Three Bubbles/Strikes And You're Out

Authored by Charles Hugh Smith via OfTwoMinds blog,

Those betting on a fourth bubble of even greater extremes will find their time at bat has come to an end.

The conventional investment wisdom holds that central banks will never let markets decline. This is an interesting belief, given that two previous asset bubbles based on central bank "easy money" both imploded, impoverishing believers in central bank omnipotence.

So perhaps we can say that the conventional investment wisdom holds that any asset bubble that bursts will quickly be reflated into an even more extreme asset bubble. That's certainly been the history of the past 17 years.

But there's a case to be made that bubbles are like strikes, and you only get three. A recent article, Deutsche: "We Are Almost At The Point Beyond Which There Will Be No More Bubbles", made a nuanced case for "3 bubbles and you're out" based on volatility and other inputs.

I propose a much simpler case for "3 bubbles and you're out":

1. Every policy yields diminishing returns as the positive results follow an S-curve.

2. What every trader knows no longer has any predictive power.

3. Policy extremes have become normalized, leaving central banks with unintended and unpredictable consequences should they push even more extreme policies in the next bubble burst.

Radical new central bank policies work wonders in the initial boost phase (see diagram below) because the sums being deployed are so large and the policy is so extreme: quantitative easing / purchase of assets by central banks, for example: never before have central banks conjured trillions of dollars, yuan, yen and euros out of thin air and used this new currency to buy bonds, stocks and debt instruments in vast quantities for eight years running.

But over time, the novelty and effectiveness of the radical policies wear off. Participants habituate to the policies, which become a given that can not be removed without disrupting the markets.

Traders are always seeking an edge, and front-running central bank policy has proven to be a very effective strategy. But once everyone starts using the same strategy, it stops working. Put another way, there's no predictive power left in what everyone knows.

So central banks suppress volatility--everybody knows that. Central banks jump in and buy every dip, stopping any decline in its tracks with unlimited buying of assets. Everybody knows this.

Eventually, everyone is on the same side of every trade. At that point, there is only one movement left--a reversal that catches everyone by surprise.

The third dynamic is that central banks are visibly getting nervous about the unintended and unpredictable consequences of their extreme policies. It's all fun and games when central banks are buying trillions of assets with money created out of thin air, but how do you stop the asset purchases when everyone depends on them as the foundation of the markets?

Are there no consequences from holding interest rates near zero for eight long years?

What about political blowback from the rising wealth inequality that central banks have fueled?

Policy extremes trigger unintended consequences as a result of being extreme. You can't throw around trillions and not generate expectations, incentives and blowback from those who don't benefit from the extreme policies.

Central banks don't control the consequences of their policies. If they respond to the popping of the current bubble with tens of trillions in new asset purchases, they might find this policy is nowhere near as effective as when it was unleashed in 2008.

Once markets grasp that central banks have lost control of the consequences of their policies, confidence, faith and trust in central banks "saving the day" will evaporate. The likely result of this realization is that markets will plummet to new lows rather than reach new highs.

Three bubbles/strikes and you're out. Those betting on a fourth bubble of even greater extremes will find their time at bat has come to an end.

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I'm offering my new book Money and Work Unchained at a 10% discount ($8.95 for the Kindle ebook and $18 for the print edition) through December, after which the price goes up to retail ($9.95 and $20). Read the first section for free in PDF format. If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.

Comments

Son of Captain Nemo FreeShitter Tue, 12/12/2017 - 08:56 Permalink

"You trying to make hairy pussy great again?"...

Isn't it funny how contradictions reveal themselves over time in interesting ways?...

Women use to wear a "landing strip" and hid it in the days money was still backed by something...

And now that money is no longer backed by anything "like BTC" and American USD $$$ post-1970s they go "balled" with less to show for it and more communicable diseases "riding it"!...

Go Figure?!!!

In reply to by FreeShitter

Son of Captain Nemo FreeShitter Tue, 12/12/2017 - 09:19 Permalink

No FS

Old school still rules. When you run out of Gold and Silver you run out of real money!

Call me when BTC backs physical Russian and Chinese Gold which is the only currency NOW THAT MATTERS!...

Until then. I'll remember the way raw bear use to taste with the "beard" and the liquor was sweeter because the "pond" was "cleaner" less polluted in those days compared to NOW!.

I feel sorry for you that you are not old enough to remember how unbelievably good it use to be!!!

