Guest Post: What If "What Everyone Knows To Be True" Is Wrong?

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

What If "What Everyone Knows To Be True" Is Wrong?

When the consensus is confidently weighted on one side of a trade or view, reality has a nasty habit of introducing blowback and/or unintended consequences.

In a followup to yesterday's entry A Contrarian Take on the Dollar's Demise, here are some other contrarian views culled from readers and recent news items. When does a contrarian view or bet become mainstream? Sometimes the answer is ambiguous. When do you look around and realize (usually with some dismay) that "everyone" now agrees with your once-lonely point of view?

Consider gold as an example. I am a fan of gold for the simple reason that it won't go to zero--something that cannot be said of purely financial assets. But as a technical observer, I can't help but notice just how lopsided the trade in gold has become.

According to the CFTC data, there are now 192,838 long contracts on gold and only 3,636 short contracts. That is a remarkably one-sided trade, and one that is technically ripe for a major reversal. When everyone agrees you can't miss on a trade, and punters are betting 50-to-1 that the trade can only go one way, then that's when it reverses and crashes.

As a technical observation, this is completely disconnected from all the fundamental reasoning behind owning gold. In other words, if you are one of the many readers who own gold long-term for peace of mind and insurance, then a 20% decline in gold is merely a "buy the dip" opportunity. For traders, it may offer an opportunity to gain on the downturn and then again on the inevitable upturn.

Correspondent Martyn T. recently made what I consider an important and contrarian point about the financial consequences of Japan's devastating earthaquake and tsunami.

So far you have not noted the way in which the Japanese insurers will affect stock markets. The Japanese government has long insisted that insurers prepare for a major event. This was expected to be an earthquake hitting Tokyo.

Obviously, they would need to have massive reserves, and these should be abroad, so that secure cash can be found.

In their rush to bring in some cash they have sold some and bought yen. This has resulted in other central banks helping to reduce the value of the yen.

But this is only the first tranche of selling. So far they won't know what liquidity they need, but as it rises so will selling, all across the developed world.

In other words, if the rebuilding and insurance claims will end up costing $300 billion, a significant chunk of that will come from insurers and re-insurers who will have to liquidate globally distributed assets such as stocks and bonds to raise the cash.

Let's assume the Japanese government will cover half of the costs of rebuilding and insurers will have to cover the other $150 billion. What will the liquidation of $150 billion in financial assets do to a vulnerable market? I hesitate to offer a prediction, but it is unlikely to be bullish.

Frequent contributor Dr. Ishabaka offered up this menu of other consensus views that "everyone knows to be true":

    - the U.S. dollar will continue to decrease in value indefinitely
    - U.S. real estate will continue to decrease in value indefinitely
    - the standard of living in the U.S. will decrease
    - the U.S. stock market is in a bubble
    - commodities will continue to rise
    - China will overtake the U.S. as the next great power
    - U.S. manufacturing is dead
    - U.S. debt will increase indefinitely
    - emerging markets will provide the economic growth of the future (along with China)
    - everyone in poor countries wants to eat more meat, and own a car
    - energy will increase in price indefinitely
    - wars and revolutions will continue to increase, perhaps leading to another world war
    - Social Security and Medicare will go bankrupt
    - defined benefit pension plans are dead
    - health care costs will continue to increase at a rate that outstrips inflation indefinitely
    - unemployment will be serious in the U.S. for the foreseeable future
    - Fenders beat Gibsons hands down (pre CBS Fenders, I mean)
    - the gap between the wealthy and the rest of us will continue to increase
    - government in the U.S. is controlled by lobbyists, unions, and other big money interest groups (banks)

    What if all these things "everybody knows" are wrong?

I am not at all sure that "everyone" knows Fenders beat Gibsons, but the list is certainly food for thought. As someone who has played both Stratocasters and my Gibson Les Paul Deluxe, I would say it's more like the difference between a cabernet and a zinfandel wine: sometimes you're in the mood for one or the other, but arguing about which is "best" is pointless, as both are superb but in slightly different ways.

Mark Twain commented on the dangers of consensus thusly: "Whenever you find yourself on the side of the majority, it is time to pause and reflect."

As I concluded yesterday:

When Bears have been eradicated, then the trade has become so lopsided that when it rolls over, it does so suddenly. When everyone agrees, then things become highly unstable. It's ironic, isn't it; on the surface, when everyone shares the same convictions and is on the same side of the same trade, things look rock-solid. Yet that very unanimity guarantees instability.

