One reason for the severity of the financial crisis, and the losses incurred by banks, is that bankers and financial analysts were using linear tools in a non-linear, highly complex environment otherwise known as the financial markets.The models didn’t work. The problem we face now as investors will end up being existential for some banking institutions and sovereigns. Our (uncontentious) core thesis is that throughout the west, more debt has been accumulated over the past four decades than can ever be paid back. The question, effectively to be determined on a case-by-case basis, is whether bondholders are handed outright default (which looks increasingly like the case to come in Greece) or whether the authorities, in their understandable but misguided attempts to keep the show on the road, resort to a policy of inflation that could at some point easily spiral out of control. As Rothbard wrote, “The longer the inflationary boom continues, the more painful and severe will be the necessary adjustment process… the boom cannot continue indefinitely, because eventually the public awakens to the governmental policy of permanent inflation, and flees from money into goods, making its purchases while [the currency] is worth more than it will be in future.” “The result will be a ‘runaway’ or hyperinflation, so familiar to history, and particularly to the modern world. Hyperinflation, on any count, is far worse than any depression: it destroys the currency – the lifeblood of the economy; it ruins and shatters the middle class and all ‘fixed income groups;’ it wreaks havoc unbounded… To avoid such a calamity, then, credit expansion must stop sometime, and this will bring a depression into being.”
So, who're you gonna believe, your NYC broker or your lyin' eyes???? Another Reggie Middleton "I told 'ya so" exclusive...
There is a little for everyone in Marc Faber's latest appearance on CNBC. The infamous boomer (and doomer) believes (as we do) that today's downgrades are less significant for stocks (at least until the realization that banks and more importantly insurance companies are about to be cut as well - keep a close eye out on Allianz and Generali (of ASSGEN fame) - it is not incidental that they are abbreviated to A&G, just one letter away from our own AIG) as it is largely priced in but the equity market's rally of the last few weeks (with its lack of breadth and volume) is strongly suggestive of a bear-market rally (as opposed to the decoupling bull market that so many hope for). His view quite simply is that the ECB has undergone a backdoor monetization and without this the EUR would be significantly stronger especially given the huge short-interest (though he sees the trend for EUR is down). Some highlights include: EUR weakness may help exports but the debt servicing costs of major European firms with huge US denominated debt wil suffer greatly, most European nations should be CCC-rated, nominally European stocks will outperform and holding quality dividend paying companies is preferred, valuation is practically impossible given ZIRP, and finally noting the irony, the worse the global economy gets (and the Chinese economy suffers), the more money printing will occur lifting nominal equity prices while real economies stumble and standards of living drop, so hold gold.
A REAL “black swan event” - an event that deviates by 180 degrees from what is “normally expected” - would be a political debate over root causes and basic principles. The great merit of Ron Paul - and the great service he is giving to his own and every other nation - is the fact that he is doing everything he can to raise the debate to that level. That makes Dr Paul a unique politician, a man who tells people what most of them DON’T want to hear or understand. Or at least they don’t think they want to understand it. Dr Paul’s great and merited attractiveness to a growing number of admirers has a very simple source. He is that rarest of creatures - a FREE man. He is beholden to nobody. He has developed his ideas and his convictions over a long and fruitful life of independent thinking. He does not compromise. He homes in on the fundamental issue and principle of any political issue and serves it up without salt or other “seasoning”. He says what he means and he means what he says. He is the living embodiment of the “dream” that most Americans have long since given up on as they saw it slip further and further beyond their grasp.
If we had to summarize the Status Quo's confidence that no black swans will threaten its control in 2012, we might begin with its faith that the system's self-regulation will resolve all systemic challenges. Just as the Status Quo has placed all its chips on a single bet--that "growth" from debt-based consumption can be resumed with vast public borrowing and saving the predatory financial sector--it also bases its confidence on the system's self-regulation. If the banking sector is riddled with fraud and embezzlement, then some minor tweaking of regulation will solve all issues. If demand for debt has collapsed, then the solution is for the Federal Government to borrow 10% of GDP every year to compensate for the decline of private debt and spending. The faith is that extending and pretending will magically restore the "growth" the Status Quo needs to support its ballooning debt. Extending and pretending offers up the compelling illusion that the system's broken self-regulation is up to the task of fixing systemic problems. In the darkness overhead, we can hear the beating of unseen wings that promise to make a mockery of the Status Quo's supreme Imperial hubris.
Rather than making some predictions, here is a list of words and phrases that were popular in 2011 that just annoy us. It would be nice if they become less popular in 2012, but we predict they will remain in use.
Nine weeks after its bankruptcy, the general public still hasn’t quite realized the implications of the MF Global scandal. Our own sense is, this is the first tremor of the earthquake that’s coming to the global financial system. And how the central banks and financial regulators treated the “Systemically Important Financial Institutions” that had exposure to MF Global—to the detriment of the ordinary, blameless customer who got royally ripped off in its bankruptcy—is both the template of how the next financial crisis will be handled, and an accelerator that will make the next crisis happen that much sooner. We critics of the current, corrupt state of affairs also sometimes confuse the SIFI’s with the system itself, whenever we say, “The whole system is corrupt!” But the system is not corrupt—it’s the regulators and SIFI’s who are corrupt. If nothing else, the handling of the MF Global bankruptcy has proven that, once and for all. That’s why we’re pulling out our money now—while we still can. Because once the general public catches on to what we already know . . . oh boy.
