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The Paradox of Risk: Central Planning Is Linear, Reality Is Non-Linear
Submitted by Charles Hugh-Smith of OfTwoMinds blog,
You thought it was safe to drive 90 miles an hour on a rain-slicked narrow road while you were tipsy because the airbag would save you, but it still hurts when you crash.
I first discussed the Paradox of Risk in August, 2008, just before the stock market melted down: The Unintended (Risky) Consequences of "Backstopping" Risk (August 12, 2008)
This is the Paradox of Risk: the more risk is apparently lowered, the higher the risk we are willing to accept.
I recently covered a related topic, The Dangerous Illusion That Risk Can Be Offloaded Onto Others (October 2, 2015).
The paradox is that believing risk has been eliminated leads us to take on insane levels of risk--levels that we would never have accepted before, levels that essentially guarantee our financial destruction.
I recently had the opportunity to discuss these topics with Max Keiser: Keiser Report: Global Paradox of Risk (25:40 -- I join Max and Stacy in the 2nd half)
There are a variety of sources of the belief that risk has been lessened or eliminated:
1. The Fed Put, the belief that the Federal Reserve will never let stocks decline by more than a few percentage points before it steps in and saves the market from any further decline.
2. The belief that hedges dependent on counterparties paying off when the market craters have effectively transferred risk to others.
3. The belief in Modern Portfolio Management, i.e. that risk can be hedged or reduced to near-zero by diversifying one's portfolio, investing in assets with low correlation, etc.
All of this is nice, but fatally flawed. Max and I discuss the reality that markets are not linear, they are fractal.
Central planning is linear, but reality is non-linear. The net result is the Fed can do whatever it wants, whenever it wants, and markets will still crash from time to time.
That markets crash is predictable, but not when they crash.
I've prepared a chart that depicts the downside of the Paradox of Risk: everyone who believes in the Fed Put, hedges or Modern Portfolio Management will view any decline in stocks as temporary. As a result, they won't sell as markets plummet.

When markets finally hit bottom, believers will assure themselves that the Fed is going to push stocks higher any day now, because they have always done so in the past.
When central planning efforts to push stocks back up falter, the believers that risk has been banished grow frustrated; come on, Fed, do whatever it takes!
Alas, the Fed has done whatever it takes but it has failed to produce the desired effect.
Now the market starts another slide to fresh lows, and the believers finally start recognizing that risk has not been disappeared: counterparties start failing, hedges don't get paid off, and a sense that events are spiraling beyond the control of central planning is spreading.
Sorry, believers that risk has been banished: it's too late, you're wiped out. You thought it was safe to drive 90 miles an hour on a rain-slicked narrow road while you were tipsy because the airbag would save you, but it still hurts when you crash: Keiser Report: Global Paradox of Risk (video)
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No, central planning, or banking in general, is fucking fraud/theft in the absence of any real RISK or COLLATERAL requirements!!!!!
Stop overthinking this "folks".
The perception of 'Risk' is always distorted by a State (of) Mind preoccupied with the here and now. Perspective is required to fully appreciate, and manage, risk. Naval gazing and risk management are diametrically opposed to each other. Thus the reason the State (of) Mind wishes us to be picking belly button lint 24/7.
We have been quite productive as the weather has been very cooperative this year. I have only one real rule, that being; do what you love to do and do it better than anyone else.
Regardless of the "fiat du jour" my tribe and I will be fine. If the bankers/financiers really want to commit suicide, I say let them.
Mises explained the unpredictability of the economy in his book Human Action.
Agents of free will don't follow ruler lines - and, like Yosemite Sam, the central planners thus always fail.
That was the point of Hayek's Fatal Conceit too. Only fools think they can command broad economic forces without f-ing it up. Of course once they F it up then they like to claim they solved it and saved us lol. Eventually the spinning top may wobble completely out of control though.
http://www.amazon.com/When-Genius-Failed-Long-Term-Management-ebook/dp/B...
@CognitiveDissonance lol unfortunately very true
@CognitiveDissoance I love your phrase State (of) Mind. I may propagate its use.
Central planning is frequently capricious and/or corrupt. You can't plan around it, so you are loathe to invest (in productive capital investment) in an uncertain regime. It is what made the Great Depression "Great": FDR and company's "bold and persistent experimentation" created an epic capital strike. FDR pushed every which way on string, over and over.
Also, Hayek.
@LawsofPhysics The illusion of no risk is the con that covers (and sells) the crime of theft.
I don't understand the low rating for this article. The title alone deserves a 4 or 5. We should be talking about this topic all the time.