There is always someone on the other side of a trade, of course: someone originated the option or futures, and someone sold the shares that someone else bought. The problem arises when a "can't lose" trade rolls over, then there are no longer enough buyers to offset the panicky, underwater sellers who are overleveraged via margin or other forms of debt.

This is in effect what still plagues the U.S. housing market: there are still plenty of sellers in the wings, hoping to unload properties, and a dearth of buyers willing to gamble that "the bottom is in." Even worse, there is a dearth of buyers qualified to buy properties at today's prices. That will become even more of an issue as interest rates rise.

As a reminder of how things can play out at real bottoms
: in the depths of the 1930s Depression, a Manhattan skyscraper was sold for the original cost of its elevators. In other words, the rest of the building was "free."

People talk about replacement cost as a metric of value in homes and buildings. In other words, this house can't drop much below $200,000 because it would cost that much to buy the lot and construct a replacement house.

That is another thing "everyone knows to be true" that is actually not true at real bottoms. Stocks can end up trading for less than the cash the company is holding.

We might conclude that being contrarian is simply considering very few possibilities as being "impossible," especially when it comes to herd behavior and investments.

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malek's picture

Then it's a true black swan!

Popo's picture

Charles Hugh Smith wrote:

"That is another thing "everyone knows to be true" that is actually not true at real bottoms. Stocks can end up trading for less than the cash the company is holding."

Scenarios like that occur when liquidity vanishes completely, and desperation trades start to occur.  People need cash so badly that values collapse.

The potential for that happening is entirely dependent on policy -- both domestic and that of FCB's.

Domestic policy is a given -- Bernanke will print.   It's his only weapon, and he's awfully proud of it.   FCB's are a slightly different story -- but thus far, they appear to tolerate, if not support Bernanke's approach.




Doña K's picture

A horse! a horse! my kingdom for a horse!

rich_wicks's picture

King Richard sure liked horses.

I think I need to buy a gun's picture

one other thought if gold goes to 750.00 like someone suggested the chinese will still buy it all from us we will be holding monopoly money and they will have all the real stuff


Mike2756's picture

"Domestic policy is a given -- Bernanke will print" because everyone knows it's true...

cosmictrainwreck's picture

hmmm.... isn't that an interesting notion? what if......?

Bicycle Repairman's picture

OK, what if?  What's your scenario?  You know what people at ZH think.  What have you got?

Muir's picture


I mentioned it dozen of times.

A couple of Illinois, a Japan more and tad more EU problems....

Bicycle Repairman's picture

I thought I was replying to "cosmictrainwreck".  Is he/she a friend of yours?

Ray1968's picture

This is a point I've been contemplating recently. QE3 is not a guarantee... at least not immediately. It pays to prepare either way.

Bicycle Repairman's picture

"QE3 is not a guarantee"

Nothing in life is guaranteed.  What do you see happening if QE3 does not happen?

MachoMan's picture

dollar up, bonds up, stocks down, commodities down less than stocks...  combined with a wide variety of plans for domestic default and balanced budget attempts...  eventually the pain leads to austerity camp shutting the fuck up and the citizenry demanding more stimulus, except better directed (bigger share for small fish).  Stimulus implemented in progressively smaller doses in successive stimulus/austerity rounds...  eventually leading to a failed auction.  This presumes dollar hegemony remains.  Previously mentioned pains may also lead to outright repudiation, whereby B9K9's "strong man" emerges to flip the bird to the rest of the world. 

MachoMan's picture

There used to be alternatives before we painted ourselves in a corner...

Hugh_Jorgan's picture

Dollar up depends on a lot of other factors, and I'm not sure if the citizenry even thinks to ask (erroneously I might add) for more stimulus. Maybe an expansion of existing entitlement programs. I do agree that auterity will not go over well, but it won't be as ugly as it gets in Europe.

Also, don't forget that if we remain on our current debt trajectory, we will default on our debt before 2020. Assuming your predictions are realized, that trajectory inevitably becomes more and more hyperbolic and thus shortens the time to default. This will guarantee the printing presses will no longer work as intended, and the Ponzi Dollar collapses.

What comes after that is anyone's guess. With the level of avarice and the social insanity currently infecting the "big-money" and power circles, I am leaning toward expecting some kind of governance crisis in America. Possibly a second Civil War and a breakup of the United States, unless we extricate our collective craniums from our collective rectums, ASAFP.

MachoMan's picture

Extension of entitlements necessarily relies upon additional stimulus.  We've already gotten first time home buyers credit, cash for clunkers, and eventually we'll get "vegetables for dirty diapers" or the like...  but, even if we don't, an extension of SS, unemployment, medicaid, etc. are all debt negative endeavors...  tomato tomahhhhto

My timeframe envisions something far before 2020...  5 more budget years tops I think.

