In “A Funhouse Mirror Through Beer Goggles,” I talked about the importance of adjusting one’s lenses to account for the ongoing drift away from “normal.”
Failing to make such adjustments can leave you with an accumulated reality deficit, ironic considering refusal to come to terms with various manifestations of distorted markets is one way of insisting that “this can’t be reality.”
The simple figure (below) shows the deficit as a percentage of GDP in the US, along with the ratio of M2 to economic output.
As the chart title and subheading suggest, the fact that nothing’s gone horribly awry more than a year on from the institution of what, outside of war time, is a wildly anomalous conjuncture on multiple fronts, casts considerable doubt on the notion that any of the “rules” you hear parroted by orthodox economists, analysts and conservatives are actually rules.
You’ll point to inflation as evidence that things are going awry, if not yet horribly so. Rather than scream “transitory!” at you, I’ll go out on a sturdier limb. We just witnessed the single largest supply chain shock in the history of the globalized economy. Unless governments around the world had simply let the pandemic trigger a deflationary spiral into an apocalyptic abyss, setting mankind back centuries in the process, some inflation was inevitable. To what extent it’s exacerbated by demand-side stimulus and, relatedly, government programs blamed for keeping workers sidelined in the US, is the question. And we won’t know the answer until at least next spring.
Until then, you have two options. One of which involves persisting in the notion that this can’t be reality. That “sooner or later, it has to stop.” The other option is just to ride the proverbial wave, something investors continued to do last week. Inflows to global equity funds were nearly $16 billion (figure below).
That was more than triple the previous week’s haul, which counted as the fourth-lowest of the uninterrupted weekly deluge in 2021. The YTD total now stands at nearly $660 billion.
I’m sympathetic to various iterations of the “this won’t end well” warning, even as I’m not fond of that phrase as a cheap, closing punchline on missives documenting purportedly egregious market disconnects.
It’s certainly not that I think all the “rules” we’ve allegedly broken will reassert themselves, like gravity. Unlike the game we play when we interact with the natural world, our economic lives (and especially our activities in capital markets) are dictated by our own psychological dispositions, subject to our own biases and quirks and ultimately governed by rules of our own creation. Adam Smith was a philosopher, after all. The Wealth Of Nations isn’t a physics text.
The reason I’m sympathetic to those who insist myriad glaring disconnects must ultimately be “resolved” is simply that if they aren’t, we’ll lose one (if not the) key frame of reference that gives order and meaning to our existence.
If money can be printed ad infinitum, if investors will pay for the “privilege” of loaning governments and corporates money, if the whole concept of “red ink” at the federal level is wholly useless (i.e., not just a pernicious “myth,” but in fact a totally meaningless concept that should be jettisoned entirely), and so on and so forth, then we should rewrite the textbooks. Virtually every classic in the canon of economics should be consigned to the fireplace. And much of what we do everyday in pursuit of wealth and economic prosperity should be viewed skeptically, as a byproduct of a discredited fantasy.
Last weekend, I mentioned that “economic man” is a relatively new being — a creature who came onto the scene a mere ~300 years ago. Prior to that, the notion that everyday people should seek gain for its own sake was considered blasphemous. “Markets” as a unifying global concept (as a frame of reference within which to contextualize human activity) and “economics” as a practical branch of philosophical inquiry, are very new ideas.
Maybe — just maybe — those ideas have worn out their welcome or, at the least, need to be updated to fit the needs of modernity.
If we’re not open to refining and reimagining the concepts that define our existence, we may lose our way entirely, disenchanted as old dogma proves increasingly incompatible with reality. Religion suffered that fate. And capitalism is just a humanist religion.
Right? Take, for instance, the old saw, “reversion to the mean”. What ‘mean’ can reversion approximate when the goal posts have been assigned such arbitrary coordinates?
Or your recent nod to the folly of ‘endlessly re-hypothicated collateral’… standing as countable on any ledger.
Perhaps it IS time to pronounce the time of death, of rationality, of long-held norms of macro economics, of any market theory. Anarchy has a place in market dynamics today as much as it ever had. The walk down wall street is as random as it ever was.
First of all, the truth is that in a solar system over six billion years old, in a society that’s probably at least 50,000 years old, we have no idea what the “mean” is. As to anarchy, in the grand scheme of things its just the inevitable state of “entropy” which all systems will devolve into. Entropy is the uniform state of chaos where everything seeks a homogeneous composition. It’s the reason for hypothermia, for instance. We are going there and no people will actually be present when we get there. Mostly, people ignore the idea of entropy but like it or not, it’s the law.
