Long Term Parking

long-term-parking

Anthony ‘Tony’ Soprano: And I don’t want to hear about the freaking economy, either! Sil, break it down for ’em. What two businesses have traditionally been recession-proof since time immemorial?
Silvio Dante: Certain aspects of show business … and our thing.

– The Sopranos, “For All Debts Public and Private” (Season 4, Episode 1, 2002)

There’s a great scene in the 4th season of The Sopranos where Tony is upbraiding his crew for their lack of “production”, particularly in the traditionally lucrative field of loan sharking. The recession is no excuse, says Tony, for failing to make money from “our thing” – organized crime. It’s a great scene because of the language, the routinization of a decidedly non-routine business. You can easily imagine Tony and Silvio as the CEO and CFO of a regional bank in 2002, exhorting their loan officers to get out there and drum up some business.

Like the Soprano Family in 2002, the problem with the US economy in 2014 is not that there is too much private debt being created, but too little. The danger for US markets is not that there is some private debt bubble about to burst, but that markets have become disconnected from the natural cycle of debt and growth, a cycle which remains decidedly anemic. 

I think it’s this disconnectedness that fundamental investors feel about this market – the “alienation”, as Marx would put it – that pushes otherwise sober market observers to wring their hands about this debt bubble and that debt bubble, this looming apocalypse and that looming apocalypse. Most recently, the media alarm bells have been about a “complacency bubble”, where low implied volatility levels for the market in and of themselves somehow create the potential for a big market drop. Even the occasional Fed governor has gotten into the act, claiming in their best Capt. Renault voice that they are shocked … shocked! … that markets are so blasé about world events. Please. This was the plan all along, explicitly laid out by Bernanke et al, that monetary policy would force everyone to buy riskier assets than they would otherwise prefer, inflating all financial asset prices and bridging the gap between the market everyone wanted and the real economy we actually had. This is not market complacency born of animal spirits and a “what, me worry?” attitude. This is market complacency born of an intentional (and incredibly successful) government plan to mold investor behavior. As a result, the current market complacency does not mean the same thing as prior periods of market complacency. And that makes all the difference in the world.

I’ve written herehere and here about why the whole “Minsky Moment” notion – which has come to be something of a rallying cry for those pointing to the dangers supposedly inherent in this market – is entirely misplaced. The Minsky-lite idea that “stability creates instability” may be in vogue, but really it’s just a vague tautology. Yes, I will stipulate that stability does not last forever. Thanks. Terribly keen insight. No, if you take Minsky’s ideas seriously you have to focus on private debt bubbles, and right now there are none in the US. Maybe there are in China, and I’m particularly interested in learning how far down the rabbit hole this commodity rehypothecation story goes. But in the US?  Nope.

But what about the $1 trillion student debt burden, Ben? What about the historically high levels of auto loan debt and corporate debt? Here’s the answer: a high level of private debt does not necessarily create a debt bubble.

First, debt in an absolute sense is never a problem. The problem, as Tony Soprano would be happy to explain to you as he cracks a baseball bat across your knees, arises when your debt obligation outstrips your ability to pay it back. This problem does not exist for households or corporations in the US. 

Here’s a chart from Fed data showing household debt service obligations as a percentage of disposable income. Debt servicing has not been this easy for American households since the Fed started compiling the data in 1980.

epsilon-theory-long-term-parking-june-16-2014-debt

For corporations, here’s a chart from Bloomberg data showing the ratio of net debt (debt minus cash) to EBITDA (earnings before interest, taxes, depreciation, and amortization) for the S&P 500. This is a very standard measure of liquidity and leverage, and today’s ratio of 1.37 is less than one-third what it was before the Great Recession. The cold hard fact is that US corporate balance sheets have not been this strong or less levered in more than 20 years.

epsilon-theory-long-term-parking-june-16-2014-debt-to-ebitda

Second, a market bubble can only exist in the form of market securities. If debt is not securitized it never reaches the public market and does not create a bubble. Here’s a chart from SIFMA data showing asset-backed securitization issuance (auto loans, student loans, credit cards, equipment loans, etc.) for the past 20 years through 2013. ABS issuance last year was not even equal to what it was in 2000, and is more than $100 billion below its peaks in the go-go years of 2005-2007. Sorry, no bubble here.