The union will not survive.  Just like individual americans have been pitted against each other (the gutting of the middle class by the top and bottom), states will be pitted against each other.  Some type of central taxing authority will eventually be rejected as being oppressive and prone to inter-meddling with disastrous results.  This taxing authority will become much more localized.  Between now and then, we might get a super authority attempt to take hold...  but whoever it may be will not be able to hold back the tsunami.  And, the weirdest part, I think the fractional states may end up being created without a single shot being fired. 

PS, we already have a governance crisis in america...  AND not a single solution to our problems involves a scenario whereby we abstain from default... 

Bicycle Repairman's picture

That seems plausible.

Here's another one (I'll admit Bernanke can't do this all by himself): WWIII.

TwoShortPlanks's picture

@ Bicycle Repairman

Question: What do you see happening if QE3 does not happen?

Answer: Come July, the Fed will have been subsidising the US Economy for 42 months. This continued stimulus has created a new normal and possibly a lowered guard of the investor. This false sense of security will have been aided by the navigation through the recent events in Japan. This is a false impression of immortality or at least perception of strength. The Fed subsidization has presented a slightly buoyant but ultimately, false impression of the US economy; QE is a crutch on which to aid in supporting a cripple. Soon, that crutch will need to be removed so that the economy is tested, and proof as to whether it can truly stand on its' own two feet becomes a very real event. The realization that the US conomy is healthy or even doomed, may take three months...a period of nervousness with so many peoples' fingers on the trigger.

Envisaging no end to QE is itself a symptom of Normalcy Bias, likewise, seeing only minor problems (as the Fed would have you believe) post QE, is also a symptom of Normalcy Bias, and the benign view that the Fed aims to do good, while ignoring the fact that a good bush-fire is a natural cleansing event, is yet again a symptom of Normalcy Bias (Creative destruction is well understood).

With so much artillery being used since the GFC, I finally see a possible change in Fed tactics. I see a very real and deliberate attempt to place the financial system is harm's way (guised as an un-tapered end of the QE Program), a crash, brought-on through a last minute panic as a sudden realisation sweeps the markets that the Fed really isn't going to continue printing (NB in action), in essence, this is like a post-rate-hike credit contraction, a Mellon-type activity to "purge the rottenness out of the system". This speculative rottenness is what is stifling true growth, it is a speculative/debt Elephant sitting on the chest of a Cardiac arrest patient, it needs to be removed or CPR is a pointless activity (it's taken 3 years to see that). I see a deliberate end to QE which will culminate in a Credit Crunch (same as a sudden rate hike). I see Governments competing with Private sectors for Credit/Finance. I see the private sector contracting rapidly and unemployment skyrocketing as money lenders put their wagons in a circle to weather the storm. I see interest rate hikes in light of continued failing Bond Markets. I see a partial unwinding of Derivatives. I see a contraction in China and a large adjustment in Commodities. I see a run on PMs and a dive on Oil demand.

No matter which way this goes, print or don't print, the money supply has been expanded. Even if the economy stands on its own two feet, the money is still sloshing around in the system. If the economy recovers, inflation will flare-up. If the economy falters, unemployment will flare-up. If the economy collapses, it will be a series of lost decades.

The fastest road to true recovery may well come, as in nature, from the ashes of a flash fire.

No matter which way this goes, PMs will either hold wealth/value, or increase exponentially.

Michael's picture

Bernanke will print forever if he can because if he stops printing, the stock and commodities markets will crash, the trillions of debt will default, and we will have a depression that makes the great depression look like a picnic. We will have a good bit of inflation for another 6 months or so till the Fed ponzi scheme collapses, then we get the depression that lasts 7 years. 3 if we abolish the Federal Reserve Corporation.

Sad Sufi's picture

Bernanke will print

Yes, but it hasn't helped housing.  Is it not possible that given the right conditions, there won't be a "reasonable" bid for other assets? Can we imagine that?

eddiebe's picture

"Domestic policy is a given -- Bernanke will print.   It's his only weapon,"

 So sorry to disagree.

 He could pull a Volker for one thing.
 Or he could link to gold for another. And I'm quite sure he can come up with all kinds of other 'weapons' that I cant think of.

Pegasus Muse's picture

"According to the CFTC data, there are now 192,838 long contracts on gold and only 3,636 short contracts."

Not sure how Smith arrives at his lopsided numbers.  Does not agree with the Gold COT Report - Futures (as of Tues, March 22, 2011) on Harvey Organ's blog.  In total there are 50K net short positions (487K) over long positions (437K).  The majority of these short positions belong to the large Commericals (the Bullion Banks).  

