“It’s easy to say that the Fed should tighten. And I think that they should,” Ray Dalio said Monday, in remarks to the Qatar Economic Forum.
The problem, he lamented, is that they can’t — tighten, that is.
I spent what you could fairly describe as an inordinate amount of time last weekend going on about why it’s mostly impossible for central banks (and especially the Fed) to truly “normalize” policy after a dozen years spent chasing ever farther down the accommodation rabbit hole. I’d immodestly suggest that the linked articles (below), are worth the time it’ll take you to read them.
Beyond a certain threshold, the abnormal becomes normal. The extraordinary becomes ordinary. I know this because, for too many years, I spent most of the day in various states of inebriation, with the only saving grace being that I was nominally stylish about it. You might get apprehensive, forlorn looks if you’re buying a sack full of airplane bottles at 10 in the morning, but it’s all smiles and “Thank you Mr.s” when you’re buying Laphroaig. And no bartender is condescending when your tab is $500, no matter how worried they may be about you.
While not every occupation I’ve ever dabbled in was conducive to being blissfully scotch-ed, the “professional” ones were. You’ve heard of “functioning alcoholics.” Honestly, that’s an overused term. Just because your boss (or some colleague) has alcohol in his (or her) system all day doesn’t make them a “functioning alcoholic.” It just makes them someone who has a (mostly) harmless vodka habit which may (or may not) be preferable to taking two percocets every day for “back pain,” a klonopin every eight hours for “anxiety” or some nightmarish cocktail of antidepressants because their psychiatrist is getting kickbacks from the pharma company (I’m just kidding. But not really.)
Most Americans are under the influence all day, every day. There’s not much difference between you and your “alcoholic” colleague. She has “back pain,” “anxiety” and/or “depression” too, it’s just that rather than go through the charade where the doctor asks a series of leading questions in order to elicit enough “right” answers to justify a prescription, she decided it’s easier to sneak a shot of liquor every five hours.
A “functioning alcoholic,” by contrast, is someone who performs well, and in some cases exceptionally well, while being literally drunk. That was me. And it was normal. After a decade of practice, I was exceptional at things because I was drunk, not in spite of it.
Quitting was theoretically possible (alcohol isn’t heroin) but it would have translated to an immediate and dramatic decline in performance. My last employer (whose face I can barely remember all these years later) would invariably say that alcohol was the problem. But that wouldn’t be quite accurate. The problem was the accumulated tolerance. Any deviation from a consumption schedule that, frankly, would have killed most people within a week, led to severe anxiety, which in turn translated to a complete incapacity to perform as advertised. And I was heavily advertised.
That is precisely where we are with markets and central bank accommodation. I said last week that (and I’m quoting myself here) “the ‘addiction’ analogy is overused to the point of being a cliché, but it can be taken almost literally now.” The mere suggestion that policy rates may be slightly off the lower-bound two years from now, was enough to cause a fairly severe reaction last week, with the curve’s abrupt reversal being the most glaring example. As for the taper, the Fed is buying, on average, $4 billion in assets every, single day. That creates an acute addiction liability, even if part of it is merely psychological.
Any deviation from the current maxed-out accommodation — indeed, any hint that such a deviation might be in the cards at some undetermined future date — is enough to cause severe consternation and could lead to total incapacitation depending on the circumstances.
In his Monday remarks (see the video clip, below), Dalio described this to the letter. “I think you’ll see a very sensitive market, and a very sensitive economy because the duration of assets has gone very, very long,” he said.
“Just the slightest touching on those brakes has the effect of hurting markets because of where they’re priced, and also passing through to the economy,” he continued.
Regular readers might note that in addition to the two linked articles mentioned above, I also penned a piece last week called “Tapping The Brakes.” Go figure.
Ultimately, Dalio assessed that the Fed “can’t tighten very much without having a big negative effect.” He’s right.
The problem with suggesting that eventually, central banks may need to simply “cut markets loose” or otherwise allow some version of creative destruction to run its course in order to purge misallocated capital, is that this isn’t akin to one person detoxing. It wouldn’t be a controlled demolition.
Indeed, the Fed’s legions of critics are fond of positing a grand “reset” of sorts, the opposite of a controlled demolition. In such a scenario, policy rates would be reset to whatever “normal” or “neutral” is imagined to be, risk-free rates would surge and central banks would become active sellers of the assets they hold.
That would unleash cross-asset chaos, and the ensuing volatility would lead to the mother of all de-leveraging events across the entire universe of vol-sensitive strategies.
Note that I went through the “grand reset.” On (multiple) doctors’ orders, I’m never to imbibe again. Allow me to say, without equivocation, that the purging of my accumulated addiction liability was a volatile event, complete with seizures.
Extrapolating that to capital markets is something I’d rather not do. Selfishly (so, leaving aside for now the widening wealth gap which goes along with central bank accommodation), I’m content for markets to remain functioning alcoholics. After all, what’s the worst that could happen? Maybe ask some of my old friends.