In a must read Op-Ed in the WSJ, Mark Spitznagel, founder of "fat tail" focused hedge fund Universa, where Nassim Taleb has been known to dabble on occasion, explains the fundamental flaw with central planning, and specifically why "moral hazard" or the attempt to avoid the destructive part of natural cycles, is the greatest unnatural abomination ever conceived by man. His visual explanation should be sufficient for even such grizzled academics who have no clue how the real world works, as the Chairsatan, to comprehend why what he is doing is an epic abomination of every law of nature: "Suppressing fire, creating the illusion of fire protection, leads to the wrong kind of growth, which then invites greater destruction. About 100 years ago, the U.S. Forest Service took a zero-tolerance approach to forest fires, stamping them out at the first blaze. Fast forward to 1988 when a massive wildfire at Yellowstone National Park wiped out more than 30 times the acreage of any previously recorded fire." Another way of calling this, is what we have been warning about for years: delaying mean reversion does nothing but that. And when the Fed finally fails to offset the inevitable, and it will - it is a 100% certainty - the collapse and destruction will be unprecedented. Ironically, the only way the system could have been saved would be by letting it fail in 2008. Now, we are sorry to say, it is too late.
A short letter written to our readers about how we are skeptical of any US bullishness
If Reg. T is a "problem" then we have a big problem.
So I don’t have a good answer for the fundamental problem of tails. But there is an observed regularity in life reflected in the sayings “it is always darkest before dawn” and “where the danger grows, so grows the saving power” to quote Holderlin. And when no one can know the future, and the mechanism governing the future is unstable, anticipation of heightened risk premia warrants a barbell. In financial markets, extreme meltdowns are met by extreme policy reactions. Practically stated, it seems best to play center bets when others do not, and the tails when others do not. After markets price in heightened risk, actively manage the position by lowering exposure to the big gain leg. Move the proceeds to the center or double down on the other tail. Perhaps this is how one should manage tails. Given that the known categories of human experience do not provide adequate predictions, luck dominates control. Nobody has it all figured out. Even when you think you have it all figured out, everything blows up in your face again. We'll never figure it all out. Nobody can predict the future, and we don't have good enough imaginations to dream up every contingency.
Nassim Taleb is wrong about the financial crisis and black swans. The ongoing financial crisis is not the result of a perplexing phenomenon of complexity. It is the beginning of a train wreck we have seen for decades. We are not wandering into a surprise or horrified by the dark specter of a Black Swan rearing its long tailed head; this macro crisis appeared on the horizon long ago, easily calculated by any actuary armed with the knowledge that governments were not investing tax streams, but stealing them for current consumption. Our monetary policies do not defend inflation; they fund deficit spending and protect banking institutions. That is their empirical purpose, and that is what technocrats are now struggling to accomplish in the EU. Further, the monetary system as constructed is not modeled after complexity; it is an artificial hierarchical oligopoly with all the single process failure points that entails, pasted on top of complex economies and kept alive by increasing leverage and bailed out by equally non-robust, frail self-serving governments without the will or common sense to reform. We are not watching complexity at work; we are watching unsustainable bureaucracies self-destruct while they force complex economies to foot the bill. There is no Superman of bureaucracy. There are no rules or regulations that will prevent failure or negate investment on our road to prosperity that we do not already know. Our institutions have just consistently rejected them. After all, leverage and redistribution is much easier than successful investment. In a complex system, these bureaus would have died and been replaced by their betters long ago.
Misquoting Shakespeare before the market open may seem like blasphemy but in a follow-up confirmation of a thesis we proposed back in July, Luxor Capital expands on the idea that something rotten is ahead for the state of Denmark. As with many of these crises, the heart of the Danish problems lie in a commercial and residential real estate boom and looming bust and with the capital/equity remaining so low in the Danish banking system (and a pitiful funding profile), it seems increasingly evident that public balance sheet support will become necessary (and perhaps not sufficient). How ironic that we pointed out, back in July, the probability that Germany will need two insolvency funds, a South-facing and now a North-facing one. Having traded in the mid 20s during H1 2011, CDS now stands at 106bps (off its September peak of 158bps) and given the interest we are seeing from hedge funds in this relatively lower cost short, we suspect this week's modest decompression will accelerate.
As the Duke of Cambridge is due to be deployed to the British territory south of Argentina, the tensions are rising within Falkland Island waters as the Argentinians board Spanish fishing vessels as President Cristina Kirchner has adopted a steadily more belligerent stance towards Britain’s South Atlantic possessions. The Telegraph is this evening reporting that 29 years on from the last major tensions, Argentina has launched a naval campaign to isolate the Falkland Islands that has seen it detain Spanish fishing vessels on suspicion of breaking the country’s “blockade” of the seas around the British territories. Are we really starting to see escalations in global geopolitical tensions? Our recent discussion of the Black Swan of Cairo perhaps points to this not being as surprising as one might believe. Perhaps most worryingly, Argentina’s claim over the Falklands was backed by a newly formed block of South American and Caribbean countries, CELAC, on Saturday with unanimous approval.
During his recent lengthy discussion on the broad topic of global central bankers, optical backstops, and our coordinated cognitive dissonance, Kyle Bass, of Hayman Advisors, suggested everyone read "The Black Swan Of Cairo" penned by no less a tail-risk philosopher than Nassim Taleb (and Mark Blyth). The Foreign Affairs article from June 2011 brings into clear prose the fascinating dichotomy between the centrally planned smoothing efforts of world bankers and politicians and the inevitable (and much larger) instabilities that spring from this suppression.
It is both misguided and dangerous to push unobserved risks further into the statistical tails of the probability distribution of outcomes and allow these high-impact, low-probability “tail risks” to disappear from policymakers’ fields of observation.
With freedom comes some unpredictable fluctuation. This is one of life's packages: there is no freedom without noise - and no stability without volatility.