"Let It Burn": Albert Edwards Has Some Advice For The Fed

Last June, when describing the series of events that will emerge once central banks lose control, Deutsche Bank's Aleksander Kocic coined the term "metastability"...

... and to explain how the current system is poised on the verge of collapse in either direction, and which - at its moments of peak instability (think relentless central bank intervention and propping) is paradoxically defined by peak and widespread complacency, and which Kocic compares to an avalanche: "a totally innocuous event can trigger a cataclysmic event (e.g. a skier’s scream, or simply continued snowfall until the snow cover is so massive that its own weight triggers an avalanche."

How does the regime change from the current "metastable" regime to an "unstable" one? To Kocic the transition will take place when systemic uncertainty, for whatever reason, is eliminated: "Big changes threaten to explode not when uncertainty begins to rise, but when it is withdrawn." He also pointed out that while there is punishment for those who seek to defect from a "complacent regime" such "metastability" is in itself unstable:

"Persistence of low volatility causes misallocation of capital. This is how complacency leads to buildup of risk – it is the avalanche waiting to happen."

Ultimately, the crash takes place when peak complacency smashes into peak, artificially low volatility:

Endemic complacency, which continues to take hold of the markets, is likely to play an increasingly adverse role the longer markets continue to operate as they recently have. However, although volatility remains depressed, the risk continues to be pushed to the tails. This is a buildup of metastablity. The longer the stick remains still, the more surely it will fall.

And while "avalanche' is one perfectly apt metaphor for what will follow sooner or later in capital markets, what Kocic effectively described is a concept that is very familiar to Austrian economists. The simplest analogy to "Austrians" like Mark Spitznagel, is the lack of controlled "forest fires" to eliminate old trees (i.e., systemic excess and "zombie corporations" from central bank intervention and record liquidity), ultimately resulting in a catastrophic conflagration of epic proportions -  a lack of "creative destruction" sowing the seeds of the system's collapse, as Schumpeter would put it:

In the financial forests of our own making, suppression is particularly problematic — and even deadly. Excess and malinvestment thrive for a time, only to be destroyed by ravages caused by their own vulnerability. Yet, as we will see, even such high-intensity "fires" (of the forest and financial varieties) will has up and redistribute resources; in the case of the market, it releases capital to areas previously avoided the to the myopic distortions of monetary intervention. (The Austrian School naturally understood this well, as explained by the Austrian Business Cycle Theory.)

The above is a good segue into the latest note, and vacation, from SocGen's "permabear" Albert Edwards, who writes that "I am just back from a two-week trip to Lake Tahoe and Yosemite/Sequoia Parks" where the macro strategist learned some important lessons that he would now like to impart to the Fed:

It was significant that we didn’t see any bears at either venue despite doing a 7.30am, 13 mile valley floor hike! I’m sure the absence of fellow bears was a significant countertrend sign. I learned something else on my trip worth sharing. We took the Yosemite Tram tour of the valley floor and the ranger gave a very interesting talk about fire.  Until 1970 Yosemite Parks was extinguishing regular small-scale fires to prevent property damage. The resultant rise in dense small tree growth meant that although fires were less frequent, they quickly got out of control. Since 1970 they have allowed more fires to burn, resulting in less damage.

Edwards' advice: "Central bankers should learn this lesson."

Of course, they won't because as we have observed in the past 20 years, the central bank M.O. is to allow a bubble grow too big for its to be successfully deflated without causing massive damage, and replace it with another, even bigger bubble.

Furthermore, as we also know, every market crash is caused by the Fed tightening too much, usually into a recession or depression, and causing the market reset that the Fed will then replace with yet another bubble. Here, the good news is that as Bank of America has shown previously, we are still early on in the tightening cycle that always ends with a market event.

But are we really? What if the Fed has tightened far more than the simple Fed Funds rate will suggest? That is the follow up point made by Edwards, who references some recent work by his SocGen colleague Solomon Tadesse, in which Solomon notes that although nominal Fed Funds is bounded at 0%, the impact of additional monetary easing due to QE was to further reduce the ‘implicit’ true underlying rate (also called the Shadow rate) below zero.

Solomon adopts the methodology for estimating shadow short rates for the US found in the widely circulated Wu and Xia (2016) paper. He shows that the Shadow Fed Funds rate hit negative 3% in mid-2014, but more importantly that a pronounced tightening cycle actually started through 2015, and by the end of that year the Shadow rate had converged back with the effective nominal Fed Funds rate (see charts below).

In other words, if one uses as the baseline not the X-axis, but the trough in the Shadow Funds Rate, the Fed's tightening is now well past the point where the abovementioned "avalanche" is expected to start.

