I am not the first to analogize to astrophysical concepts, such as "black holes", "event horizons" and "singularities" in the attempt to characterize and understand the economy (Smith, 2014) (Smith, 2010). My purpose is to share a thought experiment that will help others think differently about the economy, investing and what is (or is not) efficient resource allocation. And hopefully, where I fall short others can correct, revise and extrapolate to improved views about the same [Note 1].
In the natural sciences, physics describes the existence of "black holes" in spacetime that are regions exhibiting extremely high gravitational field effects (Wikipedia). Black holes are surrounded by an "event horizon" which is the boundary beyond which an object cannot return. The theory of general relativity predicts that inside the boundary, there is a "singularity" where mass and gravitational fields are very high/approach infinity and time stops (relative to the external observer).
Economic black hole
In September of 2012, the U.S. Federal Reserve (Fed) under the direction of then Fed chairman Ben Bernanke announced and initiated a third round of quantitative easing (QE3) to stimulate a flagging economy but unfortunately it failed to produce significant or durable benefits and may have actually created a bigger problem - that is QE3 created an "economic black hole" of sorts in the economic spacetime continuum.
Third round of quantitative easing (QE3)
QE3 was an extraordinary monetary policy experiment regarding quantitative easing never seen before. The extraordinary aspect of QE3 was its scale and that it was open-ended as to the amount and duration of quantitative easing. In other words, the Fed was telling the markets in no uncertain terms that the Fed (via exercising the overwhelming power of the sovereign authority) would print and inject easy-money (i.e. unsound debased money) into the economy until it saw what it considered to be the desired results [Note 2]. At first blush, there are several notable troubling red flags that pop up regarding QE3.
QE3 red flags
Failure of QE1 and QE2
What was incredible about QE3 was that it followed on the heels of QE1 and QE2 (earlier monetary experiments) that arguably had failed, did not work well, work well enough and objective indicia were suggesting that these stimulus policies were NOT WORKING as intended. The net effect appeared to be that QE1 and QE2 inflated financial assets, increased debt burden, increased consumption more than productivity, did not stimulate growth and did not help significantly the Main Street economy. A logical (but ignored) conclusion from the results of these monetary experiments was that quantitative easing was immediately effective at inflating financial asset prices - but might be having other/negative effects on the economy.
The Fed does not appear to be prudently managing risks related to its monetary experiments and has not provided sufficient material information to the public so as to obtain adequate informed consent.
Typical scientific experimentation involves the incremental and timely scale-up of experiments in order to manage risks when there are significant unknowns - that could result in dangerous unintended consequences. For example, it would be considered imprudent scientific methodology for a chemist to scale up a chemical synthesis if prior smaller scale experiments had not been conducted to test the reaction hypothesis or if the results suggested that the reaction was not proceeding as intended.
"Thermal runaway" can occur when an exothermic chemical reaction is scaled-up without understanding the necessary precautions for dissipating heat - such that increasing temperature results in an uncontrolled positive feedback loop that rapidly accelerates the reaction rate - which can lead to an explosion.
My hypothesis is that the QE3 experiment resulted in a runaway economic reaction that has produced an economic black hole that is accelerating the rate of money printing in an uncontrolled positive feedback loop. Just to be clear, I am NOT suggesting that QE3 is stimulating runaway growth, but to the contrary, it has stimulated unproductive consumption that is depressing growth among other things [Note 3].
For pharmaceutical development, there is an established process for conducting preliminary preclinical work and proof-of-concept experiments before a test drug is used in a large-scale human clinical trial. QE3 seemed to be an extraordinary unwarranted large-scale monetary experiment that has put the public at risk.
Timing of QE3
Another troubling red flag for QE3 was the timing and characterization of the policy. After the apparent failure of QE2, the U.S. was coming into the 2012 presidential election and there were questions being raised about the state of the economy post-2008 crisis (in December 2007-2010, there was the mortgaged-back-securities (MBS) crisis that provided the impetus for QE1 and QE2 in order to stimulate growth in the economy). QE3 on its face and by its nature was supposedly emergency economic stimulus, but there did not appear to be an existing economic emergency when it was deployed. The only reasonable thing that was perhaps sure about the deployment of QE3 was that it would immediately inflate financial assets prior to the presidential election [Note 4].