One of your best. Obviously, the younger generations (and they all younger than me) understands this in some reptilian part of the brain if not overtly. Bob Farrell (and others) may disagree. But the twin opposing forces — central banks’ “printing presses” and Covid-19 — were not part and parcel of the forces for which the gurus of trading had to contend. These forces are not going to slink away in the dark of the night. So, adjust to the new reality.
As someone with a degree in capitalist theology (otherwise known as economics) I had a hard time letting go, but you convinced me. Distortions don’t have to correct in any timeframe worth considering. This time IS different, Reinhart and Rogoff’s evidence notwithstanding.
Not only as Americans but as Homo sapiens, we need to develop some new myths to replace the old myths that are no longer are working to bind us together. If not, we might be headed for significantly more violence not only within America but within the human species.
Our economic problems might really be conceptual limitations of the human brain. Perhaps brain science is the only science that can save us now.
Excellent article, great sentiment and so true.
The further we get away from gold the more we find it’s all negotiable. We were supposed to have a depression, stocks were supposed to be really really cheap.
I liked seeing the batteries wear out in the bullhorns.
“… then we should rewrite the textbooks. Virtually every classic in the canon of economics should be consigned to the fireplace.” Yes! While some real life Montag grins the fierce grin of all men singed and driven back by flame, it was a pleasure to burn…
I have an undergraduate degree in Economics (with a second major in English in case the first one was bogus) and one of my four doctoral fields was also Econ. After all this immersion in the “dismal science” I am convinced that all freshly minted economists should come with a sunset date of 20 years (or less) that would force them to do something valuable with their life after that date.
Seems odd that the emergence of market capitalism philosophy arose concurrent with the importation of coffee into Europe. Then “bare teeth” aggression and “winner take all” attitudes arose after the commercialization of tobacco.
It could be that the current civilization has been on speed for 350 years.
Don’t forget Cocaine. I hear wallstreet is fond of it as well. Yes I suspect stimulant and acceleration addiction is physiological first and economic second as well.
This is a bit of a strawman argument.
The strawman is that the referenced events, by all known economic relationships, just had to result in a calamitous depression, the End of Days, whatever.
But who thought that? Some vocal pundits, celebrity investors, and professional wisemen. Some institutional investors and traders, and some number of retail investors – you know, the ones who liquidated everything at the end of February 2020 and are still waiting for price action to prove that they weren’t wrong.
But who didn’t think that? Thousands of professionals and thousands or tens of thousands of retail investors who piled in to buy assets at astounding bargain prices. Including lots of readers of this blog, I reckon.
The latter group didn’t grow up observing different economic relationships and market dynamics than the former. The gravities they learned to walk in were the same gravities. They applied the same basic professional experience, did the risk-reward assessment, and simply came to different conclusions that turned out to be the winning bets.
If we were to ask the “winners” what experience, relationships and principles they relied on, I’d wager the list wouldn’t be foreign to the “losers”. It would be something like: in times of crisis money flees to the safest and most liquid assets; the currency in which everything is bought and sold is the one you want; a guy who is currently named Powell has an endless supply of that stuff; the bulk of asset valuation is based on future cashflows not current losses; most other people learned the same valuation theories that you did; in extremis, most companies’ cost structures are way more variable than in normal times; pandemics don’t last more than a year or two; we actually know a lot about coronaviruses; professionals who lose money today have to make it back tomorrow STAT or say sayonara to their careers; RSI < 30 is usually a buying opportunity; RSI < 30 but moving up is almost always a buying oppty; and hey, we’ve seen this picture before and we saved the playbook from last time.
It might not be some rigid macroeconomic equivalence or formula. I’ll bet most market participants don’t even own an economic textbook. But we’ve all, or most all, lived through the same market cycles, crashes and booms. We all, or mostly all, have at least a practical if very imperfect and partial working knowledge of the basics of at least a couple of the same markets. It’s just that, like someone, who is probably passed away by now, once told me – patiently and a little pityingly, like he was talking to the village idiot – in the short run, this has always been and will always be a zero sum game, the guy on the other side of the trade thinks he’s right and you think you’re right and one of you is wrong.
It’s not like the rules of the game have changed, it’s just that things got real weird and confusing there and everyone had to make decisions real fast and some people’s rigid macroeconomic formulae models turned out not to be the best basis for betting.
And/or, that they are playing the long game and will be proven right – eventually. I’m actually kind of sympathetic to that possibility. The elastic can stretch a long way for a long time before it snaps back.
First, this: “The latter group didn’t grow up observing different economic relationships and market dynamics than the former.”
—Some of them surely did. If you’re 25 on Wall Street right now (or 25 on Robinhood), you were just mastering the fine art of walking on two legs when the Towers fell. You were 13 for Lehman.
