Goldman's "Early Warning Signals"

Tyler Durden's picture


Fed officials have repeatedly emphasized the importance of financial stability for monetary policy. But, as Goldman Sachs points out, knowing which financial and macroeconomic imbalances to monitor is challenging, not least because of the limited number of past crisis episodes in the US. To help The Fed, Goldman surveys a large economic literature that studies the effectiveness of "Early Warning Systems" (EWS) in detecting banking crises, costly asset price busts, and currency crises across a broad range of countries. While they suggest subtlely that the Fed is clueless with regard what to look for, they note that credit markets and asset-price run-ups (especially when they occur together) provide a statistically clear warning signal... and as we know, both are flashing red currently.


The results, Credit markets are the canary most often cited...


And as we explained here in detail (and numerous times in the last few weeks), Credit is flashing redder than ever.



As Goldman notes, we draw three key lessons from our survey:

First, several indicators turn up repeatedly as valuable warning signs. In particular, credit growth, run-ups in asset prices (especially house prices), the current account, the real exchange rate, and GDP growth are frequently cited across studies. Other indicators appear more frequently in studies of particular types of crises, such as weak governance and regulation in the case of banking crises, or reserve holdings in the case of currency crises.


Second, many studies note that the joint occurrence of multiple signals provides a statistically clearer message. For example, rapid credit growth in the context of weak bank regulation or an asset price run-up fueled by large current account deficits might send a stronger warning sign than the indicators do independently.


Third, EWS nonetheless tend to have a modest signal-to-noise ratio. The models fail to predict some crises, and in other cases struggle to assess the likely severity of a bad outcome. For example, they might have been unable to distinguish between the consequences of US asset price collapses in 2000 and 2007. The models also sometimes send false positives, calling to mind Paul Samuelson's remark that "Wall Street indexes predicted 9 of the last 5 recessions." In addition, some indicators are as coincident as leading, and studies that are more ambitious in testing for an advance warning sign tend to have less success. Finally, the lessons drawn from one set of crises do not always apply to the next. Indeed, research by San Francisco Fed economist Mark Spiegel reports little success in predicting which countries would have been hit by the global financial crisis.

*  *  *

The bottom line is that despite Fed officials proclaiming omniscience, Goldman believes the Fed cannot accurately identify bubbles and therefore the costs of tightening in response to a potential bubble are too high no matter what...

To The Moon Alice (unless a 'free' market decides otherwise)

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Tue, 08/05/2014 - 17:56 | 5051265 yogibear
yogibear's picture

LOL, as stable as fraud is. The Fed's balance sheet is much larger due to mark to fantasy accounting. 

Banks have 0 reason to be responsible. Just take bank reserves and off-shore them. Run the bank into bankruptcy and get bailed out again.  Every banker should be doing this. The Federal Reserve encourages fraud and money laundering.

Coporations are encouraged to continue to offshore technology, businesses and factories. The government encourages welfare, EBTs, section 8's, medicaid and free schooling for illegals. So more illegals flood the US to get the freebies.

What can go wrong with this picture?

Tue, 08/05/2014 - 18:02 | 5051287 wallstreetapost...
wallstreetaposteriori's picture

Every item on that list should be red.... WTF is Goldman smoking?

Tue, 08/05/2014 - 18:19 | 5051338 aVileRat
aVileRat's picture

Statistical leading indicators tested for when they proved to be positive signals vs. false positives.

Nothing on that list should be shocking to anyone, but the order of when people could identify bad signals with when it actually Affected general perception (it became a statistical flag) is important for players new to the cycle and/or playing from Home.

What is new, is Jim Cramer is now worried about technical mean reversion, and market risk which has grossly underappreciated energy security and cheap-profitable R&D. This should also be nothing new to a ZH poster but who it is, has some interesting connotations in market psych.



Tue, 08/05/2014 - 17:56 | 5051268 NOTaREALmerican
NOTaREALmerican's picture

Hmmm,   all three "problem" areas have a simple solution:   more free money.