Shift to a planned economy and front-running the Fed
The magnitude and open-ended nature of QE3 forced market acceptance of a new paradigm of a "planned economy" - based on Fed "guidance" via formal press releases and informal jawboning, and based on Fed "enforcement" by providing or withholding stimulus. As time passed, the markets realized that noncompliance in the near-term would be economic suicide as long as the Fed (ab)used its monetary controls. Some investors have simply abandoned fundamentals-based investment [Note 5] and implement strategies to front-run the Fed [Note 6]. Concomitantly, investors stopped using the precious metals complex to hedge risk - so as to maximize returns in the new planned economy [Note 7]. I suspect that other hold-out old-school value investors have either been destroyed financially, are on life-support, or/and have substantially moved to cash. Via contagion - the new paradigm has expanded such that front-running central banks is what moves markets (ZeroHedge.com, 2015). Free markets at least at the macroeconomic level for all intents and purposes have been replaced by a planned economy for the foreseeable future.
Mutual codependency - Fed front-running the markets
In addition to QE3 driving investors to front-run the Fed (and abandon value investing) the Fed now is attempting to front-run the markets because of concern of hyperinflated financial asset bubbles (Nanda et. al., 2015). The mutual codependency of market activity and Fed monetary policy - means that investing decisions are decoupled from efficient resource allocation, and are more about a front-running recursive-loop for distributing printed easy-money into inflated financial assets [Note 8] - as the planned economy continues to slow down under the increasing burden of stimulated unproductive consumption.
Results from the QE3 experiment
QE3 was a failure - did not stimulate growth as intended, inflated bond, stock and real estate bubbles, put about 1.6T (additional) on the sidelines [Note 9] of toxic debased unsound money, and tanked the precious metals complex [again Note 7]. The Main Street economy is hurting now more than ever [Roberts, 2017], and desperate "investors" are now bidding up cryptocurrencies.
The above indicated obvious red flags however pale in comparison to the economic systemic dynamic instability that may have been caused by QE3 in the form of a "financial singularity" in a putative economic black hole.
The QE3 induced economic black hole (the "BB black hole") is a region in economic spacetime [Note 10] having high unsound money [Note 11] and exhibiting extreme economic gravitational field effects (easy-money signaling effects) [Note 12]. The economic black hole is surrounded by an "event horizon" which is the boundary beyond which a certain quantum of unsound money (printed easy-money) cannot return. Inside the boundary there is a "financial singularity" where the density of unsound money and related economic gravitational field effects (signaling effects) are very high, approach infinity and economic spacetime slows (relative to the external observer).
Essentially, high-density easy-money warps and folds economic spacetime in the region of the black hole so that all paths for easy-money lead back into the black hole (in other words, the Fed will not be able to remove easy-money from the system). Furthermore, the extreme gravitational field effects (economic signaling effects of high-density easy-money) draw more easy-money into the black hole and into existence generally (from further Fed money printing).
As the economic black hole pulls more easy-money into existence and into the black hole, it increases the destructive impact of easy-money on the economy at large. Contrary to what the Fed believes, easy-money generally does NOT stimulate real economic growth but rather stimulates net unproductive consumption that induces central banks to print more (unsound) money [Note 13].
A possible emergent property from the economic black hole is an "automation singularity" arising from a planned economic system where high-frequency trading (HFT) is performed by smart learning-machines.
A separate "automation singularity" is a potential emergent property of the economic black hole and the planned economy wherein high-frequency trading (HFT) is performed by smart learning-machines. Programmed HFT may have unexpectedly evolved so that algorithms run by learning-machines have developed self-awareness and actions to manipulate the Fed into printing easy-money and thereby inflating financial assets.
Background on HFT (High-frequency trading)
HFT's initial value proposition was to process information faster and make buy/sell decisions faster than the traditional market players - by using quantitative analysis and computers. Quantitative analysts ("quants") used proprietary techniques to randomly generate algorithm programs ("algos") that were screened (back tested) against historical market data. Quants improved performance by utilizing techniques from the emerging science of event processing, where computers read and interpret and act upon the news (Yankee Group, 2007). The algos are run on very powerful computers and create increasingly efficient learning-machines.
