Three Black Swans

Sunday, July 23, 2017
By Paul Martin

By: John Mauldin
GoldSeek.com
Sunday, 23 July 2017

Yellen Overshoots
ECB Runs Out of Bullets
Chinese Debt Meltdown
Too Many Planes; Grand Lake Stream, Maine; Colorado; and Portugal

“The world in which we live has an increasing number of feedback loops, causing events to be the cause of more events (say, people buy a book because other people bought it), thus generating snowballs and arbitrary and unpredictable planet-wide winner-take-all effects.”

– Nassim Nicholas Taleb, The Black Swan

What do you do?” is a common question Americans ask people they have just met. Some people outside the US consider this rude – as if our jobs define who we are. Not true, of course, but we still feel obliged to answer the question.

My work involves so many different things that it isn’t easy to describe. My usual quick answer is that I’m a writer. My readers might say instead: “He tells people what could go wrong.” I like to think of myself as an optimist, and I do often write about my generally optimistic view of the future, but that optimism doesn’t often extend to the performance of governments and central banks. Frankly, we all face economic and financial risks, and we all need to prepare for them. Knowing the risks is the first step toward preparing.

Exactly 10 years ago we were months way from a world-shaking financial crisis. By late 2006 we had an inverted yield curve steep and persistent enough to be a high-probability indicator of recession 12 months later. So in late 2006 I was writing about the probability that we would have a recession in 2007. I was also writing about the heavy leverage in the banking system, the ridiculous level of high-yield offerings, the terms and potential turmoil in the bond and banking markets, and the crisis brewing in the subprime market. I wish I had had the money then that a few friends did to massively leverage a short position on the subprime market. I estimated at that time that the losses would be $400 billion at a minimum, whereupon a whole lot of readers and fellow analysts told me I was just way too bearish.

Turned out the losses topped well over $2 trillion and triggered the financial crisis and Great Recession. Conditions in the financial markets needed only a spark from the subprime crisis to start a firestorm all over the world. Plenty of things were waiting to go wrong, and it seemed like they all did at the same time. Governments and central bankers scrambled hard to quench the inferno. Looking back, I wish they had done some things differently, but in the heat of battle – a battle these particular people had never faced before, with more going wrong every day – it was hard to be philosophically pure.

(Sidebar: I think the Fed’s true mistakes were QE2, QE3, and missing their chance to start raising rates in 2013. By then, they had time to more carefully consider those decisions.)

We don’t have an inverted yield curve now, so the only truly reliable predictor of recessions in the US is not sounding that warning. But when the central bank artificially holds down short-term rates, it is difficult if not almost impossible for the yield curve to invert.

We have effectively suppressed that warning signal, but I am laser focused on factors that could readily trigger a global recession, resulting in another global financial crisis. All is not well in the markets. Yes, we see stock benchmarks pushing to new highs and bond yields at record lows. Inflation benchmarks are stable. Unemployment is low and going lower. GDP growth is slow, but it’s still growth. All that says we shouldn’t worry. Perversely, the signs that we shouldn’t worry are also reasons why we should.

This is a classic Minsky teaching moment: Stability breeds instability.

The Rest…HERE

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