Tuesday, 30 September 2008

Containers, credit and Nassim Nicolas Taleb

Reading Marc Levinson’s influential book, The Box, about how shipping containers changed the world has made me think of a new way to approach the credit crunch.

The general thrust of Levinson’s book is that containers massively reduced the cost of shipping, meaning the end of traditional docks, and associated industries, and separating industry from the restraints of transport. Things could be sent anywhere, from anywhere. Hence China.

As with most single-issue economics books, too much weight is put on the book’s main subject, while other important factors are downplayed or ignored. Levinson makes no mention at all of wider political or economic trends, such as pressure for free trade, increased capital movements and the Cold-War-inspired inclination of the US to open up its market to south-east Asian imports.

But this critique is not my link to the credit crunch. Instead, it is Levinson’s rather brief point about the container’s role in the introduction of ‘just in time’ industrial production, where materials are transported (often long distances) at precise times, in different factories.

His point was that the container helped allow a much higher-risk and lower cost form of production to develop. Containers were one part of a technological shift reducing inventories and allowing producers to outsource work that had previously been done inhouse. Vertical integration was out, horizontal integration in.

What does this have to do with the credit crunch? Well, the same explanation seems to apply to the financial industry. For leaner inventories read lower capital measures, for outsourcing of work, read ‘originate and distribute’ rather than hold-to-maturity.

From this perspective, the banks’ main crime may only have been to copy what the rest of industry was doing (MBAs anyone?) and assume that widespread disintermediation would reduce risk and improve efficiencies, as it seemed to have done in the wider economy. What wasn’t known was that horizontal integration and disintermediation would reduce smaller risks but increase the likelihood of a ‘Taleb distribution’, ie lots of small gains but occasional massive losses.

Using a container-ship-inspired analogy, it must seem to banks that the withdrawal of liquidity is as unexpected and as unlikely as waking one day and finding the sea has been completely drained. But from a Taleb perspective, the credit crunch is simply a black swan sailing into view.

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