On an off topic issue, Jim Rickards is out today with a new interview on King World News in which he discusses in more detail the Fed's Trillion$$ Balance Sheet and its ability to conduct QE in Perpetuity. 
Howard_Beale's picture

That is the link for the Commitment of Traders report for 3/22.

I suspect the author was using the managed money data which is overwhelmingly long. Still doesn't match his numbers but managed money stands at:

183,912 long vs. 5037 short.

Math Man's picture

According to the CFTC data, there are now 192,838 long contracts on gold and only 3,636 short contracts. That is a remarkably one-sided trade, and one that is technically ripe for a major reversal. When everyone agrees you can't miss on a trade, and punters are betting 50-to-1 that the trade can only go one way, then that's when it reverses and crashes.


Bingo!  We have a winner!  Every one should be buying puts on GLD.  20 implied vol - you're almost a fool not to.  And throw in some silver puts while you're at it...  you'll make a mint.

The precious metals markets have gotten way ahead of themselves.  Everybody's buying because the dollar is supposedly devauling... so what?  PMs are sky rocketing, so you're going to get crushed - the moves up are just not justified realitive to the dollar.

Since Sept 1, the dollar index is down 8%.

However, silver is up close to 100%....

PMs are a mania - plain and simple.   And we all know how they end.  Do yourselves a favor and sell now before it is too late... or if not, at least buy some puts and hedge yourselves up.

doggings's picture

the only thing that's ever certain is the PM trolls lack of understanding of history and fundamentals. 

Hang The Fed's picture

The only thing that is ever certain is that nothing is.

Bazooka's picture

In other words, the more things change, the more things remain the same. This is the universal prinicple of duality....per Buddha.

Mr Lennon Hendrix's picture

The Buddha was not referring to fiat money creation.  Think about what fiat is; it is not a real asset.  It is backed by nothing.  It is a piece of paper with the head of a dead man on it. 

Also, there is no difference betweem a paper dollar and a digital one.  I think about the system crashing everyday.  I imagine people thorwing paper money at goods.  I think of the expression on people's faces when they are bargaining and they realize everyone has dollars.  Once created a dollar is forever in "existence", there is no debt destruction of dollars.

You are saying that reality is not real, and what is real is not.  That is a simple fallacy.

Doña K's picture

Used to live in a country where bullion gold was not legal. Inflation at the time was running at 150%/year. On payday, my friends would run to the jewelry store and buy simply made gold chains. Every month they will convert their savings into gold chains. Easy to sell, easy to hide, easy way to preserve savings.    

BigJim's picture

If by 'dollar' you mean physical dollars, you're correct (though they do get withdrawn from circulation and destroyed as they age)

However, if by 'dollar' you mean all the money aggregates (like M2, M3) then you're mistaken - all those dollars disappear when the loans that created them get paid back. That's one of the problems - when the money is created, it is used to buy assets and thus bids up the price of those assets. But when the loan is paid back, the money 'vanishes', yet the asset is still 'valued' (at least, psychologically by the purchaser) at the same value as when the loan was created. This isn't a problem if loans are being destroyed and created at the same rate, or more loans are coming into existance than are being paid back, but in a downturn, when fewer loans are being made, there's literally less money in the system to bid for that asset.

stewie's picture

If by 'dollar' you mean physical dollars, you're correct

No he isn't.  If all loans got paid back, all physical currency would end up in the Fed's vault, essentially destroying all buying power.

Mr Lennon Hendrix's picture

all those dollars disappear when the loans that created them get paid back.

No; the bank sits on the cash, until they use the cash to facilitate new loans.

stewie's picture

No; the bank sits on the cash, until they use the cash to facilitate new loans.

Well, no.  The bank doesn't get to keep all the cash paid back.  The Asset (the loan) is offset by the liability (the cash).  Left & right side of balance sheet cancel each other out.  They do keep the interests however.

This is my understanding of how things work.


Basically banks create money by making loans and profits from the interests.  If the loan is defaulted on, they loose the Asset part of the transction but retain the liability.  So they suffer a loss if they can't liquidate the collateral and cover the remainder of the principal.  With this model, they have an incentive to make loan to clients that they believe can repay the principal & interests.    

This worked pretty well, until Clinton screwed it all up by cancelling Glass-Stegall.  A decision that he made at the same time he faced a Monika-induced impeachment.  I think he was black-mailed into doing it.





equity_momo's picture

Youre half right, or half wrong.