Solomon notes that although the six Fed Funds rate hikes since Dec 2015 amount to a total of 170 basis points (bp) of tightening, one can argue that if we add the 300bp (Shadow) rate hike to the current Fed Funds rate of 1.70%, the degree of monetary tightening in the current cycle stands at 470bp.

This number is troubling because it is in line with the peak rates of tightening cycles in the post-inflationary era of the 70s and early 80s (see charts below).

What is the implication? As Edwards concludes, "it is therefore reasonable to argue that the US has already faced a ‘normal’ tightening cycle and any additional rate hikes are taking us into territory not seen in recent times. This already may be enough for the Fed to have broken something."

And the punchline:

... if that is not enough and the Fed is to be believed, rates are heading to 3.4% (ie another 170bp rise) for a total of 640bp of tightening at a time when the US corporate sector is drowning in a sea of debt. That might be the time for me to revisit Yosemite and Sequoia where the bears should be a lot more visible.

If the SocGen analysis is accurate, the Fed will have a very big fire on its hands very soon.

Comments

Quantify Bondosaurus Rex Thu, 06/07/2018 - 12:24 Permalink

I find it somewhat unbelievable the Rothchilds could have that sort of effect or even if they did would want a Nuclear power the preeminent nuclear power on the planet to self destruct. It wouldn't be advantageous to their investment to have radiation possibly covering the earth. This simplistic view of the world where a single family controls all, is absurd. You have watched far too many James Bond flicks. Or you should double up on your meds or stop taking illegal meds.

In reply to by Bondosaurus Rex

ddiduck Quantify Thu, 06/07/2018 - 13:01 Permalink

Historically, they were quite transparent as no awareness of their power was acknowledged. Their greatest weakness is their need to be invisible, as in, the manipulation of geopolitical boundaries for implementing wars, invasions, assassinations, etc! Anyone who denounces their influence is either a complete idiot or a deep state operative pushing disinformation. They ARE THE CENTRAL BANKS OF EVERY NATION ON THE PLANET, period! So long as they can remain invisible! Just curious are you on any meds?

In reply to by Quantify

Quantify ddiduck Thu, 06/07/2018 - 13:12 Permalink

The world is very complicated, monarchies, Communists, Socialists, Dictators, wars and ideologies. Even a group of bankers with trillions at their disposal can't control it. Far too many variables. Humans are far too unpredictable. Who would have thought that North Korea would be willing to negotiate with the Donald a year ago? Who would have known that Israel would make an alliance with the Saudis? Who knows the next big energy breakthrough will be? There are evil Oligarchs like Soros, but they can only control so much.

In reply to by ddiduck

wmbz Thu, 06/07/2018 - 11:48 Permalink

"This already may be enough for the Fed to have broken something"

Banksters Inc. aka the Fed, "broke" something a long, long time ago...

Juggernaut x2 mily Thu, 06/07/2018 - 11:52 Permalink

If you look at that Fed Funds Rate chart the only thing that is bullocks is 10 years of ZIRP which has effectively destroyed a generation of savers. This Alberts guy- what he writes is just words that you can take or leave- but the actions of the Fed- those have real consequences. 

In reply to by mily

ElTerco mily Thu, 06/07/2018 - 14:06 Permalink

The fake forcing function of free money started 35 years ago. Of course it is still turning, until it fractures. There is a backlog of $21,000,000,000,000 of demand that has been pulled forward that has yet to clear. It will clear catastrophically one day. And that doesn't count derivatives, which are additional leverage on that $21,000,000,000,000 .

In reply to by mily

DavidFL Thu, 06/07/2018 - 11:49 Permalink

What a bunch of BS; 3 % on the 10 year bond is enough to break something? What a pityful state the world economy is in.

I think the real problem is the US$ carry trade which is now running in reverse. Screw all of the speculators who have been feasting off rate differentials for 10 years.

LawsofPhysics Thu, 06/07/2018 - 11:50 Permalink

That's a whole lot of bullshit.  Don't overthink this asshat. Anytime absolute power is given to a select few people/corporations you will get this sort of corruption/fraud.

Why do the useless fucks in banking/finance have access to free fucking money (ZIURP/NIRP) without doing any REAL WORK or facing any REAL RISK while everyone else must face real risk and perfomr real work?!?!?

Fuck em!  Jump you fuckers!!!

In the meantime...

"Full Faith and Credit"

same as it ever was!

Blankfuck Thu, 06/07/2018 - 11:50 Permalink

These FED RESERVE CENTRAL BANKTARDS SHOULD BE EXECUTED FOR HOW THE MISMANAGED BY GIFTING THEIR BANKER FUCKER FRIENDS AND CEOS WITH ALL THE PRINTED PONZI WEALTH. THE AMERICAN PEOPLE FOOT THE BILL FOR THEIR LAVISH LIFESTYLE. 

