The Keys to Understanding the Collapse of the Status Quo: Credibility and Expectations

by CHARLES HUGH SMITH August 15, 2012

When expectations are raised to impossible heights based on the promise of exponential financialization, the credibility of the Status Quo is doomed.

Data is important, but not all trends can be quantified. Longtime readers know that I value data and often use charts to explain the forces of transition/collapse. But there are profound dynamics that are not easily quantified, instances in which quantification may obscure our understanding.

Credibility and expectations are two such dynamics. Both credibility and expectations are very real forces, despite their status as inner states immune to direct measurement.

Beneath the surface of financial statistics, the real bedrock of any political and financial Status Quo is its credibility in the minds of its subjects. Once the people lose faith in the system, it will collapse under its own weight, a process I described in When Belief in the System Fades (March 12, 2008).

The corollary to this structural need for highly motivated, dedicated people to work the gears is that if their belief in the machine fades, then the machine grinds to a halt.

The loss of credibility in the European Union, China, Japan and the U.S. is now in full swing. Credibility is like a sand castle; every false promise, every half-truth, every simulacra "solution," every secret deal, every surrender to vested interests, every politically expedient but ultimately disastrous "fix" removes a handful of sand from beneath the sand castle.

When enough sand has been removed, the castle collapses under its own weight.

The most interesting characteristic of this hollowing out process is the apparent stability of the Status Quo until the sudden "nobody saw it coming" collapse. In the current era, the Arab Spring is a regional example of this hollowing out of credibility; in the late 1980s, the process was exemplified by the "nobody saw it coming" implosion of the Soviet Empire. In 2007-08, the exposure of phantom wealth tracked a similar pathway, with apparently "solid" institutions imploding "unexpectedly."

Can anyone seriously claim the European Union, the European Central Bank and its alphabet-soup programs still retain a shred of credibility? Every EU/ECB "save" is fictitious, every "fix" expedient, every promise empty, every face-saving summit a living lie.

Ultimately, all the posturing, promises and saves come down to an impossibility: "rescuing" phantom assets purchased with astounding levels of debt by issuing even more astounding levels of debt.

Does anyone truly believe this absurdity is anything more than a transparent fraud designed to extend the life of a failed, corrupt system constructed on fantasies and lies?

Those with assets are fleeing for less fantastic and dangerous climes. The handful of French millionaires who are supposed to magically bail out a failed-state that absorbs 55% of GDP are busy transferring their assets out of France, a mass exodus of capital that is also playing out in China, where those who embraced the slogan "to get rich is glorious" are transferring their wealth, ill-gotten or well-earned, overseas.

So vast is this outflow of wealth that for the first time the outflow of capital from China exceeds the inflow of investment capital. The smart money is exiting, and the last batch of credulous "China story" rubes are dumping their capital down a rathole.

The same process is visible in global stock markets, where the smart money is selling. The loss of credibility in the digital bucket shop known as the U.S. stock market is evidenced by the outflow of some $200 billion over the past few years. To some degree, this has been offset by the influx of foreign capital desperate to escape the black hole of the euro, but the steady erosion of faith in the U.S. stock market is striking: as noted last week, 80% of the trading is either invisible, officially sanctioned manipulation or computers trading.

If the U.S. legal system weren't hopelessly compromised, the U.S. stock markets would be shuttered as corrupted beyond redemption.

Globally, the erosion of petrocapitalism (more on that later this week, via correspondent Ray W.) and the self-destruction sequence of financialization are laying waste to the credibility of politicos' promises. It was so easy to be a politico when financialization (exponential expansion of debt and leverage) raised the global tide, lifting all boats; extravagant promises based on everlasting "growth" could be issued, votes bought and the vested interests of crony-capitalist cartels and public employees lavishly rewarded.

In this environment, expectations were raised to impossible heights. Expectations are the yin to credibility's yang: together they form a unity, as credibility is linked to the fulfillment of expectations. If expectations are raised and then dashed, credibility is eroded and then lost entirely.

Expectations everywhere have been raised to heights so lofty that the air has become thin: all these expectations are like debt-money claims on the real world: the claims can expand to near-infinity, but the real world remains stubbornly limited.

As lofty expectations are unmet, the credibility of the Status Quo inevitably decays and implodes. We are as yet in the early stages of this process. Let's check back in 2014 to see if the sand castle of the Status Quo has collapsed in a heap of wet sand, or if it is merely sagging in the pre-collapse phase.