From Ben Davies of Hinde Capital
On the 12th November 2014 - some 10 years after it was launched - lander module Philae which accompanied the Rosetta spacecraft touched down on Comet 67P/Churyumov-Gerasimenko (67P) to begin extra-terrestrial scientific observations. The on-board telemetry communicated back to Earth some 28 light-minutes away revealed that the lander had bounced twice off the surface of 67P. The first bounce may have lasted two hours and over 1 kilometre and is considered the largest space bounce in history which we would put it on a par with the incredible bounces in the US and Japanese stock markets this past month!
Back here on Earth Japanese monetary policy has similarly taken a giant leap forward for mankind by conducting its own scientific experiment. On the 31st October 2014 Bank of Japan Governor Kuroda-san implemented an addition to his ‘Qualitative & Quantitative Easing’ (QQE) policy begun a year ago. The surprise event was less the timing and magnitude but the clear brazen coordination of monetary and fiscal policy using the conduit of the Japanese Government Pension Fund to implement it. The QQE drove stock markets into a frenzied rally.
Central banks have been conducting a seemingly coordinated financial program of unconventional monetary policy – assuringly scientific in its nomenclature of QE and QQE – media commentators marvel at the boldness (stupidity) of policymakers ‘to go forth where no man has gone before’ and eradicate the spectre of debt deflation.
Policymakers have been studying and implementing ‘Bubbleology’ – the science of bubble money. The impact of this earthly science on both economies and financial markets has been truly dismal. It is clear it is creating a divergence between economic and financial reality.
Far from eradicating the perils of debt deflation it is clear this program has merely initiated more fiscal and private sector balance sheet irresponsibility, as both continue to lever up. The capital (‘near money’) allocation of such leverage has resulted in rising asset classes, primarily housing stock, equity and bonds where the pursuit of yield has ignored all credit risk sensibilities. All this has occurred at the expense of daily living standards and the misdirection of capital.
We are witnessing the continuation and completion of the financialization of our economies and markets which began at the instigation of governments and central bankers in the years leading up to the 2008 crisis. There is no attempt to foster sustainable capital and income through innovation and production which ultimately drives healthy employment. Rather financialization of asset classes driving elevated prices which creates an inequality of wealth, albeit illusionary wealth. Land, housing stock and excessive equity price growth in reality drains productivity away from entrepreneurship and the employment which enables sustainable taxable income for nations to run prudent fiscal surpluses.
We are in the butterfly vortex of a momentary illusion of ‘hyperinflated’ wealth - for the value of money is sinking rapidly - destroying the purchasing power of the global majority. Markets have a memory and from the first moment central banks expanded their balance sheets the flap of Lorenz’s wing has cast a shadow over financial and economic stability. In this HindeSight I endeavour to highlight where the echoes of monetary history are manifesting themselves in systemic risk across the globe.
The Delicious Science of Bubble Money
About 15 years ago I went on a three week stint to Tokyo to cover the overnight US Treasury trading seat at Greenwich NatWest. I remember many cultural delights about that trip, not least of all the clubs and hostess bars of Roppongi! But one of my abiding memories was Bubble Tea. I was addicted to it but other than the side-effects of a sugary rush it’s fair to say this was perhaps a less troublesome elixir for a young single gaijin and one with a rather large company expense account at that.
Bubble Tea, also known as 'pearl milk tea' actually originates from Taiwan. It is essentially a tea mix of your choice infused with rich creamer served cold with natural large, chewy tapioca balls which you suck up through a big fat straw. The term bubble is an anglicized derivation from the Chinese word 'boba' which itself refers to the 'large' tapioca balls or pearls.
Fast forward 15 years and whilst meandering around London I saw a bunch of neon Bubbleology signs. Turns out they are Bubble Tea shops and they practice the ‘science of bubble tea’ making. Imagine my joy. I have finally been reunited with my favourite beverage on my home soil.
In an era of serial financial bubble blowing I thought to myself how apt to use this name to refer to central bank money printing on account of its clear ability to create one asset bubble after another with rich infusions of money.
So Bubbleology – the new ‘delicious science of bubble money’ - looks to serve grateful market participants with rich creamy rushes of infused tea, intravenously administered through the conduits of repressed and fiscally dominated financial institutions.