TOO BAD ITS ILLEGAL TO DO WHAT I WOULD CONSIDER JUST TO PUT THEM AWAY, I GUESS THE FBI IS IN THEIR POCKET ALONG WITH POLITICIANS 

 

THEY ESSENTIALLY STOLE FROM THE AMERICAN PUBLIC BY PRINTING PONZI AND STUFFING THEIR OWN POCKETS WITH IT AND BUYING HARD TANGIBLE ASSETS, LAND, HOMES ETC

Cautiously Pes… Thu, 06/07/2018 - 11:55 Permalink

(hand raised in back of class)

Umm...Professor Edwards, will we be discussing this quote at any time during the semester?  I did not see it on the syllabus and was just wondering....   

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.
~Henry Ford

jmack Thu, 06/07/2018 - 11:59 Permalink

The Ideal is that people get paid for investing their capital, regular normal people.   That is problematic because of the emotions of greed and fear create boom bust cycles.  So the banks try to design a system that eliminates the animal spirits' effect on capital markets, or at least blunts it, so we now have a managed economy, not a capitalist system.  you decide if it is better or worse.

Blankfuck Thu, 06/07/2018 - 12:01 Permalink

MOTHER FUCKTARDS THESE EVIL GOT AWAY WITH!

MOTHER FUCKTARDS THESE EVIL GOT AWAY WITH!

MOTHER FUCKTARDS THESE EVIL GOT AWAY WITH!

 

These FED RESERVE CENTRAL BANKTARDS SHOULD BE EXECUTED FOR HOW THE MISMANAGED BY GIFTING THEIR BANKER FUCKER FRIENDS AND CEOS WITH ALL THE PRINTED PONZI WEALTH. THE AMERICAN PEOPLE FOOT THE BILL FOR THEIR LAVISH LIFESTYLE. 

TOO BAD ITS ILLEGAL TO DO WHAT I WOULD CONSIDER JUST TO PUT THEM AWAY, I GUESS THE FBI IS IN THEIR POCKET ALONG WITH POLITICIANS 

 

THEY ESSENTIALLY STOLE FROM THE AMERICAN PUBLIC BY PRINTING PONZI AND STUFFING THEIR OWN POCKETS WITH IT AND BUYING HARD TANGIBLE ASSETS, LAND, HOMES ETC

turkey george palmer Thu, 06/07/2018 - 12:17 Permalink

When a corporation borrows to buy back stock the funds go to holders of the stock who then must reinvest the funds elsewhere driving wave after wave of funds into various stawks. Once a high enough rate hits which will be this month or next Sept maybe the process will be erse as selling produces wave upon wave of selling or withdrawl of funds from stawks. It's not going to be a little slope either as every new low forces another new wave of selling. Easily tripping circuit breakers, once the panic forces the PPT to fail well stop your grinnin, and drop your linen

snblitz Thu, 06/07/2018 - 12:57 Permalink

when the US corporate sector is drowning in a sea of debt.

Why is the US corporate sector downing in debt?  Perhaps because the Fed drove down interests rates to create near zero cost borrowing?

Is the problem tightening or loosening?  If loose monetary policy is **always** followed by tightening is not "loose monetary policy" the problem?

If tightening always leads to problems, then why tighten?

If both loosening and tightening lead to problems why do either?

Blah, blah, blah. The system itself is unstable and perhaps, as experience shows, it cannot be made stable.

But there was a stable system prior to 1913:

https://finitespaces.com/2018/04/07/why-we-create-sound-money-and-governments-wreck-them

 

Blankfuck Thu, 06/07/2018 - 14:22 Permalink

Remember, you cant trade a juiced market in fairness with the FED RESERVE FUCKTARDS PONZi PRINTERS plus FUCKTARD CEOS WHO BUY BACK SHARES THEN SHOW BETTER EARNINGS PER SHARE.

WE ALL LIVE IN A CONTROLLED FUCKTARD WORLD BY DICTATORSHIP OF THE FED RESERVE AND CENTRAL BANKER FUCKTARDS

abgary1 Thu, 06/07/2018 - 16:49 Permalink

Until 1970 Yosemite Parks was extinguishing regular small-scale fires to prevent property damage. The resultant rise in dense small tree growth meant that although fires were less frequent, they quickly got out of control. Since 1970 they have allowed more fires to burn, resulting in less damage.

 

I think this applies to the economy too.

The pursuit of perpetual economic growth by way of central bank easing to suppress recessions and depressions will no end well.

Corrections in the economy and markets are necessary in a well functioning, debt driven  economy.

 

End the central banks and neo-classcial economic theory.