The formula used to create the global financial markets today seems to represent the same kind of leap in potency that the formula for nitroglycerine represented relative to black powder. I imagine I diminish the truth, namely that past global markets were indeed crazy and volatile, but today they seem so much more complex and dynamic. As an acolyte in the church of financial salvation, I might study a modern koan and offer one possible response.
Is the car that parks itself really a better car?
It is until you realize that the only people who know how to fix it are the ones who made it and that if it ever gets a mind of its own, the war between humans and machines will have tacitly begun.
I am thinking here of the global financial mechanisms that we have built not so much intentionally, but as byproducts of our fiddling. Japanese monetary policy and the ensuing yen-carry trade certainly contributed to the bubbles that led to the recent, sudden collapse of asset prices in 2009; however, the US monetary policy offers a newer, more imposing mechanism for leveraged risk-taking, the dollar-carry trade. By shorting US treasuries, the speculator gets to borrow at the implicit low rate and can then take risks with currencies, commodities, or equities; it’s an incredible mechanism if you’re right, and no hedge-fund manager worth his suspenders (I suppose just as many have tattoos now) would just sit there and try to squeeze out six percent in stocks or fixed income. So the zero interest-rate policy is a deliberate form of extortion into the use of this mechanism—for the sophisticated managers, and to a lesser extent on the investing public. But I must hie on to my point..
With so many players short US Treasuries (for carry-trade and position trades), the recent economic numbers sent some highly leveraged positions in both bonds and equities into unwinding mode. The US treasuries are seeing spikes like internet stocks used to after they announced a split (okay, maybe not quite as bad). But the economic weakening shouldn’t have been all that great for the bonds. Here’s the conundrum: US treasuries should be under pressure, reflecting the very obvious balance-sheet problems that were made clear in the course of the recent debt-ceiling debate, but they’re crashing up. In the first place, the revenue side of the US budget picture will be sorely affected by the economic turndown. Secondly, it’s obvious that the Sorcerer’s Apprentice (Bernanke) is there with his hand on the switch for QE3, impatiently asking “Now?” and “Is it time, yet?”
Many traders look for a blowoff top to signal the end of a major market trend. I think, despite the anticipation of more economic weakness, that this is it—the end after a three-decade rally. Why now? US treasury investors will soon see the negative feedback loop that presents itself to them: economic weakness is not good for long treasuries from a credit-risk standpoint (any more than it is for Greek debt), and the Fed is soon going to print more money in response to further weakness. Certainly there aren’t as many bond shorts left to cover as there were a week or two ago. If my prediction is accurate, we will see the bonds and stocks decouple with both bonds and stocks suffering from the deleveraging process.
Meanwhile, in the face of mechanisms that distort the perceived order of things, I will park my own car, and be sure to light any fireworks with a long match as they are so much faster, brighter and dangerous these days.