Second, this: “But we’ve all, or most all, lived through the same market cycles, crashes and booms”
—Really? Are you 100 years old? How many actual crashes and booms have you, yourself, really traded through professionally? I’ll wager that’s a small “n,” at least from a statistical perspective. And many of the people buying on Robinhood and other retail platforms have traded through exactly 1 (one) crash: March of 2020.
Third, this: “It’s not like the rules of the game have changed, it’s just that things got real weird and confusing.”
—That’s like saying, “It’s not like the rules of the game have changed, it’s just that instead of a round basket, it’s square now, the goal is 7.5 feet tall instead of 10, the three-point line is now a five-point line and free throws are worth 32 points.”
Admittedly, when I think about the people who make up the market, I tend to think about the ones who run most of the institutional long money in the world. Not the Hoodies.
On the institutional side, they are generally in the 40-60 age range and have been doing this for 15-35 years. So most of them have seen 2020, 2008; many have seen 2001; a few have seen 80s/90s events; very few are left who personally saw the 1970s.
I know, there’s 25 yo’s on trading desks and HFs and 80 yo’s in corner offices, but they’re more the tails of the curve.
Personally my institutional market experience goes back to 1997 so I feel like I’m sort of mid-pack. Not counting being a retail investor before then, because I didn’t learn much from that.
My “n” of major market crashes is 3 (2001, 2008, 2020), my “n” of corrections, meltups, headfakes and mini-versions of those is, not sure, 20 or 30?
The thing is, unless you’re an actual quant, having “n” of 50 or 100 or whatever is needed for statistical significance isn’t important. There are general things (relationships, dynamics, also psychology, disciplines) that you can use, and they haven’t changed so very much in, at least, the period that I’ve seen.
One big boom-peak-crash-bottom cycle, closely observed, probably exhibits most of these things.
In fact, I’m not sure they’ve changed that much since before that. In early 2001 I was working with an experienced guy, he’d been a stock investor since the 1960s. I was trying to learn how he picked stocks, and he showed me his files on some good picks from back in the day, all his longhand notes and models penciled on graph paper. It was really cool to see.
I don’t remember him telling me things that would be so foreign today. Of course, a bunch of today’s things didn’t exist back then, but I don’t think most people need to – or can hope to – grasp even a majority of what is going on in the market, in order to succeed: most players have specialties.
After all, we still draw lessons from things like the South Seas and Tulip manias, the Weimar hyperflation, and other historical events.
Good stuff. Thanks for this. These are the kinds of comments that make the site more valuable.
Since the industrial revolution, the innovators/engineers who have facilitated this, view the world is non-zero sum. Why did the people that finance it view the world a zero sum?
Yessir! Someone much smarter than me once said that the purpose of all financial innovation is to transfer risk to folks less equipped to evaluate it.
Good quote…..
Zero sum in short run. Not in long run.
It’s always been obvious that economic theory has ignored population biology and ecology. Economic growth forever, with no reference to resource depletion or population dynamics, is not possible. If you’re a bacterial colony, you can grow exponentially only until you get too crowded and deplete the nutrients on your plate, at which point you’re on the flat part of the S curve. More drastically, there are many instances of population explosions followed by crashes due to depletion of resources. There are gradual extinctions, and then there are mass extinctions due to major geological or astronomical events or perturbations. You might argue that humans are different, that we can innovate, we can adapt to changing conditions, we can extend the carrying capacity of our earth. And we can, to a point, for a certain amount of time. But eventually it will become evident that we are organisms first and foremost, and we cannot invest our way around inconvenient truths.
I am a broken record. Theory, the search for correlation and maybe causation, take a backseat to experience. Druckenmiller said something to the effect I’m wrong so often I need to find other ways to make money besides being right,,, I retreat to today’s price action is tomorrow’s news…Example- did $145 oil break the back of the mortgage market? Did $12 oil push the tech boom of 1999? I don’t think it’s crazy to look at stuff like that….Some of the smartest option traders I know have basically rigged together an equivalent to the commitment of traders report….Did the inverted yield curve of 2019 predict covid?
“ Did the inverted yield curve of 2019 predict covid? “
I don’t think so. I don’t see how it could have?
Still, if you saw the inverted curve and that led you to derisk in 2019, you were happy. Lucky is as good as right.
Excellent post.
Perhaps a flip side to the conundrum you outlined — when you Google something and “discover” that everything you’ve ever been told about, say, making a fire in a fireplace, is wrong. The other worry is that we are also replacing true scholars of lore who did their best to describe what they saw and experienced, with the omnipotent but faceless authority of Google and Wikipedia to deliver us the facts we need in order to know what to think about anything.