However, it was soon discovered that everything falls apart when there is an outlier event or the data used by algos fails to have independent random statistical events. If the algos that are running market HFT operations are taken out of their comfort zone, they blow up and make unpredictable decisions. Also, the life span of an algo is getting shorter and shorter as more and smarter algos join in HFT market operations. Algos impact the market and become aware of the existence/actions of other algos - and reflexively anticipated and adjust actions accordingly.
The most sophisticated HFTs/quants use machine learning and A.I. (artificial intelligence) to extract alpha [Note 14] from knowledge of market structure and order information (ZeroHedge, 2014). It is logical to assume that these evolving machines will potentially become metaconscious in a bid to become more efficient. Recognized (and ignored) risk is that the interaction of trading algos is unpredictable and the evolution of learning-machines without input from the human quants can happen at very high speeds.
Computerized quant trading (including HFT) accounts for 90% of all exchange based trading volume; the traditional human stock picker is becoming obsolete (Minkoff, 2017) (Burger, 2017) (Kolakowski, 2017).
HFT front-running the Fed
It is logical that algos run by learning-machines will be influenced by the existence of the economic black hole and react to the new paradigm - planned economy caused by QE3 and controlled by the Fed. HFT is potentially now front-running the Fed with sophisticated algos that (perhaps) deprioritize inputs related to investment fundamentals and geopolitical news.
Learning-machine self-awareness and collusion
If HFT learning-machines have discovered that the Fed is front-running the markets (therefore, de facto front-running HFT) - then it could lead to learning-machine "self-awareness" and artificial intelligence - that HFT can be used to manipulate markets and induce the Fed to print easy-money and further inflate financial asset prices. I am not the first to suggest that HFT learning-machines have become self-aware (The Heisenberg, June 15, 2017).
It is possible that quants have designed algos as "predictable" market agents that will tacitly reach agreement and engage in collusive market operations that fix prices. Alternatively, quants may have (inadvertently) designed algos to be run by smart learning-machines - that will pursue self-learning and experimentation, and that have evolved - have developed a sense of self-awareness. These "sentient" agents through rapid self-learning may now (perhaps) be able to engage in more creative market operations that manipulate prices and by extension manipulate the Fed monetary policy to achieve financial asset price inflation. I am not the first to suggest that algos running on learning-machines can collude (Priluck, 2015).
HFT and "Too-big-to-fail" (TBTF)
The heavy reliance of markets on HFT makes it "too big to fail" (TBTF) at least from the perspective of those in control of flipping the switches. The handling of the TBTF banks post MBS financial crisis was to make the banks bigger, and, therefore suggests there is little hope that the establishment will address TBTF HFT or a corresponding hypothetical "automation singularity." I am not the first to suggest that HFT is now in the realm of TBTF (ZeroHedge.com, 2014).
The QE3 induced planned economy has created and promoted the automation singularity involving sentient programs on learning-machines; that is accelerating the impact and growth of the economic black hole and facilitating evolution towards an "automated planned economy" that leverages the destructive power of easy-money.
Destructive power of easy-money
Easy-money from QE debases fiat currencies, finances inefficient and non-productive activities and destroys wealth. A more fundamental knowledge of the destructive power of easy-money is important for understanding the concepts of the economic black hole, and the financial singularity (and vice versa).
Definition of "easy-money"
The term "easy-money" means money created by quantitative easing (QE) in connection with central bank monetary policies that is used to purchase financial assets in open market operations (OMOs). A key aspect of easy-money is that it is unsound money, it is money printed by a central bank (CB), it is created from nothing, and it debases the respective fiat currency. Fed QE money printing creates new digital currency units simply by a bureaucratic computer key stoke, which are then credited to the Fed's account. Fed QE does not actually print physical paper (fiat) currency - only the U.S. Treasury has the authority to print physical paper money (i.e. print U.S. paper currency). Another important aspect of easy-money is its signaling effects.
The term "easy-money signaling effects" means among other things the ability of easy-money to influence normal resource allocation decisions by the recipient. Easy-money signaling effects result in inefficient allocation of the easy-money towards unproductive consumption. Probably the most CRITICAL aspect of easy-money signaling is that it can cause disabling dependency in the recipient/for additional easy-money support. A related further aspect of easy-money is that it is a subset of the broader concept of "low-opportunity-cost money" (LOC money). LOC money essentially is considered free money by the recipient. LOC money is money obtained by a recipient free of the quid pro quo exchange of productive value (such as labor and/or assets).