Tue, 08/05/2014 - 17:58 | 5051270 Bemused Observer
Bemused Observer's picture

It cracks me up, all these people trying to 'read the signs'. As if there was anything coherent in all that fudged and adjusted data.

They'd be better off eviscerating a sheep and holding fistfulls of entrails up to the heavens.

Or check the horoscope pages of their local newspapers. Magic 8-ball, Ouija board, draw straws, whatever.

Tue, 08/05/2014 - 18:09 | 5051311 Bemused Observer
Bemused Observer's picture

Come to think of it, this whole economy of ours is rather like a religion, isn't it? The world of finance has as tight a hold over our lives as the Catholic Church ever had over the faithful in the early Middle Ages. Not 'technically' in charge of the secular (the King was), they nonetheless ran the show. The mere threat of excommunication (banned from the credit markets) is enough to keep everyone in line.
We have our clergy, the Yellens and Blankfeins, our confirmations and baptisms of obtaining credit and going into debt, our sacred obligations of paying it back no matter what.

Finance may not be an actual religion, but it functions in much the same way in our lives. So what's the difference?

Tue, 08/05/2014 - 18:16 | 5051335 NoDebt
NoDebt's picture

Sadly, they don't do human sacrifice to appease angry gods or make it rain any more.  Aside from that, not much.

Tue, 08/05/2014 - 20:47 | 5051893 Bemused Observer
Bemused Observer's picture

I know, they've stripped all the theatrical flair out of the thing. And you have to go to New Guinea to see a good witch-burning these days....(just kidding, that was horrible..)

But yeah, it is the same. I'm glad I'm not the only one who sees it.

Wed, 08/06/2014 - 11:38 | 5054188 MASTER OF UNIVERSE

Bankster suicides is a form of human sacrifice to appease the overlords of Wall Street. These suicides are enough to instill fear in the populations of Banksters allowing further criminality to continue which, in turn, fosters more money to rain down from the commandiong heights of Investment Banking.

Tue, 08/05/2014 - 18:30 | 5051368 NOTaREALmerican
NOTaREALmerican's picture

Re:  So what's the difference?

There is none.   

Politics and religion simply create a forum where the smart-n-savvy people can manipulate the dumbasses with bullshit for fun-n-profit. 

Anything plus bullshit will have more value for the creator of bullshit:

Morals + bullshit -> religion

Government + bullshit -> politics.

paint + bullshit -> spatter art

stuff + bullshit -> bling

money + bullshit -> finance.


Bullshit, don't leave home without it.

Tue, 08/05/2014 - 21:34 | 5052102 Kirk2NCC1701
Kirk2NCC1701's picture

It turns out that relationships can only thrive or survive WITH a certain optimal level of Truth and Bullshit.  Too little or too much are both bad.

Truth is like salt: You can't live without it, but too much will kill you.

Bullshit is like spice: "Without it, life is dull.  Too much of it ruins things.

A good life therefore needs optimal levels of both salt and spice.  It also needs optimal levels of "sugar".  ;-)  ;-)

Sugar, salt and spice makes life good, and the world go round and round.

Tue, 08/05/2014 - 18:41 | 5051424 SheepDog-One
SheepDog-One's picture

The kings always answered to the priest standing behind the throne with a knife, and never got to be kings in the first place without their approval.

Tue, 08/05/2014 - 17:57 | 5051272 Captain Jack Sparrow
Captain Jack Sparrow's picture

My last paycheck was $9,500 from online piracy and my sister wants to blow eveyone on this site...

Tue, 08/05/2014 - 18:00 | 5051273 q99x2
q99x2's picture

Well if a reputable Bank like Goldman says something it must be worth posting.


Gerald Celente says war is coming. Hope Goldman doesn't survive it.

Tue, 08/05/2014 - 17:59 | 5051276 BandGap
BandGap's picture

What a crock of shit. Goldman can never be wrong because they play both sides. Fucking Yahoo!