epsilon-theory-long-term-parking-june-16-2014-asset-backed-securities

Third, even if a high level of poorly underwritten private debt manages to find a high degree of securitization – I’m looking at you, student debt – a bubble can’t exist if the private debts are backstopped by public debt. This was the magic of the Temporary Liquidity Guarantee Program (TLGP), which for my money was the single most important program – far more than QE 1 – in preventing the world from imploding after Lehman’s bankruptcy. If the FDIC had not placed the full faith and credit of the United States behind the future issuance of private unsecured debt of FDIC-insured bank holding companies in November 2008, I have no doubt that the entire financial system would have collapsed for lack of liquidity. I mean, why do you think Goldman Sachs and Morgan Stanley became ordinary banks? Do you think they wanted to come under the thumb of Sheila Bair? No, the TLGP was the difference between life and death for Goldman Sachs and Morgan Stanley, as there is no way on God’s green earth that they would have been able to fund themselves given their highly levered balance sheet without a US government guarantee on their unsecured debt. So they chose life, which for Goldman Sachs amounted to about $30 billion in new funding. For GE Capital it was about $90 billion. How nice it must be to be too big to fail, and how infuriating it is to hear Lloyd Blankfein and crew claim today that Goldman Sachs was just fine all along and they never wanted to accept TARP money in the first place. Well, no kidding, Lloyd. TARP was a sideshow in many respects, a way to recapitalize all the banks choked by bad RMBS. It’s debt guarantee programs like the TLGP and the Fed’s Commercial Paper Funding Facility that the big boys like Goldman Sachs needed to keep their private debt bubbles from bursting (a true Minsky Moment!) and that’s what they got. Today, of course, owners of student debt receive the same protection. It was politically impossible to see the shadow banking system collapse in 2008, and it is politically impossible to see the student lending system collapse in 2014.

Okay, so maybe there are no private debt bubbles lurking around, and maybe Minsky-esque bubble-bursting isn’t the danger. But isn’t there some sort of danger associated with the $5 trillion dollars in public debt on the Fed’s balance sheet? Isn’t this a dangerous bubble? Yes and yes! But it’s an entirely different (and counter-intuitive) sort of danger than what everyone is shouting about.

First the punch line. The Fed’s public debt bubble can only burst if private debt growth takes off, and the bursting of the Fed’s bubble leads to rampant inflation, not rampant defaults.

Why? Because the massive debt racked up by the Fed in its QE purchases of US sovereign debt and mortgage-backed securities doesn’t work like household or corporate debt. The money for this buying spree never actually enters the real economy, but instead sits in the reserve accounts of the big banks. And that’s where it sits, and sits, and sits … until the big banks use those reserves to make private loans to households or corporations that want to use that money for some sort of real-world economic activity. This private lending activity is what turns reserves into money, and the cascading usage of that money – where it flows through multiple hands making real economic purchases – is what turns money into inflationary pressures and expectations.

I’ve referred in prior notes to the nitroglycerin-like nature of $5 trillion in bank reserves, and this is what I meant: if these massive reserves were ever to start getting into the real economy through private debt growth, the Fed debt bubble begins to explode in a rolling series of inflationary expectation blasts. What does the Fed do then? It either lets the inflationary blasts roll through the world economy and hope for the best, or it “drains” the reserves by QT – quantitative tightening. Either result is a nightmare for markets. In the former, the Fed is saying that it has lost control. In the latter, the Fed is saying that it’s still in control, but it’s going to embark on a massive and experimental tightening regime, the mirror image of its market-supportive policies of the past five years. Pick your poison.

I remember a 2011 dinner with a chief economist for a bulge bracket bank, both of whom shall remain nameless (I’d drop a hint like “he’s been consistently wrong on the US economy for the past 5 years”, but that really wouldn’t help you identify him in this crowd). Usually I feel bad for these guys at events like this, as the nature of their position forces them to make predictions that they really don’t want to make, but this guy couldn’t wait to make his bold forecast for the US economy: another quarter or two of 1-2% growth, and then off to the races with 4%+ growth as far as they eye can see. My response: God help us if you’re right. Debt is the oxygen for the flame of economic growth. You cannot have strong economic growth in the modern US economy without strong private debt growth, and if you have strong private debt growth it means that the Fed genie is getting out of the bottle. This was in 2011. The Fed genie is twice as powerful today.

But here’s the thing. Precisely because the bursting of the Fed’s public debt bubble through private debt acceleration would be a disaster of unimaginable proportions, I don’t think it will ever happen. So far it certainly hasn’t. Here’s a chart of the velocity of money since 1960.

epsilon-theory-long-term-parking-june-16-2014-velocity

But if the velocity of money never picks up, that means that private debt growth never takes off. And if private debt growth never takes off, the real economy remains stuck in this mediocre, constantly disappointing growth malaise.