Every central bank has its own set of magical ingredients. The BoJ administers a rich elixir of ‘Macha Bubble Money’ adding more creamer to every new infusion by which to keep the Pavlovian market salivating. The FED and BoE offer their own special potion of ‘English Breakfast Money’ superbly rich in its enunciation, crisp and firm on the pallet, whilst the PBOC offers up a soothing medication of ‘Oolong-some Bubble Money’. The ECB version, however, is somewhat more fruity and zesty in its consistency - more Tapioca ‘Money Balls’ than bubbles – well, at least for now.
Monetary Echoes, Memories & Markets
Greenspan was the maestro of bubble money science and presided over almost two decades of monetary bubble infusions in an attempt to save us from perceived threats of dastardly deflation. Except a decade ago the debt levels were trivial in comparison with what exists today. Greenspan initiated the largest global bubble money experiment on earth being implemented on Earth today. It is risible to me that he now promotes ‘gold’ – the ultimate anti-bubble money asset.
It is the echoes of this monetary history which reverberates strongly today creating a seemingly stable equilibrium of economic and financial asset growth. Nothing could be further from reality.
Markets have a memory effect whereby future price movements have a higher probability of repeating recent behaviour than would otherwise be suggested by a purely random process. At the moment I believe market behaviour is a reverberation of the memory of past credit cycles propagated by central bankers who never fully allowed the cycles to complete from boom to bust. So the cycle heights either run higher and/or longer until such time as no amount of credit keeps the well-oiled financial markets rising and the economy ticking over.
This is a classic example of the law of diminishing returns - each new dollar printed exacts less and less return or output.
I have always intuitively believed that markets have significant order in their chaos and that we could predict this by looking at the relationship between credit cycles and market behaviour. I believe the inherent structure of a market carries a multitude of participants (economic agents) all with different rationale for making a purchase or a sale. Rational or irrational is in the eye of the beholder; what seems rational to one person may seem quite the opposite to another. Linear systems of econometrics that follow equilibria models do not allow for human action which is why the efficient market hypothesis has long been disproved.
This classic financial theory which assumes markets are efficient was first introduced by Louis Bachelier (mathematician) in the 1900s. The concept assumes that competition among a large number of rational investors eventually lead to equilibrium and the resulting equilibrium reflects the information content of past, present and even anticipated events. So an event of the magnitude of 19th October 1987 statistically should never occur if one were to subscribe to conventional financial wisdom. This was the day the Dow Jones Industrial Average plunged more than 20% in one day, an unlikely 20-standard deviation event whose probability of occurrence is less than one in ten to the 50th power. It is intuitive to me that the financial markets are one large consciousness - a conscious mind. The price and 'value' beliefs that are embedded in a market have a memory and a history based on decades of interconnected economic agents, all with different agendas, motivations and needs. Traders/ Investors think themselves largely independent souls but they are not. They are interconnected by a neural network, figuratively and actually both in the past and present which all impacts a future outcome in the markets.
Its rather analogous to a field of mushrooms which appear to be individual plants, when in fact they are a merely the temporary component of a fungal network, known as a mycelium, that exists underground all year round almost indefinitely.
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What is increasingly evident is that market participants are increasingly embroiled in a reflexive relationship between central bank actions, guidance and price action. The more the market moves contrary to central bank desires – ie downwards - the more the central bank injects the bubble money and reassures markets with the promise of more infusions of its rich elixir. This reflexive behaviour has led to a mindset that extends beyond institutional traders and investors but to populations as a whole. We are observing a complete financialization of the global economy and markets by this mindset. The speculative mindset that my house is now my investment, that my 401K or pension pot is my productivity for the future or that oil is some kind of arcade game rather than a highly productive resource for our economy is accepted as normal behaviour. This is the behaviour of the maddening crowd.
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An Austrian economic scholar and market participant quipped to me - "after six years and trillions of dollars of intervention, the only truly unconventional policies that remain are those which practice sound money, official inscrutability, and an approach which is a good deal less Hjalmar Schacht and a good deal more Adam Smith."
Although humorous, this is a deadly serious point to consider. As you will see from the economic charts in the following sections this enormous global experiment is not working. The overhang of too much debt and moribund growth continues to threaten national balance of payments and the well-being of populations.
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Much more in the full presentation, including numerous pretty charts, which can be found here