Monday, October 5, 2015

The Perilous Misperception That Central Bankers Have Mitigated Market Risk......ANOTHER PESKY FACT!

The Perilous Misperception That Central Bankers Have Mitigated Market Risk

This past 
week provided further evidence that the bursting global Bubble has progressed to a critical juncture, afflicting Core markets and economies. Ominously, few seem aware of the profound ramifications – or even the unfolding hostile market backdrop. Even many of the most sophisticated market operators have been caught off guard. There is, as well, scant indication that Federal Reserve officials appreciate what's unfolding.

I was again this week reminded of an overarching theme from Adam Fergusson's classic, "When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar German": throughout that period's catastrophic monetary inflation, German central bank officials believed they were responding to outside forces. Somehow they remained oblivious that the trap of disorderly money printing had become the core problem.

At this point, let's hope the true story of this period gets told. I'm trying: monetary policies for almost 30 years now have been disastrous, a harsh reality masked by epic global market Bubbles. AND A MAJORITY OF CITIZENS TO IGNORANT TO NOTICE OR UNDERSTAND!

It's incredible that confidence in central banking has proved so resilient, though this dynamic no doubt revolves around a single – and circular - dynamic: "whatever it takes" central banking has thus far succeeded in sustaining securities market inflation. And it's astounding that central bankers at this point are professing "It's ok to get the party going." The central bankers' beloved Party is going to get smashed.

The Fed over recent decades nurtured securities market inflation and even turned to targeting higher market prices as its prevailing reflationary policy instrument. Importantly, the Fed and central bankers later resorted to the full-fledged manipulation of broad market risk perceptions. This was a game-changer. Essentially no risk was outside the domain of central bankers' reflationary measures. As such, audacious markets could Party on, gratified that central bankers had relegated hangovers to a thing of the past.

Central banks have convinced market participants that they can ensure liquid (and continuous) markets. Markets perceive that the Fed and global central banks have the willingness and capacity to backstop securities markets. While impossible to quantify, these perceptions have become fully embodied in securities markets around the globe. Importantly, central bank assurances and market perceptions of boundless central bank liquidity are today fundamental to booming global derivatives markets.

There's a perilous misperception that central bankers have mitigated market risk. They have instead grossly inflated myriad risks – market, financial, economic, social and geopolitical. As for market risk, Trillions were enticed to global risk markets under false premises and pretense – certainly including specious central bank assurances. And there is the multi-hundreds of Trillions global derivative marketplace that operates under the presumption of liquid and continuous markets. Importantly, central bank manipulation – of market prices and perceptions – fomented the type of excesses that virtually ensures a crisis of confidence. STUPID IS AS STUPID DOES!

Individuals can hedge market risk. The broader marketplace, however, cannot effectively hedge market risk. There is simply no one with the wherewithal to shoulder the market attempting to offload risk. Yet central bankers have convinced the marketplace that do "whatever it takes" includes a promise of market liquidity. And this perception of boundless liquidity has ensured a booming derivatives "insurance" marketplace.

There's a crisis scenario that's not far-fetched at this point. Fear that global policymakers are losing control spurs risk aversion. The sophisticated leveraged players panic as markets turn illiquid. The Trillions-dollar trend-following and performance-chasing Crowd sees things turning south.Worse still, illiquidity hits confidence in the ability of derivative markets to operate orderly. In short order securities liquidations and derivative-related selling completely overwhelm the market.

It comes back to a momentous flaw in contemporary finance: Markets do not have the capacity to hedge market risk. Indeed, the perception that risks can easily be offloaded through derivative "insurance" has been instrumental in promoting risk-taking. Never have markets carried so much risk. And never have markets been as vulnerable to an abrupt change in perceptions with regard to central banker competence, effectiveness and capabilities.

Today's paramount systemic financial threat is not new. Risk is now high for a disorderly – Party Crashing - "run" on financial markets.  At the minimum, global markets will function poorly as faith in central banking continues 
to wane.

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