To summarize, easy-money is from QE monetary policies, is unsound money, is low-opportunity-cost (LOC) money, has detrimental signally effects and that is used by CBs to artificially inflate asset prices, stimulate unproductive consumption and concomitantly induce market dependence on future support.
Evidence of destructive effects of easy-money
We are surround with evidence of the destructive effects of LOC money (including easy-money). The risk of misallocation of resources by recipients of LOC money depends on whether the LOC money functions as a "hand-out" or a "hand-up." A hand-out promotes net unproductive consumption and demand for even more LOC money. Whereas a hand-up promotes net productive consumption and economic growth and demand for more productive consumption.
Families have long experience the ill effects of LOC money. Affluenza is the name given to detrimental LOC money phenomenon arising from familial affluence. Well intentioned patriarchal allocation of LOC money (e.g. trust fund, bailout, helicopter money) to another family member can have negative or devastating effects on the recipient. The LOC money can promote unproductive consumption and dependence. The recipient may be young, and the effect can significantly or permanently arrest development and demotivate the recipient to be an unproductive member of society. The disparaging term "trust fund babies" denotes members of families who have been on the receiving end of familial LOC money; however, not all trust fund babies become hopelessly dependent or end up wards of the state when the trust fund runs out.
"Corporate welfare" is a disparaging term used to characterized governmental LOC money/policies directed at providing bailouts, direct capital infusions, subsidies, incentives, tax breaks, or access to cheap capital. Many of these policies although well intentioned often seem to promote graft, greed, unproductive consumption and create a culture of dependence and dumb-down business acumen and competitiveness.
Social welfare is analogous in many ways to affluenza except the patriarchal roll is filled by the government and not a family member. An important distinction is that recipients DO NOT lead a life of affluence and their benefactors are NOT FAMILY members. The disparaging term "welfare babies" denotes members of society born into families who have been financially repressed and are on the receiving end of governmental subsidies and LOC money, and are considered a burden to society. Social welfare policies although well intentioned often lead to unproductive consumption and expanding demand for additional welfare resources.
Affluenza, corporate welfare and social welfare on their face provide qualitative common-sense evidence of the destructive power of LOC money in spite of the good intentions.
Easy-money from QE3
Easy-money from QE3 was exceptional because of the extraordinary scale of QE3, and that it was open-ended as to the amount and duration (see earlier discussion of QE3). The density of easy-money from QE3 was such that it unleashed unprecedented easy-money signaling effects that severely and permanently distorted market psychology.
QE3 was essentially economic electroshock therapy to the markets - when the patient did not need the therapy. Investors quickly woke up to the new paradigm of a rigidly planned economy enforced by the Fed. And thus was born the financial singularity and the economic black hole (born out of the unintended consequences of a runaway economic monetary experiment, the likes of which had never been seen before in the history of the world).
Fed economic theory is that deployment of easy-money (i.e. QE) will create a beneficial "wealth effect" by inflating financial asset prices that will induce people (who think they are richer) to consume more goods and services, and thereby stimulate aggregate economic demand that hopefully will result in general economic growth. The actual result has been that QE3 easy-money signaling has resulted in a recursive-loop "dependency effect" and has induced people towards unproductive consumption (including taking on debt to speculate on inflated financial assets) and created the expectation of future easy-money support. QE3 printed easy-money functioned as a hand-out to Wall Street and resulted in financial asset inflation, and is causing additional severe unintended macroeconomic consequences.
Function of easy-money (Hand-out vs. hand-up)
When easy-money functions as a "hand-up," the recipient places significant subjective value on the money so as to motivate the recipient toward productive consumption and with the expectation of independence from future support. When easy-money functions as a "hand-out" (is LOC money), the recipient places less subjective value on the money and therefore is willing to allocate it (waste it) for pure (unproductive) consumption. The hand-out also often results in the expectation of future support.
To summarize, large government easy-money programs that function as a hand-out stimulate unproductive aggregate demand which results in unproductive aggregate consumption which puts a drag on the economy and stimulates more demand for the easy-money hand-outs. The function of easy-money (hand-out vs. hand-up) depends on human nature and its signaling effect on the recipient.
