the flattening of the yield curve, the following table (which ignores taxation) illustrates what this means. The left column of the table assumes that $100,000 is invested for ten years at the 3 month Treasury Bill yield and the right column assumes that $100,000 is invested for ten years at the 10 Year Government Bond yield.

In simplistic terms, what this is telling us is that "The Market" is expecting the purchasing power of money to degrade by a cumulative 10.4% over a ten year period as a result of inflation, assuming that interest rates represent nothing other than the "time value of money".

This needs to be viewed against a background of Central Bank policy which is to "manage" inflation to a target of 3% p.a. compound. In turn, (again simplistically) this implies that the purchasing power of money should degrade by around a cumulative 36% over the coming ten year period.

Ultimately, this is why Mr Greenspan is talking about a "conundrum". The Fed's ballooning of the money supply "should" be having a potential 36% cumulative impact, not an expected 10% cumulative impact. And, in turn, this begs the question: Is the slow down in "precession" (movement of the economy at right angle to the external force, see gyroscope explanation above) evidence of healthy homeostasis, or is it evidence that the spinning of the gyroscope is about to slow? At face value, the argument in favour of homeostasis is more compelling, provided consumption in the developed countries does not abate.

It could well be argued by the optimists that Kelo vs City of New London is evidence of a system adapting to maintain internal equilibrium, and is not really a cause for major concern if we assume at the same time that an organic system is predisposed to maintain its viability as opposed to self destruct.

It could also be argued that the Reverse Auction process which impoverishes no one but the inefficient, and enriches the distribution channel and those whom it supports - may also be a force for homeostasis and a maintenance of the gyroscopic forces within the global economy. Indeed, it might even be argued that the "super profits" that are likely to flow from a fattening of the channel's Gross Margins at the expense of the manufacturer's profits could be diverted to pay down the debt mountain - as this excess wealth is recycled via the multiplier effect through the economic system.

This analysis seems to be devolving to the threat of "exogenous" variables to impact on the gyroscopic forces - the most visible of which (at present) is the threat of Avian Flu. This, and a world that may be "behind the curve" in the move away from its dependence on oil because of the US Government's myopic view of the future which, in turn, gave rise to its failure to ratify the Kyoto protocols and all that that particular omission implies.

Unfortunately (from this analyst's perspective) precession is a condition precedent to continuing viability. If all we have is "rotation without translation" (spinning of wheels without forward progress) then the gyroscopic system will eventually wind down. Eventually, unless "new" sources of wealth are created, consumers will become so deeply mired in debt that they will lose the capacity to maintain all but essential consumption; and the "engine" of the continuing momentum will lose its capacity to drive the system, regardless of how much fuel the Fed pumps into the system's fuel tanks (banks).

Unfortunately, whilst the deteriorating Movie attendances may have a very innocent explanation (such as an improvement in home entertainment systems and a predisposition to increase one's social interaction with friends at home) another possibility has much more sinister implications. It seems equally probable that the rising cost of fuel is cutting into people's budgets, and the first expenditure to be cut back is "discretionary", of which movie attendance is a high profile example.

Of interest, however, is that the equity markets are not showing signs of weakness at present. Indeed, quite the opposite. Dow Theory - the most reliable of all macro indicators from this analyst's perspective - is even pointing to the possibility that a bullish reversal may be at hand.

Perhaps we should all aspire to cultivate a predisposition that was embraced by my children's generation: "Don't Worry. Be Happy."

Perhaps we should only start to worry about the gyroscope after it starts to slow down and not before. After all, the largest gyroscope in our environment, the Earth, has been spinning for a very long time.

A one-ounce gold nugget is rarer than a five-carat diamond.

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