In reply to by FreeShitter

LawsofPhysics Tue, 12/12/2017 - 08:31 Permalink

"Once unemployment goes below 6.5% we will normalize interest rates" - Ben Bernanke"We would never directly monetize the debt, that would be wrong" - Ben BernankeIt's a good thing I didn't believe him, many of us didn't and are much "richer"... Let me be clear folks, roll the motherfucking guillotines, NOTHING changes otherwise.In the menatime..."Full Faith and Credit"same as it ever was silly sheep!

44magnum LawsofPhysics Tue, 12/12/2017 - 08:53 Permalink

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"The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks." John Dalberg Lord ActonIt isn't russia, N korea, Iran, the blacks, the muslims, the mexicans and all the others they keep throwing at us.ITS THE FUCKING BANKS

In reply to by LawsofPhysics

Money_for_Nothing Tue, 12/12/2017 - 08:39 Permalink

Tax cut bubble. Once it passes manufacturing will start moving to low tax states as the high tax states implode. Trump has made moving overseas a risky proposition. Raw venality is being exposed.

EddieLomax Tue, 12/12/2017 - 08:40 Permalink

I do believe the market can never crash if the central banks can keep on producing new money.However at some point it becomes more profitable for people to not use the new money used because it loses its purchasing power so quickly.  I'm struggling to see where this will happen as every central bank likes to destroy the value of the currency it is supposed to protect, but it has to happen somewhere.I guess this explains bitcoin, I don't agree with that implementation, but seeking something that does not depreciate as fast at a minimum is always a better deal.  At somepoint then everyone will be holding an asset and not selling until they are offered vastly more for it, hyperinflation of a sort along with stagnation in the economy.

buzzsaw99 Tue, 12/12/2017 - 08:41 Permalink

this is nothing but bullshit cliches and a bunch of vague unsupported assertions.  i told myself i'd stop reading this guy's shit yet here i am.  slow news day i guess.

small axe Tue, 12/12/2017 - 08:47 Permalink

the question is not if the latest bubble will burst, but who will bear the brunt of the damage, the status quo or the citizenry. Average people are traditionally the victims of bubbles, but with today's mega-bubble, the status quo is "all in", and hopefully the bubble bursting will bring down government and put big money on its knees, rather than make ordinary people pay the price of economic policy folly. Hopefully...

xear Tue, 12/12/2017 - 09:28 Permalink

I ordinarily like Charles Hugh Smith but this is faulty reasoning."Once markets grasp that central banks have lost control of the consequences of their policies, confidence, faith and trust in central banks "saving the day" will evaporate. The likely result of this realization is that markets will plummet to new lows rather than reach new highs."Wrong... trust in central banks disappeared long ago and it doesn't matter. In the next market crash they will print money and buy up stocks and save the markets. As long as they can print money, how can that fail to work? If the petrodollar collapses there may be a problem but that is a different dynamic.

brushhog xear Tue, 12/12/2017 - 09:45 Permalink

It all depends on how much of the market is central bank money and how much is private investor's. There is also a question of the central bank's balance sheet, they seem concerned about the balance sheet...so is there a limit? IDK. Maybe when the balance sheet looks bad enough the rest of the world ( not you and me but other banks and governments ) consider them a bad lending risk?

In reply to by xear

brushhog Tue, 12/12/2017 - 09:39 Permalink

I'd like to see a chart showing proportion of private investment to central bank money in the market. That would be the whole story right there. Central bank money is either a small percentage of the market, leading the private money.....or, as many here suggest, it is the bulk of the market, in which case it literally CAN keep it going for a very very long time...limited only by the ability of central banks and government to maintain faith in the currency.

xear brushhog Tue, 12/12/2017 - 10:03 Permalink

The Swiss National Bank alone already owns over $80 billion in stocks. That is just one small central bank. They are all doing it now. Slightest market slack and they all come in again with unlimited money. The only thing that can stop it now is a currency crisis.

In reply to by brushhog

Vlad the Inhaler Tue, 12/12/2017 - 11:28 Permalink

Wrong!  It's pretty obvious that the Central Banks have got retarded but FULL RETARD is yet to come.  You can hear them leaking hints here and there- ban cash, NIRP, universal basic income, direct purchase of equities.  When that fails they will turn to the ultimate solution which is always war.  "The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists." -Ernest Hemingway