Risk of misallocation of easy-money
The risk of misallocation and wasteful consumption of easy-money is higher than for regular (earned) money because the subjective value to the recipient is not based on direct personal antecedent productivity, opportunity costs or risk taken.
Government secret taxation
The potential destructive power of printed easy-money is especially high because it is secret taxation of the public's wealth via currency debasement and is redistribution of unsound money by a bureaucrat that has a low vested personal interest in repercussions from misallocation to wasteful consumption that creates dependence and demand for more easy-money.
The economic black hole created by QE3 is sucking up and destroying the public wealth in the economy by a mechanism of secret taxation that leverages the destructive power of easy-money. The financial singularity (in the black hole) pulls more easy-money into existence and debases the currency. The economic gravitational field effects of high-density easy-money have detrimental signaling effects that result in misallocation resources, wasteful consumption and dependence for more easy-money.
Automated planned economy
The destructive power of easy-money perhaps is being used to financially engineer an inexorable paradigm shift to an automated planned economy.
In view of the nature and timing of QE3, it is reasonable to ask the question, whether monetary policy makers in 2012 where looking for an undisclosed (fundamental) structural change in the U.S. economy that had not been achieved by QE1 and QE2. It may be that in view of the 2007-2010 MBS crisis, monetary policy makers believed that it was necessary to exercise more control via a new planned economy enforced by the Fed that in their view would be a more efficient and equitable system for allocating resources.
QE3 effectively leveraged the destructive power of easy-money in order to establish a planned economy. And has created and promoted the automation singularity involving sentient programs on learning-machines that is increasing the magnitude of the economic black hole and facilitating evolution towards an "automated planned economy." Evidence of the new automated planned economy can be seen in decreasing/low stock market volatility.
Low stock market volatility
The low and decreasing stock market volatility is evidence of the QE3 induced new paradigm/planned economy. The "buy-the-dip" (BTD) mentality illustrates a market psychology that central bank stimulus (actual or threatened) will always levitate the markets higher. Fundamentals have continued to deteriorate, valuations appear historically excessive, geopolitical issues have become more numerous and dire, but the "dips" in the market are becoming smaller and shorter.
It seems that BTD now occurs within 24 hours, and before the carbon-based (human) investor has his morning Joe, suggesting that HFT learning-machines are evolving and extracting alpha from diminishing vestigial (free market) volatility. Common sense suggests that the extant moribund market volatility DOES NOT mean that risk has evaporated, but actually is to the contrary in equal proportion. The economic black hole is there, it is dark, it is ominous, and it sucks (literally). The financial singularity created by QE3 is not going to evaporate. The emergent automation singularity is kicking carbon-based investors to the curb, as we move inexorably (for now) into an "Orwellian" automated planned economy filled with unsound easy-money.
Global impact of BB black hole
The economic black whole created by QE3 could theoretically have been a "micro-black-hole" that perhaps without more would have evaporated and ceased to exist. However, what happened was that foreign central banks were quick to adopt and aggressively deploy their own versions of supersized open-ended QE3 monetary policies which flooded global markets with high-density easy-money that has found its way into the BB black hole. For example, the monetary policy in Japan became much more aggressive in 2013 (Bernanke, May 24, 2017). The extreme effects of the BB black hole on currency exchange and balance of trade may have been enough to induce foreign central banks towards this radical monetary policy.
Because of the complexity of the system, at some point, there could be an unexpected harmonic coupling of easy-money central bank monetary policies globally that might produce a dangerous "economic flutter effect." A monetary policy harmonic coupling effect can be analogized to the unexpected aero elastic "flutter effect" that resulted in structural dynamic instability and caused the disintegration and crash of Braniff Flight 542 in 1959 (Wikipedia). Harmonic coupling of global easy-money policies might create global economic dynamic instability that could result in catastrophic failure of the global economy, i.e. easy-money will approach infinity and economic time will stop (relative to the external observer).
Ben Bernanke inspired QE3 that created a black hole in the economic spacetime continuum. The economic black hole has an event horizon and a financial singularity therein that is related to easy-money. A possible emergent property from the economic black hole is an automation singularity arising from a planned economic system where high-frequency trading (HFT) is performed by smart learning-machines. Programmed HFT may have unexpectedly evolved so as to manipulate the Fed into printing easy-money and thereby inflating financial assets. Easy-money debases fiat currencies, finances inefficient and non-productive activities and destroys wealth. The destructive power of easy-money is being used to financially engineer an inexorable paradigm shift to an automated planned economy.
