Sunday, August 30, 2015

Manipulation = Fragility

In markets distorted by permanent manipulation the most powerful incentive is to borrow as much money as you can and leverage it as much as you can to maximize your gains in risk-on asset bubbles.
A core dynamic is laying waste to global financial markets: the greater the level of central bank/government manipulation, the greater the systemic fragility.
One key characteristic of this fragility is that it invisibly accumulates beneath the surface stability until some minor disturbance cracks the thinning layer of apparent stability. At that point, the system destabilizes, as it has been hollowed out by ceaseless manipulation, a.k.a. intervention.
There are a number of moving parts to this dynamic of steadily increasing fragility.
One is that any system quickly habituates to the manipulation, that is, the system soon adds the manipulation to its essential inputs.
For example: if you lower interest rates to near-zero, the system soon needs near-zero interest rates to remain stable. Raising rates even a mere percentage point threatens to fatally disrupt the entire system.
Another is that permanent intervention (i.e. manipulation, or to use a less threatening word, managementstrips the system of resilience. When participants are rescued from risk by central bank/central state authorities, they take bigger and bigger gambles, knowing that if the bet goes south, the central bank/state will rush to their rescue.
One of the core sources of resilience is a healthy fear of losses. If you're going to face the consequences of your actions and choices, prudence forces you to either hedge your bets or diversify very broadly, so if bets in one sector go south you won't be wiped out.
Thanks to the permanent manipulation of central banks and states, trillions of dollars have concentrated in high-risk, high-yield carry trades that are now blowing up.
A third source of fragility in manipulated financial systems is the perverse incentives generated by cheap credit and assets bubbles. In markets distorted by permanent manipulation--near-zero interest rates, central bank asset purchases, quantitative easing, etc.--the most powerful incentive is to borrow as much money as you can and leverage it as much as you can to maximize your gains in risk-on asset bubbles.
Why this increases system fragility is obvious: when the bubbles pop, the debt has to be paid back. But once the assets drop enough, selling won't raise enough money to pay back the debt.
At that point, the borrowers are bankrupt, and the dominoes of debt topple the entire financial system.
Dave of X22Report and I discuss these dynamics in Central Banks Have Manipulated The Markets Which Will Ultimately Crash: (42:48)

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