It’s what I call the Entropic Ending, a long slog of a gray winding-down, neither fire nor ice, neither Happy nor Shocking, where the transformation of emergency monetary policy into permanent government program creates a low growth, low inflation political equilibrium that can last for decades. Stocks will go up and stocks will go down, but not by much either way. Perpetually disappointing growth translates into persistently dashed expectations of corporate earnings growth, but the programmatic Fed backstop of financial asset prices essentially outlaws a significant price decline. There are neither secular bull markets nor secular bear markets in an Entropic Ending, just an ossification of an increasingly mediocre status quo.

The Fed’s bubble is currently parked in the banking reserve system, and I think that’s where it’s going to stay for a really long time. I titled this note “Long Term Parking” because it’s the title of my favorite Sopranos episode, where Christopher’s girlfriend gets whacked out in the New Jersey woods and they park her car in the long-term parking lot of Newark airport to create a narrative that she is just away on a trip, not dead. Similarly, the Fed has whacked the prospects for robust economic growth with its QE policies. Similarly, the Fed has created a narrative that strong growth is just temporarily and oddly missing, not permanently depressed by its policy decisions. Keep hope alive, the Powers That Be say, a vibrant real economy will return from this unplanned vacation any day now. Yeah, right. My guess is this happens about the same time that Adriana picks up her car from the Newark parking lot.

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Risk Analysis in the Golden Age of Central Bankers

When I was a little kid we had a sand box. It was a quicksand box. I was an only child … eventually.
Steven Wright

A brief note today on what might be an arcane subject for some but is a great example of the most basic question in risk management – are you thinking about your risk questions in a way that fits the fundamental nature of your data? Do you understand the fundamental nature of your data? Our business incentivizes us to build complex and ingenious models and data analysis systems in order to generate an edge or dodge a bullet. But are we building our elaborate mental constructs on solid ground? Or on quicksand?

I’ve spent a lot of time recently talking with clients about measuring market risk across a wide range of asset classes and securities as part of an adaptive investment strategy, and I get a lot of smart questions. One of the best was deceptively simple – what do you think about using implied volatility to measure risk? – and that’s the question I want to use to illustrate a larger point.

First let’s unpack the question. Volatility is a measurement of how violently the returns of a security jump around, and in professional investment circles the word “volatility” is typically used as shorthand for risk – the higher the volatility, the greater the embedded risk. There are some valid concerns and exceptions to this conflation of the two concepts, but by and large I think it’s a very useful connection.

Within the general concept of volatility there are two basic ways of measuring it. You can look backwards at historical prices over some time period to figure out how violently those prices actually jumped around – what’s called “realized volatility” – or you can look forward at option prices for that same security and figure out how violently investors expect that prices will jump around in the future – what’s called “implied volatility”. Both flavors of volatility have important uses, even though they mean something quite different. For example, a beta measurement (how much a security’s price moves relative to an underlying index) is based on realized volatility. On the other hand, the VIX index – the most commonly reported gauge of overall market risk or complacency – is entirely based on the implied volatility of short to medium-term options on the S&P 500.

The big drawback to using realized or historical volatility is that it is, by nature, backwards looking. It tells you exactly where you’ve been, but only by extrapolation provides a signal for where you are going. In a business where you always want to be looking forward, this is a problem. Using realized volatility means that you will always be reacting to changes in the broad market characteristics of your portfolio; you will never be proactive to looming changes that might well be embedded within the “wisdom of the crowd” as found in forward-looking options prices. If you’re relying on realized volatility, no matter how sensitively or smartly you set the timing parameters, you will always be late. This was the point of the smart question I was asked: isn’t there useful information in the risk expectations of market participants, information that allows you to be proactive rather than reactive … and shouldn’t you be using that information as you seek to balance risk across your portfolio?

My answer: yes … and no. Yes, there is useful information in implied volatility for many purposes. But no, not for the purpose of asset allocation. Why not? Because we are living in the Golden Age of Central Bankers, and that wreaks havoc on the fundamental nature of market expectations data.