Tue, 08/05/2014 - 18:14 | 5051329 Dr. Engali
Dr. Engali's picture

I read that piece earlier today. That was some of the funniest muppet bait garbage I've read in a long term. 4.5% fed funds rate.... Lol. It's never going above 1% again.

Tue, 08/05/2014 - 18:52 | 5051466 SheepDog-One
SheepDog-One's picture

4.5 they must think everyone is real stupid....never again.

Tue, 08/05/2014 - 19:47 | 5051668 Carpenter1
Carpenter1's picture

"Never" huh?

It will when the vampires blow this abortion to kingdom come, and with it will go all the BTFD'ers and everyone who has 100% faith in the FED.

Like you, by the sounds of it.

Tue, 08/05/2014 - 21:24 | 5052040 Dr. Engali
Dr. Engali's picture

If you think that anything above 1% on the fed funds rate won't blow this system to kingdom come, then you are completely clueless. Last time the fed tried raising rates at .25% per meeting they didn't have anywhere near the leverage that's in the system now. An inverted curve is the death nail to debt based petro-dollar.

Edit: I'm making the assumption that you do comprehend exactly what the fed funds rate is. Judging by your comment that may be a faulty assumption.

Tue, 08/05/2014 - 18:01 | 5051284 Groundhog Day
Groundhog Day's picture

muppet slaughter


Tue, 08/05/2014 - 18:04 | 5051294 Wahooo
Wahooo's picture

So basically goldstein is warning it will bomb the school before it bombs it.

Tue, 08/05/2014 - 18:06 | 5051298 maskone909
maskone909's picture

$GDXJ looks increasingly bullish despite divergence from the metals. That should raise warnings

Tue, 08/05/2014 - 18:20 | 5051341 Comte d'herblay
Comte d'herblay's picture

I had a nightmare that there was a little man inside my head who has been keeping a running tab since I joined this site and others, to gain some knowledge, share some insights, introduce my mother, Budgie Twitters, to a wider audience, and generally associate with somewhat more sophisticated types that I cannot find on those other sites like WonderWall, Playboy, and MAD.

The tab so far has a monstrously large number of hours, weeks, days, and months of accumulation and a little note at the end of the current tally that reads, "So, my little sparrow, what have you learned that will help you during the rest of your life"? 

There is no response, and I am unable in the cold light of day to find anything I've learned that would prove useful in 1) making more money, 2) having sex with more girls, 3) distilling my own whiskey, 4) changing the tire on my 21 yr old P/up truck.

There shoulda been a warning back in 2006 that,  while extinction is the only guarantee for all of us as evidenced by the ZH Motto, this site IS guaranteed to not restore your original hair color,  or remove worry lines from the third eye of your forehead, or make you more desirable to supermodels, movie starlets, and lap dancers.

The most one can say for it is, it is good mental therapy, a harmless venting spout. The silence one would have to endure by not saying anything about the things that are going on which we are powerless to influence, control or even in many cases, notice,  as the immortal Jimmy Buffet says, we would all go insane.







Tue, 08/05/2014 - 18:32 | 5051381 NOTaREALmerican
NOTaREALmerican's picture

Re:  I had a nightmare

It's not a nightmare,  he's actually there at night keeping a running tab. 

Tue, 08/05/2014 - 18:36 | 5051394 Captain Jack Sparrow
Captain Jack Sparrow's picture

I like ZH because the articles are real and tell the fucking truth about what is going on.  With any luck I might get the odd stock tip from time to time.  I usually post to try and cheer up some of you pessimistic pricks! :)

Wed, 08/06/2014 - 09:22 | 5053434 Comte d'herblay
Comte d'herblay's picture

Aye, captain.

