Inevitable Catastrophe
Insulate participants from risk with policies like the Bernanke Put and you guarantee destruction of both the market and institutional legitimacy
By Charles Smith (June 24, 2011)
Identify the
common characteristic of these three statements:
1. The Federal Reserve will never let the stock market decline, i.e. the "Bernanke put"
2. The Chinese government will never let property prices decline
3. The European Central Bank will never let Greece default
The answer of
course is moral hazard: a person who is insulated from risk will have an
insatiable appetite for risky bets because any gains will be theirs to keep but
any losses will be covered by the central bank or government. The global
financial authorities’ success in propping up assets (stocks in the U.S., real
estate in China, banks in Europe, etc.) over the past three years has
strengthened this asymmetric disregard for systemic risk into a dangerously
quasi-religious faith that central banks and governments have essentially
unlimited power to keep asset prices aloft via printing money, manipulation of
markets and financialization of their economies.
What happens if
markets crumble despite massive, sustained central bank and government
intervention? The institutions that created moral hazard will be revealed as
false gods, and that faith will be destroyed.
This loss of faith
in the transparent functioning of markets will trigger what I call the
delegitimization of both the markets and the institutions which have
essentially promised a permanent upward bias in assets.
We can see the
global scale of this central bank-cnetral State induced moral hazard in the
tight correlation of all markets: the stock exchanges rise and fall in
near-perfect unison, oil and gold rise and fall in parallel with equities, and
so on.
As I have noted
before, beneath the surface there is really only one trade in the entire global
marketplace: all assets on one side and the U.S. dollar on the other.
Correlation is not causation, of course, but it is more than peculiar that
every decline in global equities is matched by a concurrent rise in the dollar.
Transparent,
independent markets do not move in lockstep. The campaign
to prop up all asset classes with implicit guarantees of intervention has
completely insulated institutions and punters who believe that the Bernanke Put
and the Chinese government's equivalent prop under real estate is not just
policy but a guarantee of god-like power.
Thus the gains
from gargantuan speculative bets are yours to keep, and any losses will be made
good by the central bank or government. This is the ideal recipe for
misallocation of capital and speculative derangement on an unprecedented scale.
Moral hazard is
the ultimate perverse incentive: it rewards all that is unproductive and risky
and punishes long-term investment and prudent risk assessment.
A second feature
of the global central bank's moral hazard is the necessity to punish any
punters who dare to bet against the banks' manipulations. Thus Fed
Chairman Bernanke could opine that oil would decline and presto-magico, a
"surprise" release of oil by central authorities occurs the next day.
This second
feature of central bank manipulation leaves a market devoid of short sellers
and thus of any buyers as markets crumble.
Once trust is
lost, it cannot be won back. Once participants' faith in the markets and in
the god-like power of central bank intervention is crushed, the markets will
lose participation on a grand scale. The authorities' favorite game, goosing
asset prices to create an illusion of recovery and rising wealth, will be
revealed as a global fraud.
Announcements of
future interventions will be scornfully dismissed and thus they will have lost
their power to prop up the markets.
All of this flows
from the very nature of moral hazard: insulate participants from risk and give
them unlimited leverage and "free money" to play with, and what you
eventually end up with is catastrophe. There is no other possible end
state.
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