Here’s an example I’ve used before to illustrate this point, courtesy of Ed Tom and the Credit Suisse derivatives strategy group. Figures 1 shows the term structure (implied price level at different future times based on prices paid for options) of the VIX index on October 15th, 2012.

epsilon-theory-risk-analysis-in-the-golden-age-of-central-banker-june-9-2014-vix

Figure 1: 8-Month Forward VIX Term Structure

If you recall, there was great consternation regarding the Fiscal Cliff at this time, not to mention the uncertainty surrounding the November elections. That consternation and uncertainty is reflected in the term structure, as it is much steeper than is typical for a spot VIX level of 15, indicating that the market is anticipating S&P 500 volatility to be progressively higher to an unusual degree from January 2013 onwards. The way to read this chart is that the market expects a VIX level of 18 three months in the future (January 15), 19 three and a half months in the future (January 31), 20 four months in the future (February 15), and so on. All of these results are higher than one would typically expect for future expectations of the VIX from this starting point (essentially flat at 17).

Now take a look at Figure 2, which shows the Credit Suisse estimation of the underlying distribution of VIX expectations for January 31, 2013.

epsilon-theory-risk-analysis-in-the-golden-age-of-central-banker-june-9-2014-fiscal-cliff

The way to read this chart is that a lot of market participants have a Bullish view (low VIX) for what the world will look like on January 31, with a peak frequency (greatest number of bullish contracts) at 15 and a fairly narrow distribution of expectations around that. Another group of market participants clearly have a Bearish view (high VIX) of the world on January 31, with a peak frequency around 24 and a fairly broad distribution around that.

So what’s the problem? The problem is that Figure 1, which is what you would come up with based on public options data, says that the most likely implied price for the VIX on January 31, 2013 is 19. But Figure 2, which is based on the trading data that Credit Suisse collects, says that a VIX level of 19 is the least likely outcome. What Figure 2 tells you is that almost no one expects that the outcome will end up in the middle at a price of 19, even if that is the average implied price of all the exposures.

Usually the average implied price of a security is also the most likely estimated price outcome of the security. That is, if options on a security imply an average price of 19 a few months from now, exposures will generally form some sort of bell curve centered on the price of 19. The most common estimation of the price would be 19, with fewer people estimating a higher price and fewer people estimating a lower price. But in those situations – like expectations of future VIX levels on October 15, 2012 – where there’s not a single-peaked distribution, all of our math and all of our models and all of our intuitively held assumptions go right out the window.

Unfortunately, these bi-modal market expectation structures are now the rule rather than the exception in this, the Golden Age of the Central Banker. Why? Because monetary policy since March, 2009 has explicitly established itself as an emergency bridge for financial markets, a bridge between the real world of an anemic, under-employed, under-utilized economy and the hoped-for world of a vibrantly growing, robust economy. On its own terms, this has been an entirely successful experiment, I suspect surpassing the wildest dreams of Bernanke et al. Stock markets have been “bridged”, reflecting what the world would look like if the global economy were off to the races, while bond markets reflect what the world actually looks like with the global economy sputtering in fits and starts. The problem today is that the experiment has been too successful. Whether you are in Europe or the US or Japan or China or wherever, the only investment questions that matter are whether central banks will continue their emergency monetary policies and what happens if the bridges are removed. These are not small, incremental policy questions. These are existential questions, reflecting binary expectations of the world with an enormous chasm in-between. With a hat tip to Milton Friedman, we are all bi-modal now.

So what’s the moral of this story for portfolio management? There are four, I believe.

In the Golden Age of the Central Banker …

1) the VIX is not a reliable measure of market complacency. Remember that the VIX itself is an implied volatility construct, built on the prices paid for options on the S&P 500 two to three months in the future. We assume that whatever the VIX is reported to be, that’s the consensus market expectation, with a lot of people holding that particular view and progressively fewer people on either side of that number. This is not necessarily the case, and when binary events raise their ugly heads it is almost certainly not the case. A low VIX level might indicate a complacent market, or it might indicate two sets of investors – one very complacent and one non-complacent – who see the world entirely differently. You have no idea what the underlying market expectations look like, and this makes all the difference in determining what the VIX means.

2) the wisdom of crowds is nonexistent. I believe in the efficiency of emergent behaviors. I believe that there is a logical dynamic process to crowd behaviors. But I also believe that crowds are extremely malleable when confronted by powerful individuals or institutions that understand the strategic interaction of crowds and make a concerted effort to master the game. There’s no inherent “wisdom” here, no emergent outcome where the crowd acts like an enormous set of parallel microprocessors to arrive at Truth with a capital T. The Common Knowledge Game is controlled by the Missionary, and our current Missionaries – central bankers, politicians, famous investors and media mouthpieces – know it.