Debt money can and does die. Given our model is built around this credit , or debt money , real defaults cause real deflation that can absolutely destroy "dollars" in circulation , creating more value for existing "dollars". There is more debt in existance than the ability to repay said debt. We have a system about paying interest , not principle.  What happens when the principle is defaulted on?  Liquidation. liquidation happens before we can move on , and that is the deflationary part of the cycle.

Think of all that printing versus the collapse in credit. Then think about how much "real money" people have. Also dont forget the demographic cycle we are in right now. The baby-boomer leaving the work force is something that economists should spend more time analyzing.

I think its telling that corporates are sat on record amounts of "cash". The media portray this as bullish. I see it as a creepy omen. Stock buy backs are another ominous sign. They're ultimately top of cycle , defensive plays. Whilst rates are low , or the ability to service existing interest obligations is manageable , corporates will remain relaxed. Once interest payments become difficult to manage , there will be a rush to repay principle. Those that cant , will default , and then liquidation will commence.

The tipping point for that will be cash flow analysis , and this is why the commodity complex is hastening this move to the liquidation part of the cycle , which will cause demand destruction to said complex.


Mr Lennon Hendrix's picture

A default destroys the loan, not the cash.  The cash was loaned into existence prior to the default.

equity_momo's picture

Go one step further. What happens if i loan you x dollars and you default on that loan?  You are forced to liquidate what you can.  Your house , car , business.  I take them.Obviously the big ball drop with subprime was the amount of non-recourse loands but in the wider world , every default has a liquidation attached.  

The loans into existence created artificially high values on assets from cars to houses to stocks. Once bondholders start to get the shaft and those loans reneged on , their pound of flesh will come from forced liquidation. Cash is not the right term. There is a fraction of cash in existence compared to the loans outstanding.

Mr Lennon Hendrix's picture

If you make a loan to me, then you gave me what at one point was cash, and I spent it.  So after the loan, the money was put into circulation.  Somone else has it now.  Sorry I can not pay you back.  You will have to eat the loan.

equity_momo's picture

Thats why you were half right. I will eat the bad loan but i will also eat whatever you have thats considered a productive asset in lieu of your default.

Money is loaned into existence and its defaulted out of existence.

Mr Lennon Hendrix's picture

You make me a loan for $100.  I spend it, and then I tell you off.  You say you want collateral.  I have none.  The default is on the loan; the dollars are still circulating.

equity_momo's picture

You're over simplifying what i admit is a relatively simple concept.  If you were right in your belief that money cannot die through default , then there would be no need for QE now would there and the banking sector wouldnt have become insolvent through negligent lending.

The dollars are not still circulating , theyre being/were used to pay down the original bad loan on the original overpriced asset.

kaiserhoff's picture

No need for QE


Hell yes.  Why is that a difficult concept?  Capital destruction is the event de jour.

AnAnonymous's picture


Following the previous example, the person is insolvent (he can not repay you), it does not mean that the other people who get his money are insolvent through circulation.

An entity loans money to another. The latter used up the money and it is circulated, has no counter value against the loan, ends the Ponzi. The money is still there in the pockets of another entity.

QE is necessary because the money still exists but not in the right pockets. So new credits put money in the right (assumedly) pockets and it is necessary for that.

Apparently, QE has been all about recapitalizing banks that circulated their money to other actors playing different parts than the banks. As banks are wished to play their parts, they need QE, which does not mean that the money the banks circulated prior that is dead.

The USD is circulating but not from the entities US economics would like.

equity_momo's picture

Wrong. The dollars are not circulalting. You understand fractional reserve lending i hope.  The dollars are sat on banks balance sheets (or stored at the fed) waiting for the deflation wave round II.   When a house goes from 100k to 300k and then back to 100k on 10 to 1 leverage and the 200k difference has been spunked by the consumer on I-Pads and home improvements (ie , they ate or set fire to those dollars) tell me how those dollars are still circulating. They didnt exist - a credit did. It was spent. Its gone. All we are left with is a mark to market clusterfk that banks are ignoring whislt they desperately try to conjure ebough dollars back from QE to mitigate when the day of reckoning comes. Theres no magic island full of dollars to offset the destruction of capital since the housing bubble burst. FFS.

stewie's picture

Nobody will make you a loan if you don't have collateral.  But if that happens anyways, the bank will loose the $100, so the newly created $100 will be offset by the Bank's loss.

Quaderratic Probing's picture

The Creature from Jekyll Island book does a good job of explaining money as debt instruments and the creation destruction of it.

stewie's picture

Fiat is not "backed by nothing". It is backed by a loan, a promise to pay back the principal AND interests.



Mr Lennon Hendrix's picture

A promise.  Shit, I will have to revise my thesis.