Join institutional investors, analysts and strategists from the world's largest banks: Subscribe today
Already have an account? log in
Who Really Understands The Risks? It’s Probably Not Who You Think.
I continue to think the biggest risk from the wind down of ECB asset purchases (and I use that example to proxy for central bank normalization more generally simply because the Fed is already normalizing and the BoJ is some ways off, so the ECB is just the most relevant case) emanates from market participants (big and small) underappreciating the extent to which years of supply/demand distortions have served to effectively relegate price discovery to the dustbin of history.
That's a simple conc
Food stamps are the bitcoin of soup lines.
H
Mmm. I do love your stuff. I am one of those getting that free ride. I read you to try to stay far enough of that slap in the face that it won’t be ice cold. My own conceit is that I like to think I am far enough ahead — lucky to be there — that when the slap comes I’ll still have enough left to finish the ride. If not, it’s too late now.
As to economists. Well, I’ve always thought, as you point out, that they suffer most from “physics envy.” They seem to “get” marginal this and marginal that, but they don’t really understand either business or people. We swallow the meme that since business is the central part of the economy and they are economists they must get business. But they don’t because they don’t really seem to get the idea of profit, in either a macro or micro sense. They assume away all the messy naughty bits associated with human participation in their precious economic system. So when they mess with the system and people don’t like it they just don’t understand. I had an economist for a dean once. He was actually a successful entrepreneur but he didn’t “get” other people. He once instituted some silly new procedural change that was going to cause most of his faculty to lose either time or money or both, while the “college” would benefit at their expense. He sincerely couldn’t understand why his faculty were unhappy with the change. He asked me why they were unhappy. After all, the college would gain. I had to remind him that these folks had families. They like food and clothing and the odd night out. They didn’t really care what happened to the college “system.” That just didn’t fit his system view. To him their behavior was not rational in the context of the good of the “system” and they should understand this.
I think this topic, in particular, highlights the gap between markets and physics. If markets were like physics, QE would be analogous to an inertial reference frame and relativity would apply, which would mean that none of the distortions being discussed here would happen. But they obviously do happen.
I think the issue is that it IS Physics but it is also Neuroscience AND Human Culture. The basic landscape is physics but all the roomba’s have human firmware and they are grouped into different code sets by culture. Predicting what they’ll do with simple mathematical formula’s is a bit cart before the horse to put it mildly. It’s hard to even understand what domains they apply in or what the underlying assumptions are.
Far and a way, this is the best essay I’ve read that you have produced. The fun part is to finally get a glimpse of your mainspring. I do hope you edit and submit to SA.
Great post, Mr. H, and thank you for giving as but a glimpse into your mental constructs. I have noticed that lately it seems your writing is lending to the fact that you’re tiring of the those that keep saying you’re simply a permabear and chicken little drum beater. I hope that everyone who reads you daily, or only comes across your writing every so often, is able to see this article and understands what you actually stand for. Please keep up your great work and know that the “haters” are just that and they’re simply noise around your signal that we hear, and (mostly) understand, loud and clear.
H- while soup lines might of been one of the outcomes, there would have been a backlash to the greed and unfettered leveraging. There would have been consequences. Would we have a Donald Trump president? Now, as have been mentioned, will the next GFC be even worse due to the even larger bubbles bursting? I would like you to peer into your crystal ball and let us know what you see the Great Experiment will bring!
“… a set of policies where the only predictable outcomes were bubbles and more inequality in order to prevent bank runs and outright chaos”, so WHY NOW is QE being eased? I understand econ is a soft science, but after all that number porn/quant porn that economics shows to the outside observer, there must be a reason why the end of QE was timed with the moron Trumpf? What’s different between 2016 (markets were still UP) and 2017 (new era of making Am. Great).? All those press conferences, all those senate hearings by Central bank, and we j u s t d o n ‘ t k n o w. But i tell you, it doesn’t smell of Central Bank “independence”.
and to the point of the bit in quotes above (which i led with, but which i forgot to address), what IMPROVED in the intervening 10 years?
H this piece is gold. I hope you port it to SA.
I think the price discovery distortions make QE and the unwinding process a “news and events” that is capable of affecting equity indices. I say this because unlike sporadic news and events, QE has been and is a very long term macroeconomic disturbance that has changed market psychology significantly. There are many that say that equity market fluctuations and valuations are determined purely by investor sentiment and not by news and events. I think that’s true to a very significant degree, but what they fail to recognize is that long term macroeconomic disturbances over time ( these are significant “news and events”) change the investor behavioral response to risk assets, and this of course affects both short and long term vol. in many different financial markets, most markedly in equity markets. This in turn affects market valuations.
One has to think about what happens when the behavioral response, that has been firmly encoded into the investor psyche via lack of price discovery, is turned completely upside down during an unwind. Sentiment will change. And as you mentioned,it goes beyond QE. Massive volumetric mutual fund stock aggregation has further obscured price discovery at the individual asset level.
Regarding QE, One also needs to ask three very basic quesruons
1.should we unwind?
The academic literature on this is a clear yes. The long term ramifications of prolonged QE and restrictive interest rate monetary policy are now very well understood. It goes far beyond the “debt trap” and the loss of risk quantification that is embedded in market determined interest rates. Long term QE paradoxically slows real economic growth and productivity in the long term,
The equity investor has little regard for the system (economy) as a whole. The equity investor has a family to feed. Insofar as the “should we” question, the equity investor would answer a firm no. (Despite realizing that future economic growth and productivity will be stunted for decades, and despite not realizing it. Reasoning doesn’t matter). The quick “here and now” realization of profit supersedes any and all future drawbacks.
2.can we unwind?
Globally, this will be very difficult. Accumulated leverage and policy divergence.
3.will the US continue to unwind and at what rate?
If we knew the answer to this we would know what the equity markets would do in the next critical 18 months. The Fed truly does understand the ramifications of prolonged QE and they do understand the dynamics of burgeoning inflation. As you mentioned they are very very intelligent. However, there are political forces (political being used very loosely) that are pulling in the opposite direction, making it difficult to sustain an unwind , as the equity market destabizes very reapidly with rapid normalization. There are very very wealthy and powerful people that have much to lose in a flailing equity market. This isn’t a conspiracy theory, it’s a fact. Combined with global monetary policy divergence (which you’ve explained very well) , normalization will be all the more challenging. I don’t know if there will ever be a complete follow through on global QE unwind. The only way that the unwind will be stubbornly pushed along in the US is through firm inflationary pressure that forces the hand of then Fed, despite any ramifications on equity markets. At this point the rate of normalization will increase and the rate is critical in determining its affect on risk asset valuations and risk markets.
I’m very grated for the academics at the Fed, because I know that they realize the issues with prolonged QE, and I know that they understand how quickly inflationary pressure can accelerate. They provide some sanity to the long term dynamics of the markets that are incessantly and relentlessly inflated by investor greed. They understand the importance of true market price discovery, asset bubbles, and how truly distorted markets have become.
Nice piece… the irony though is the economists who pursued QE are the doomers. If they weren’t they would not have done it. Don’t forget poverty is measure of government intervention.