Friday February 10, 2006 - 11:41:31 GMT
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Black Swan Capital - www.blackswantrading.com
‚ÄúA crowd is not merely impulsive and mobile. Like a savage, it is not prepared to admit that anything can come between its desire and the realization its desire.‚ÄĚ
Gustave Le Bon, The Crowd
We recently pondered about why, after 14 hikes in a row from the Fed, liquidity still seemed so abundant, stoking the juices of commodities aficionados far and wide. Soon after our pondering, we noticed Morgan Stanley star Andy Xie was pontificating on that very subject: [our emphasis]
‚ÄúThe cooling property bubble may have triggered liquidity rotating from property into commodity and emerging markets (EM) in the past three months. The global economy is experiencing multiple bubbles. The cooling of one does not decrease risk appetite and just triggers bubble rotation.
‚ÄúThe increased use of derivatives, which reflects rising risk appetite, has partly offset the liquidity reduction effect of the rate hikes by central banks. The monetary tightening is not achieving as much effect as in the past because risk appetite keeps rising due to the pass successes in taking on more risk. The central banks, the Fed in particular, may have to tighten much more than expected to achieve the desired effect.‚ÄĚ
It seems all so ‚ÄúMinsky-esk.‚ÄĚ
The following passages explaining Minksy‚Äôs theory of financial instability comes from a paper by L. Randall Wray, ‚ÄúFinancial Instability,‚ÄĚ Working Paper No. 19, July 2001. We thank our favorite Princeton economist, and friend of Black Swan, Deene, for forwarding this paper and providing us a ‚Äúcrash‚ÄĚ course on Minsky a few months back.
‚ÄúThis leads directly to Minsky‚Äôs second contribution, the financial instability hypothesis. Over time, the economy naturally evolves from one with a ‚Äúrobust‚ÄĚ financial structure in which hedge positions dominate, toward a ‚Äėfragile‚Äô financial structure dominated by speculative and even Ponzi positions. This transition occurs over the course of an expansion as increasingly risky positions are validated by the booming economy that renders the built- in margins of error superfluous‚ÄĒencouraging adoption of riskier positions. Eventually, either financing costs rise or income comes in below expectations, leading to defaults on payment commitments.‚ÄĚ
‚ÄúCentral to Minsky‚Äôs exposition is his recognition that development of the ‚Äúbig bank‚ÄĚ (central bank) and the ‚Äúbig government‚ÄĚ (government spending large relative to GDP) helps to moderate cyclical fluctuation. The central bank helps to attenuate defaults and bankruptcies by acting as a lender of last resort; countercyclical budget deficits and surpluses help to stabilize income flows. The problem, according to Minsky, is that successful stabilization through the big bank and the big government creates moral hazard problems because economic units will build into their expectations the supposition that intervention will prevent ‚Äėit‚Äô (another great depression) from happening again. Thus, risk-taking is rewarded and systemic fragility grows through time, increasing the frequency and severity of financial crises even as depression is avoided.‚ÄĚ [Our emphasis]
There is increasing concern incoming Fed Chairman Bernanke is quite the moral hazard type‚ÄĒand may have to ‚Äúprove‚ÄĚ himself by being tougher than expected. And just maybe the other central banks are getting in the game to tamp down on the multiple-bubbles, as Mr. Xie suggests, and we know, are abundant. Will the guise of liquidity begin to fade?
Today Bank of Japan Governor Toshihiko Fukui signaled that the bank is getting closer to ending its policy of holding rates near zero, Bloomberg reported. The yen liked that news:
‚Ä¶but the gold market didn‚Äôt seem too impressed. It‚Äôs down $7 bucks this morning, after spurting $14+ yesterday. Was it a trap for gold bulls? No way dudes, the Fed‚Äôs there for you‚ÄĒparty on!
Black Swan Capital
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