Give me a break, with writing like "You thought it was safe to drive 90 miles an hour on a rain-slicked narrow road while you were tipsy because the airbag would save you, but it still hurts when you crash" what do you expect people to rate it as?
That's like saying style is everything and substance is nothing.
When the first Russian or American plane is downed in Syria, you can expect gold to jump 10% and oil to do the same.
US refuses to call Russian embassy shelling in Syria terrorist attack — Lavrovhttp://tass.ru/en/politics/828856
The fraud/theft is global now, stop buying into the old good/bad memes, it is nothing but fucking theater.
Non-linear AND chaotic, but all the alleged smart people think they can control it all because, of course, this time is different and we're soooo much better than the last bunch of fuck-ups......
THIS IS the CORE of THE PROBLEM.
For many decades America prided itself on having FREE AND FAIR MARKETS. The whole argument for supporting the American system of commerce was this ... A free market - run by fair principles and equal rules for all players - is the most efficient way to do business.
And I have to say, during the years when America ACTUALLY believed in its own principles and followed them - the country really prospered. The Free Market system did function very well.
During the same years, America actually conducted wars (and Cold Wars) against countries that did not have free markets. And popular dictum was that socialized planning and central planning were BOUND TO FAIL. Americans fought in wars, and died in wars, that were popularized by these slogans. You can argue, perhaps rightfully so, that some of those wars were conjured up by politcial agendas. But Americans were told these things.
It is ironic that now America is abandoning those Free Market principles, and abandoning the idea that the market should be a place that is Fair and Equal for players. Cynical manipulation and greed have destroyed a great system.
Markets are being saved again, don't worry.
The Big Bang of Fiat seeks a smooth expansion, where nothing can exceed the speed of the VoM.
In the real universe, however, just as Space itself expanded faster than the speed of light, the Dark Financial Energy and Dark Financial Matter are expanding at their own rate. And just as physicists still don't have a model for Dark Energy and Dark Matter, so too modern Economists do not have a real model of the financial and economic 'universe' on planet Earth.
They just don't comprehend or model Complexity Theory of finance and economics -- not when you try to include the many non-linear, cross-linked and stochastic variables, and the feedback loops. Using their linear equations that resemble 5th Grade Math, is like using PV=nRT or F=ma for all problems in physics, chemistry and biology.
People need to wake up and stop being comfortably numb Citizens and comfortably dumb Sheeple. They need to care enough to actively challenge all Givens and Assumptions, examine Core Values (own and of others), ID what the real Fundamental Policy Issue should be (not the one being spouted as a distraction or derailment), start thinking and analyzing for themselves, talk to others, get organized, and take it from there.
Heck, even Bernie Sanders said in the Democratic Debate last night, that "people need to wake up and start a Political Revolution", where the interests, lifestyles and wealth of the 99% matters more than those of the 1% or 0.1%. 'The Billionaires vs the 99%', as he framed it.
Get informed, get involved, get active. Create your own version of an effective and relentless Special Interest Lobby -- a lobby that will not get co-opted by outside forces or interests. Do that, or remain a sheeple and accept everything that will happen to you.
i had my economic epiphany at a political rally outside shinjuku station in tokyo many years back. the area was packed so tight that any individual movement was impossible. all you could do was go with the surge of the crowd. my wife and i with a child in a stroller had to cross the square to get to the triain station. a coupla guys noticed our plight and started yelling at the crowd to let us through. miraculously the crowd almost spontaneously opened a 100ft path to the front of the train station. as soon as we passed the crowd returned to its natural chaos.
the crowd is like the economy. money surges into investments that look good, drawing all sorts of money with it as it comes and goes in utter chaos that only looks like order from afar. it can be manipulated for special circumstances but the manipulation can only be temporary to be effective. trying to manipulate the entire crowd is futile in the end and is totally dependent upon the skill of the confidence game to keep some order in the chaos.
the car driving analogy is most appropriate because most people don't consider driving a dangerous activity when it is, in fact, the most dangerous thing they do in their lives. that's why so much effort is put into safety technology to reduce risk. the market is the same, not many people really appreciate the full risk profile of the market. that is why you get blank stares when you suggest it is important to keep enough gold and silver around for seed money in the event of a real crash. most of the world understands that concept from experience. the west and the usa haven't had any real distress since the depression and ww2. this streak of good luck has only encouraged the math heads on wall street to legislate and algo the risk out of the market with the fed acting as the pit stop of last resort.
it really is a brilliant construct......that will crash and burn any minute now.
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Well, no problem then. After the Fed has shot its wad, there is always Congress. They can pass laws against "speculators" -- defined as anyone who sells stocks or bonds of any sort -- or anyone who hoards gold and silver. That should do the trick for a while.