3) fundamental risk/reward calculations for directional exposure to any security are problematic on anything other than a VERY long time horizon. Game-playing has always been a big part of the market environment, and it dominates successful directional bets on a very short time horizon. Similarly, stock-picking on a fundamental basis has always been a big part of the market environment and dominates successful directional bets on a very long time horizon. Between the very short-term and the very long-term you have this mish-mash of game-playing and stock-picking. One impact of the pervasiveness of the Common Knowledge Game today is that it pushes out the time horizon on which stock-picking on a fundamental basis can really shine. If you’re in the stock-picking business the value of permanent capital has never been greater.

4) I’d rather be reactive and right in my portfolio than proactive and wrong. I started this note with an acknowledgment of the weakness of risk assessments based on realized or historical volatility – it’s inherently backwards looking and you will always, no matter how finely calibrated your system, be late to respond to changing market conditions. But here’s the thing. This is what it means to be adaptive.You can’t be adaptive without something to adapt TO. Will you miss the market turns? Will you occasionally get whipsawed in your reactive process? Without a doubt. But you won’t get killed. You won’t be on the wrong side of a binary bet that you really didn’t need to make. You won’t discover that your pretty little sand box is really filled with quicksand. The Golden Age of the Central Banker is a time for survivors, not heroes. And that’s the real moral of this story.

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The Minsky Moment Meme

epsilon-theory-the-minsky-moment-meme-june-2-2014-esurance

That’s not how it works. That’s not how any of this works.
– Esurance “Beatrice” commercial

There’s a wonderful commercial in heavy rotation on American television, where three women of a certain age are discussing one of the friend’s use of Facebook concepts such as “posting to a wall” or “status updates”. The protagonist of the scene, Beatrice, takes these concepts in an entirely literal way, attaching actual photographs to an actual wall and delivering an un-friending message in person, at which point her more hip friend says, “That’s not how it works. That’s not how any of this works.”

I have exactly the same reaction to today’s overuse and misuse of the phrase “Minsky Moment”, originally coined by PIMCO’s Paul McCulley to describe how economist Hyman Minsky’s work helped explain the market dynamics resulting from the 1998 Russian financial crisis, such as the collapse of investment firms like Long Term Capital Management. Today you can’t go 10 minutes without tripping over an investment manager using the phrase “Minsky Moment” as shorthand for some Emperor’s New Clothes event, where all of a sudden we come to our senses and realize that the Emperor is naked, central bankers don’t rule the world, and financial assets have been artificially inflated by monetary policy largesse. Please. That’s not how it works. That’s not how any of this works.

Just to be clear, I am a huge fan of Minsky. I believe in his financial instability hypothesis. I cut my teeth in graduate school on authors like Charles Kindleberger, who incorporated Minsky’s work and communicated it far better than Minsky ever did. Today I read everything that Paul McCulley and John Mauldin and Jeremy Grantham write, because (among other qualities) they similarly incorporate and communicate Minsky’s ideas in really smart ways. But I’m also a huge fan of calling things by their proper names, and “Minsky Moment” is being bandied about so willy-nilly these days as a name for so many different things that it greatly diminishes the very real value of Minsky’s insights.

So here’s the Classics Comic Book version of Minsky’s financial instability hypothesis. Speculative private debt bubbles develop as part and parcel of a business/credit cycle. This is driven by innate human greed (or as McCulley puts it, humans are naturally “pro-cyclical”), and tends to be exacerbated by deregulation or laissez-faire government policy. Ultimately the debt burdens created during these periods of market euphoria cannot by met by the cash flows of the stuff that the borrowers bought with their debt, which causes the banks and shadow banks to withdraw credit in a spasm of sudden fear. Because there’s no more credit to be had for more buying and everyone is levered to the hilt anyway, stuff either has to be sold at fire-sale prices or debts must be defaulted, either of which just makes the banks withdraw credit even more fiercely. The Minsky Moment is this spasm of private credit contraction and the forced sale of even non-speculative assets into the abyss of a falling market.

Here’s the kicker. Minsky believed that central banks were the solution to financial instability, not the cause. Minsky was very much in favor of an aggressively accommodationist Fed, a buyer of last resort that would step in to flood the markets with credit and liquidity when private banks wigged out. In Minsky’s theory, you don’t get financial instability from the Fed massively expanding its balance sheet, you get financial stability. Now can this monetary policy backstop create the conditions for the next binge in speculative private debt? Absolutely. In fact, it’s almost guaranteed to set up the next bubble. But that’s a problem for another day.