Tue, 08/05/2014 - 18:48 | 5051449 Simplifiedfrisbee
Simplifiedfrisbee's picture

Caught in between a tough place and a shit hole are you boomers? What is the purpose of ZH again? I have nothing but respect for those who informed me about the depths of monetary policy a couple of years ago but now I am befuddled by such complacent ignorance. Any ideas to share boomers? Life has been so luxurious in commodities and services that it no longer has much to offer in stimulation for you all. If not then you serve to provide disservice. Explain how such complacent humans become such worthless contributors to intelligence?

Tue, 08/05/2014 - 20:22 | 5051551 deflator
deflator's picture

 Explain how such complacent humans become such worthless contributors to intelligence?


 On top of all the other shit I have to do? I do see what you are sayin' though, 1-4 "should" be the natural order of things if, "things" were "normal" right? 

Wed, 08/06/2014 - 09:25 | 5053429 Comte d'herblay
Comte d'herblay's picture

Manage your expectations, bon ami.

IT is not the purpose of another human bean to contribute anything to you.  The sole reason for one's existence, for indeed, winning the lottery of conception, which has it at 1 chance out of each 330,000,000 spermatazoa, its purpose is to reproduce itself. And that's it.  Nothing more is required. All the rest of this nonsense, absurdity, and pornographic downloading is just maple icing on a Panera cinnamon roll.

Having already been a student of the economy, in all its unfeterred and managed glory, the concepts espoused on ZH have worked to the detriment of nearly everyone who has NOT used it as a contrary indicator for over 6 years and counting. 

From that standpoint, as the diametrically opposed bell"weather" (sic), of what should be done re: how to interpret the FED, arguably the most omnipotent force for profit in the history and prehistory of the universe, it has been near a perfect 'negative space' as one could hope for.  

It's like having a hidden sound sensing device operating in real time in J Yell's and b 4 him, Ben's water closet, as they type in the next 100 billion to Lord Blankfein's Christmas Savings account, with an added 5% interest for being ten minutes late. 

Forsake precipitateness; embrace complacency. 

And J B T D.  

You'll  thank me later. 

Tue, 08/05/2014 - 18:31 | 5051375 Big Ben
Big Ben's picture

Everyone knows that they ring a bell when the market hits the top.

Unfortunately, the bell is rung every day when the market closes.

Wed, 08/06/2014 - 00:09 | 5052678 Implied Violins
Implied Violins's picture

The bell tolls for thee...says I, with irony.

Tue, 08/05/2014 - 19:11 | 5051437 SheepDog-One
SheepDog-One's picture

So if I'm reading this right, GS is waiting for S&P to shed about 100 and then the money printing starts again to bail all the banks bad bets out again?

Tue, 08/05/2014 - 19:18 | 5051538 deflator
deflator's picture

 Sounds about right...

Tue, 08/05/2014 - 19:55 | 5051694 Loucleve
Loucleve's picture

Buy Portuguese bank bonds!

Tue, 08/05/2014 - 20:11 | 5051748 deflator
deflator's picture

 I missed out on the dip! (famous last words)

Tue, 08/05/2014 - 19:19 | 5051545 WTFUD
WTFUD's picture

The bottom line is that. . . the Fed is JPM and a few Banking Families.

Tue, 08/05/2014 - 20:42 | 5051867 1gunguy
1gunguy's picture

The Fed is fed up to their eyeballs in bullsheet


Smoke and mirrors


Tue, 08/05/2014 - 22:56 | 5052449 hedgiex
hedgiex's picture

When you have dysfunctional markets (rigged and manipulated by banksters) these risk models are useless.

When you put the Goldman label on them, there is a great chance that the regulators will lap on them. So they will become the elements to build snake oils for the likes of Goldman to plunder further with minimum risk captial, etc.

Atop of these concotions (flashed out as regulated products), the banksters will trade in opposite directions when all their muppets are on one side.

First repair the markets (the ecosystem) by first clearing off the perverse predators who are getting desperate to grab as much as they can now.

Do NOT follow this link or you will be banned from the site!