Imagine a world of lead pencil factories. Everyday a dazzling amount of inputs are dropped at the factory gate. Cedar logs trucked from Northeast of California,  ‘lead’ shipped from graphite mines of Sri Lanka, rubber ‘plug’ trained through Indonesia were dumped into auto assembly lines, molded, glued and labeled as a pencil. Mainstream economics tends to abstract from this medley of complexity and simplify pencil-making as one ‘production model’: output = f(input).

 

This relation was perfectly true… but only before the pandemic kicked in. As truck riders were forced home, cross-country waterways slowed & flights delayed following strict covid-related regulation, the global supply chain clogged up. Inputs were still there, but we did not see outputs getting produced.

 

Hence what this buzzling system counts on is not a simple relation, but rather the underlying infrastructure that supported the smooth travel of each integrant from one place to another, the ‘plumbing’ of production.

 

If we replace the logs, ‘lead’ and ‘plugs’ into bank notes, T-bond, or tranches of CDOs, we would have been studying the ‘financial plumbing’. 

 

For years the functioning of financial plumbing remains an open secret among hedge fund managers and IBD economists. A secret undefended as mainstream economics seems too indulged in the ‘production’ side of the economy - production of goods, derivatives of financial engineering, and hence less about the flows of funds. Instead of digging into the fabric of the financial world, to see how money is created, distributed and recycled, economists prefer to assume away all the fuss.

 

GFC changes everything. When the fabric breaks down, people are startled to see the economic laws that used to govern the financial world fail to work. Covered Interest Parity was ripped apart by an ever-widening XCCY basis. Inflation hibernates in a decade of QE.

 

Hence why financial plumbing is important: it shows up as an unnecessary undertaking in a time of peace. Whereas the wind of change blows, it offers a novel standpoint.

 

But normal times are what economists seek to explain. Crises are.