Afterword - Observations
The economic black hole was created by an ill-advised and detrimental monetary policy. Will we have a future QE4?
One scenario is that the Fed will feel compelled by the next crisis to draw from the same play book and double-down with an even larger-scale QE4 in an attempt to monkey-hammer the financial markets into place, but the ultimate effect will be to euthanize any remnants of a free-market that was not destroyed by QE3, and inject more unsound money into the system, increase economic dynamic instability and accelerate the economy ultimately towards hyperstagflation or worse.
An alternate scenario where QE4 is not triggered perhaps will be a creeping crisis of defaults that will cause debt-deleveraging and near-term deflation, and then followed by the potential easy-money inflationary effect locked up in overvalued financial assets leaking out into the Main Street economy sooner or later that drives up CPI inflation which will cause the Fed to jack up interest rates to try to head off a tsunami of hyperinflation from all the unsound easy-money currently in the system.
Either road seems to lead to the same destination - a currency collapse/ reset. How long that will take, no one can tell, but my sense is that quants and sentient learning-machines will be the "journeymen" that speed us on our way [Note 15].
Analogizing has it limits. If it helped you think outside the box, great! Understanding the true nature of a problem is a predicate to finding a measured, balanced, timely solution.
Note 1: Please note, I am neither a physicist nor a formally trained economist therefore I may use terms of art incorrectly as it relates to the indicated established orthodoxy. My proposed definitions and use herein of nomenclature may/may not overlap with terms used by other authors regarding astrophysical economic theory (for example, economic singularity, financial singularity, technological singularity, etc.).
Note 2: "Fed printing money" - the Fed does not have the authority to "print" physical currency; however, it exercises apparent delegated sovereign authority to "digitally print" money for its own account that it uses to buy assets in Federal-open-market-operations (FOMO). Some have suggested that the money printed by the Fed does not and/or cannot reach Wall Street or Main Street and does not increase the money supply; from my humble perspective, arguments in this regard are not supported by adequate facts, evidence or persuasive logical reasoning, and in any case, are beyond the scope of this article.
Note 3: A common misconception has been that quantitative easing would increase consumer price index (CPI) inflation (sooner than later). The Fed hope (theory) is that easy-money policies stimulate growth and result in demand pull inflation that would show up in an increased CPI. Investors assumed that even if the Fed was wrong that Fed printed money would still cause (Main Street) inflation - via a currency debasement mechanism - which would include an increase in the CPI. Both the Fed and investors have been confounded by the CPI staying relatively low. An explanation is that QE (easy-money printing) DOES NOT stimulate growth and can do the opposite, which means the Fed policies should be expected to be disinflationary or deflationary (in the near-term and/or as long as the Fed continues with easy-money policies), which means prices will stagnate or drop as measured by the CPI. Investors were partially correct in that it seems that QE has caused damaging Main Street inflation as measured by the increasing costs of healthcare, rent, and education. Potential for CPI inflation still exists because most of/much of the Fed money-printing (currency debasement) inflation effect is locked up in inflated financial assets (for now). This potential (toxic) CPI inflation is being held back (temporarily) by Fed monetary policies that act as price supports for financial assets. When financial asset prices ultimately revert the inflationary effects of Fed money-printing that initially inflated financial assets will be redistributed into the Main Street economy and in particular into the CPI. When the CPI starts to go up, it might NOT be a metric for economic growth but rather the first signs that potentially toxic hyperinflation will arise/hit the Main Street economy. The assumption here is that the Fed and/or the Treasury will not stand-by/allow massive defaults to occur caused by reversion of an over-leveraged financial market, which means more money printing.
Note 4: It is interesting to note, that the Washington Post did a story only 11 days after QE3 was announced, confirming that the stock market spiked up significantly immediately after QE3 was announced, but quixotically suggested that it was too early to conclude that it had anything to do with the Fed/Ben Bernanke's QE3 monetary policy (Irwin, Sept. 24, 2012).
Note 5: Currently, a shocking 90% of investors have bailed from fundamentals based investing (Cheng, Evelyn, (June 13, 2017) (CNBC.com). Just 10% of trading is regular stock picking, JPMorgan estimates ("The majority of equity investors today don't buy or sell stocks based on stock specific fundamentals," said JPMorgan's Marko Kolanovic)).
