When the herd thunders off the cliff, most participants are trapped in the stampede.. One of the most perverse consequences of the central banks “saving the world” (i.e. saving banks and the super-wealthy) is the destruction of low-risk investments: we’re all speculators now, whether we know it or acknowledge it. The problem is very few of us have the expertise and experience to be successful speculators, i.e. successfully manage treacherously high-risk markets. Here’s the choice facing money managers of pension funds and individuals alike: either invest in a safe low-risk asset such as Treasury bonds and lose money every year, as the yield doesn’t even match inflation, or accept the extraordinarily high risks of
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In the fantasy world conjured by central bank stimulus, markets never go down and economies never slide into recession. Financial engineering has eradicated risk. But the dynamics interact in ways that can’t be controlled. As inflation heats up globally, central banks are being forced to “normalize” interest rates and yields, and political pressure to stop saving banks and the super-wealthy is mounting.
All speculative markets deflate, slowly or suddenly, depending on the marginal buyers and sellers. The shakier the marginal participants, the greater the likelihood that the speculative bubble will pop with a suddenness that surprises the vast majority of participants. Take a look at stock valuations as a percentage of GDP, i.e. the real economy: stocks are clearly in a bubble. |
US Stock Market to GDP Ratio 1960-2020 |
The national Case-Shiller housing price index: bubble. |
S&P/Case Shiller 20-City Composite Home Price Index |
The Seattle Case-Shiller housing price index: super-bubble. |
S&P/Case Shiller WA-Seattle Home Price Index 1995-2015 |
The Dallas Case-Shiller housing price index: super-duper-bubble.
You get the point: virtually every supposedly low-risk asset class is actually a super-risky, super-dangerous bubble. Speculation drives valuations far beyond financial rationality because we’re herd animals and unearned gains supercharge our greed, especially when we see all sorts of undeserving people making fortunes for doing nothing but running with the herd. |
S&P/Case Shiller TX-Dallas Home Price Index 2005-2015 |
Risk has a knack for hiding in plain sight. Few people look for it, and even fewer recognize it. Only a handful act on it.
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