Saturday, March 14, 2015

Volatility Unleashed!

Markets Could Be Shuttered Without Notice!
It appears volatility may be about to be unleashed by the soaring dollar and the markets could be getting ready for a wild ride. Ben Bernanke made a statement last week that I thought should have received a lot of attention. A MarketWatch story on Mar 2, 2015 4:07 p.m. details how the former Fed Chairman said Presidents should have the power to declare economic emergencies along the lines to declare war. “I am sure it is not politically possible, but it would be worth thinking about,” Bernanke said.

While the Fed retains the authority it needs to respond to another financial crisis Bernanke said these crisis “tend to have a certain chaotic element to them,” that no one can predict. He made these remarks during a panel discussion sponsored by The Hutchins Center on Fiscal and Monetary Policy. He went on to say "in light of this, it might make sense to give “the president some ability to declare emergencies or take extraordinary actions and not put that all on the Fed,” Bernanke said “The constitution gives the president significant flexibility to respond to military situations, in part because they are chaotic," he noted. The article then went on to point out how shortly after the collapse of Lehman Brothers in the fall of 2008, the Bush White House went to Congress and asked for authority to purchase troubled assets from financial institutions.

These comments have garnered little of the media coverage they deserve. At issue is the idea or concept that we should allow a President, even one who is not an economist or lacks a strong economic background, to take complete and immediate control of the mechanisms governing our free market system. With the transfer of control would come massive unintended consequences, I find this both unthinkable and scary. The fact that a former Federal Reserve Chairman would even make such a statement should send shivers of fear down the spine of people across the globe. This would defy all past historic precedents and laws by transferring the total economy and our economic freedom into the hands of one person. In a world so interlaced with international financial ties the impact is difficult fathom. This should make us wonder what exactly Bernanke knows that we don't, it should also highlight just how fragile the foundation of our economic system really is. 

The reason I think this should have received far more attention is that it screams massive risk still exist. After seven years the "System Is Not Ready!" and cannot adjust to what lies ahead. It is incredibly naive and pure folly to think that during a crisis a band-aid applied from Washington by any President is the solution or even a makeshift stopgap to economic carnage. Back in January of 2013 I wrote an article that received a great deal of attention, the bulk of it is reprinted below, the importance of the message it contains should not be lost.

Saturday, January 26, 2013               
                                             FLASH CRASH on Steroids!
Most investors think that even if things go downhill fast they will be smart enough to get out of the markets. After the debacle in 2008 where they saw the market do nasty and violent swings they learned a few things, this time they figure they will make the right moves before it is to late. But what if it hits like the flash crash on steroids? We know that can't happen because circuit breakers have been put in place to arrest panic style moves, but imagine a market that falls, trade is halted, and the market simply does not reopen for days, or even weeks.

For a long time I have been trying to develop a scenario for a market "super crash" and a reasonable map that would arrive at such a situation. To say I'm negative about this economy is a gross understatement. I saw the last housing bubble coming and predicted the crash in my book Advancing Time. We have never recovered from the Great Recession. By printing money, imploding interest rates, and exploding the Federal Governments deficit we have only delayed the "big one".

I recently came upon these two quotes on macroeconomic stabilization and crisis. First, from Macresilience;
"As Minsky has documented, the history of macroeconomic interventions post-WW2 has been the history of prevention of even the smallest snap-backs that are inherent to the process of creative destruction. The result is our current financial system which is as taut as it can be, in a state of fragility where any snap-back will be catastrophic."
And next from Nassim Taleb (author of The Black Swan);
"Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite."
These quotes suggest an analogy with ideas about forest management when natural fires are suppressed. If random fires do not periodically clear away forest underbrush, we see a build-up of flammable material sufficient to power a massive conflagration. I certainly think an equivalent truth applies to financial markets. The longer it has been since a painful collapse, the greater the willingness to pile on leverage and complexity, such that the next crisis becomes unmanageably awful. The "Too Big To Fail" and other policies implemented since 2008 have laid the groundwork for "The Big One", or what we will someday look back on as the mother of all sell-offs. My studies in micro-economics, and observations in the current real-estate market, both as a owner and hands on landlord allows me to predict, we ain't seen nothing yet!

Even after two years I stand by this scenario. Financial instruments, intangible paper, and promises are the warehouse or vault where America stores close to 71% of household wealth. All those involved in these huge financial markets  should be aware that at any time a danger exist the music might suddenly stop. Whether it be the result of a massive cyber-attack, war, or a major natural disaster it is foolish and a bit silly to think as a really bad scenario plays out the markets would continue to function as normal and without a hitch. Expect that all promises made or implied will be reworked in favor of those in power or left unfulfilled.

1 comment:

  1. Sooner or later this button will be pushed.

    When that occurs, those who trusted will be like people dancing in the Happy Land club in NYC when Julio Gonzales struck his match. Obliviousness and hope do not constitute a plan.

    For people to get their wealth out of markets, pensions, etc. they have to 1) transact a trade of some sort, then 2) withdraw their wealth in banknotes. All other "wealth conditions" are subject to the whims of markets & politics. Those in authority will undoubtedly see both of these acts as contributing to the rout, and first one and then the other will undoubtedly be officially proscribed in a vain attempt to stop the carnage.

    Today people are used to mentally thumbing through the "dollars" on their balance sheets and (to the extent that they have any wealth at all) their financial planners' retirement calculator projections. What they don't realize is that "mental money" only exists as long as everyone else agrees.