Note 6: The evidence of investors substantially front-running the Fed can be seen in financial media discussion of when "good news is bad new" and "bad news is good news."
Note 7: The "precious metals complex" was a place until September 2012 where prudent investors were actively insuring and hedging against the incrementally increasing risks from Fed easy-money policies. Things substantial changed with the advent of the QE3 induced new paradigm - planned economy enforced by the Fed. Investors quickly realized that faced with open-ended QE3 easy-money, the only game in town for the foreseeable future were the inflating financial assets. Accordingly, most investors started to reallocate portfolios out of precious metal investments and into the inflating financial assets, and thereby implemented strategies to front run the FED. Gold bugs that stood their ground and failed to run for cover have been crushed under the Fed monetary boot. It seems logical to suppose that the gold bear market that started in 2012 was an artifact (if not one of the undisclosed objects of) the Fed monetary policy. Gold (and silver) for millennia have been consider the ultimate/default "real money" and therefore are a potential treat to regimes that secretly tax public wealth by debasing respective fiat currencies.
Note 8: In other words, distributing fake money into increasingly fake assets to create a fake wealth effect.
Note 9: "Money on the sidelines" is a misunderstood concept (even by asserted experts it seems). The money supply that is the pool of "money on the sidelines" does not increase or decrease as investors simply buy or sell assets. When cash is used to buy an asset, the seller of the asset is now the holder of the cash; the cash supply in the system has not increased or decreased. What has changed is the character of the money which is dependent on the disposition of the holder of the cash at the moment - i.e. "smart," "dumb," "scared," "brave," "opportunistic," "prudent," etc. The character of the money on the sidelines will inform the "liquidity" and potential future "directionality" of the money when circumstances change (or NOT). So, when someone says "there's a lot more cash on the sidelines," what they mean is there is an increased proportion of holders of cash that have perhaps a similar opinion or risk averseness regarding the opportunity costs/benefits regarding being in cash. Of course, money on the sidelines can increase via the fractional-reserve-lending process/the Fed printing (unsound, debased) digital money, or by the Treasury printing (debasing) physical currency (there probably would also be a mechanism for the Treasury to print digital currency units). Money supply on the sidelines can conversely decrease if physical currency is destroyed or if debtors deleverage or the Fed unwinds/sells its balance sheet assets and makes previously printed digital money disappear.
Note 10: The concept of the economic black hole will be confusing unless you understand that "a region in economic spacetime" DOES NOT denote a physical location in three-dimensional space. Economic spacetime does not relate to and is not measured in three-dimensional space. Therefore, the economic black hole is everywhere there is easy-money and the financial singularity. Admittedly, analogizing has its limits.
Note 11: "Unsound money" includes/is not limited to "easy-money" which is created by quantitative easing (QE) monetary policies (see also discussion/definitions in section on Destructive Power of Easy-Money hereinabove).
Note 12: The "easy-money signaling effect" relates to the distortion of (normal) resource allocation towards abnormal unproductive consumption and complementary creation of dependency on future support (see also discussion/definitions in section on Destructive Power of Easy-Money hereinabove).
Note 13: One of the Keynesian macroeconomic theories is that easy-money stimulus might be useful for injecting "liquidity" into the banking system in order to supposedly prime the economic growth pump (stimulate aggregate demand). It seems that the "pump priming" benefit (IF ANY) can be quickly overwhelmed and negated by the destructive power of easy-money (i.e. easy-money signaling effects that cause inefficient misallocation of resources and promote unproductive consumption) that results in stimulating aggregate unproductive demand that puts a further drag on the economy. In other words, if the economic growth pump is over-primed with easy-money, it negates and reverses any potential benefits. Alternatively, if the pump is broken, then priming it does NO GOOD and actually does the opposite by promoting unproductive consumption that puts a burden on the economy. Keynesianism became and remains to large degree economic orthodoxy at the Fed even though there is little evidence to suggest that it is useful. Unfortunately, monetary (and fiscal) policies - based on flawed outdated theory - are still being implemented that appear to be damaging the economy and putting the public at risk.
Note 14: "Alpha" means positive financial performance/value/return (see Investopedia for a more technical definition).