If you don’t have a levered bubble of private debt you can’t have a Minsky Moment. Do we have one today? Sorry, but I don’t see it. I see crazy amounts of public debt, a breathtaking level of nitroglycerin-like bank reserves, and a truly frightening level of political fragmentation within and between every nation on earth. All of these are problems. Big problems. HUGE problems. But none of them create a private debt bubble. To be sure, we can all see worrisome examples of speculative excess popping up in every financial market. But that’s a far cry from a bubble, even a garden-variety tech bubble or LBO bubble, much less something like the housing bubble of 2004-2007 where private Residential Mortgage-Backed Securities (RMBS) went from practically nothing to a $4 trillion debt asset class. Maybe a private debt bubble is building somewhere, but it ain’t here yet. The one place I see a potential private debt bubble is in China around infrastructure construction (which looks suspiciously like American railroad financing in the 1870’s), but even there it’s far from clear how levered this effort is, and it’s perfectly clear that the debt is inextricably intertwined with public and pseudo-public financing.

Why is the distinction between a public debt bubble (which we have) and a private debt bubble (which we don’t) so important? Because a private debt bubble is always ultimately popped as Minsky suggests, with current cash flow concerns and a surprise default prompting private lenders to turn off the spigot of credit. It doesn’t work that way with a public debt bubble. It doesn’t work that way because current cash flow is only a minor part of the sovereign debt purchase calculus, at least when it comes to a major country. It doesn’t work that way because central banks can purchase a government’s debt securities, either directly as in Japan or indirectly as in the US. It doesn’t work that way because public debt is always and in all ways a massive confidence game, dominated by the Common Knowledge Game. Put simply, sovereign debt does not have the same meaning as private debt, and that makes all the difference in the world in how our current market environment ultimately plays out.

It’s why I am negatively inclined towards investment managers that use fundamental economic rationales as the basis for some can’t-miss trade that Country ________ [fill in the blank] will inevitably implode. Just look at the difference between Spanish or Portuguese sovereign debt yields in the summer of 2012 (trading like a distressed corporate credit about to go BK) and those same bonds today (trading close to all-time highs). Did the Spanish and Portuguese economies experience some miraculous renaissance, some explosion of real economic growth to support enormously tightened spreads at a fundamental level? Yeah, right. No, what happened was that Mario Draghi and Angela Merkel made a political statement – “whatever it takes” – to create an informational structure where everyone knows that everyone knows that the European Powers That Be will not allow Spain and Portugal to default. That’s it. That’s all it took. Just words. Words that have no place in Minsky’s theory (or any economic theory), but are the beating heart of the Common Knowledge Game.

Can a public debt bubble pop? Of course it can! But the dynamic process that leads to a public debt bubble popping has very little to do with Minsky’s theory and a whole lot to do with game theory, very little to do with economics and a whole lot to do with politics. It’s this game theory piece that last week’s Epsilon Theory note, “When Does the Story Break?” tried to explain.

To recap … no money manager I know thinks that the real economy is off to the races, which is why the long end of the yield curve remains so depressed and no one trusts these stock market highs. US GDP was negative in Q1 of this year! I don’t care what the weather was like, that’s nuts. And global growth is even more anemic. But at the same time, no money manager I know thinks that the Fed will allowfinancial markets to crack. The QE genie is out of the bottle, and there’s no putting it back in regardless of whether the Taper gets all the way back to zero monthly purchases or not. There is an unbelievably strong Common Knowledge informational structure around the unlimited power of central banks to control market outcomes – what I call the Narrative of Central Bank Omnipotence – and until that confidence game is broken this public debt bubble will not be popped.

Look, I totally understand why so many investors, particularly dyed-in-the-wool value investors, are so frustrated with the repercussions of Zero Interest Rate Policy (ZIRP). When the risk-free rate is nothing, of course you are forced to reach for yield. The Fed has successfully pushed everyone into buying riskier assets than they would otherwise prefer to do. But just because you’re frustrated is no reason to believe that the situation must change. Just because you have personal experience with private debt bubbles and a catchphrase (Minsky Moment!) to describe those experiences does not mean that you are looking through the right lens at today’s market environment of a coordinated public debt bubble throughout the Western world. This is a different animal, unseen since the 1930’s, and it requires a different vocabulary and perspective. That’s what I’m trying to provide with Epsilon Theory.

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