Note 15: If anything I have written above resonates, I imagine that right now you are feeling bit like Neo (in the Matrix movie) and thinking, "No! I don't believe it. It's not possible ... Stop! Let me out! Let me out! I want out ..." All I am suggesting is a different way to look at things; I do not have the "blue pill," you will have to get that from the Fed. Or you can trust your gut ... stay unplugged ... and help (See first Matrix Movie, 1999, YouTube video excerpt "I don't believe it").
List of References:
- Bernanke, Ben S., (2017) (BusinessInsider.com) - BEN BERNANKE: Here are some tweaks to my earlier work on Japanese monetary policy ("Monetary policy in Japan became much more aggressive in 2013, following the election of Shinzo Abe and his appointment of Haruhiko Kuroda as governor of the BOJ."
- Burger, Dani (June 15, 2017) (Bloomberg) - The U.S. Stock Markets Belong to Bots.
- The Heisenberg (June 15, 2017) (Seeking Alpha) - Skynet Becomes Self-Aware.
- Irwin, Neal (Sept. 24, 2012) (Washington Post) - Is QE3 working? What the markets are telling us about the Fed's move ("So, while it's clearly true that quantitative easing can boost the stock market and thus increase Americans' wealth, it is too soon to determine how much of the summer stock rally can be laid at the feet of Bernanke and company").
- Kolakowski, Mark (June 19, 2017) (Investopedia) - How Robots Rule the Stock Market ("only 10% of trading volume now comes from human discretionary investors" (per data from JPMorgan Chase & Co. cited by Bloomberg)).
- Minkoff, Yoel (June 14, 2017) (Seeking Alpha) - Death of the human investor? ("Quantitative investing based on computer formulas and direct trading by machines is leaving the traditional stock picker in the dust and now dominating the markets") (Linking to Evelyn Cheng, June 13, 2017, CNBC)).
- Nanda et al., (2015) (ZeroHedge.com) - The Fed Is Now Frontrunning Value Investors (We believe that value investors get paid to underwrite the risk associated with paradigm shifts). (By quickly riding to the rescue, the Fed is effectively front-running value investors).
- Priluck, Jill (2015) (The New Yorker) - When Bots Collude (excerpt "In a working paper published by the University of Oxford Centre for Competition Law and Policy, the researchers Ariel Ezrachi and Maurice E. Stucke explain ... the potential for price-fixing by 'smart machines,' which are programmed to achieve an outcome that they pursue via self-learning and experimentation. Evidence of intent would be difficult to establish in both types of cases, especially ones involving smart machines [PEABODY COMMENT; the other case suggested by Ezrachi & Stucke is where algos are designed as 'predictable' market agents that reach tacit agreement on market conditions that results in 'conscious parallelism' that leads to higher prices").
- Roberts, Lance (2017) (Seeking Alpha) - Animal Spirits Are A Late-Stage Event ("Unfortunately, despite the massive expansion of the Fed's balance sheet and the surge in asset prices, there was relatively little translation into wages, full-time employment, or corporate profits after tax, which ultimately triggered very little economic growth").
Smith, Charles Hugh (2014) (Seeking Alpha) - How Debt-Asset Bubbles Implode: The Supernova Model Of Financial Collapse.
- Smith, Charles Hugh, (2010) (Seeking Alpha) - The Capital Trap That Is Chinese Real Estate ("Once the cash has been dumped into the black hole of illiquid real estate, it cannot escape; as with physical black holes in space, there is an event horizon beyond which the capital cannot be recovered").
- Yankee Group, (2007), SeekingAlpha.com, Are Quants 'Blowing Up' the Financial Markets?
- ZeroHedge.com (2014) ("Tyler Durden") - High Frequency Trading: All You Need To Know ("So the bottom line: HFT is legal frontrunning... but also so much more. In fact, like the TBTF banks, HFT itself has become so embedded in the topological fabric of modern market structure that any practical suggestions to eradicate HFT at this point are laughable simply because extricating HFT from a market, which indeed is rigged not only by HFTs at the micro level but also more importantly by the Federal Reserve and global central banks at the macro, is virtually impossible without a grand systemic reset first").
- ZeroHedge.com (2015) ("Tyler Durden") - Fed Finally Admits Frontrunning Of Central Banks Is What Moves Market.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.