"Collapse is recurrent in human history.."
“Collapse is recurrent in human history; it is global in its occurrence; and it affects the spectrum of societies from simple foragers to great empires. Collapse is a matter of considerable importance to every member of a complex society, and seems to be of particular interest to many people today. Political decentralization has repercussions in economics, art, literature, and other cultural phenomena, but these are not its essence. Collapse is fundamentally a sudden, pronounced loss of an established level of socio-political complexity.
“A complex society that has collapsed is suddenly smaller, simpler, less stratified, and less socially differentiated. Specialization decreases and there is less centralized control. The flow of information drops, people trade and interact less, and there is overall lower coordination among individuals and groups. Economic activity drops to a commensurate level, while the arts and literature experience such a quantitative decline that a dark age often ensues. Population levels tend to drop, and for those who are left the known world shrinks.”
“Sir, ‘Can the Fed prevent Japanese-style deflation, a period of falling prices associated with economic stagnation, from taking hold ?’ is a common refrain nowadays.
“The US Federal Reserve’s obsession with Japan is pretty disastrous. First, Alan Greenspan opened the taps wide for too long, fearing Japanese-style deflation, which fuelled the housing bubble that led to the recent financial crisis. Now, fearing the lost decade plus, the Fed is probably going to keep easing until some different but unpleasant outcome is the result. Stagflation perhaps, or hyperinflation ?
“This is so ironic, because for so long people have sneered at the Japanese for their inability to steer their economy to recovery. Perhaps because they have sneered so much, it is no longer possible to admit that after a huge housing bubble bursts, there is nothing to do except suffer many years of economic indignity.
“The fixation with Japan was not helpful during Mr Greenspan’s watch, nor, I fear, will it be of much use this time. The Japanese may be different, but they were not stupid.”
As with so many things in modern culture, the Japanese got there first. Quantitative easing, effectively the last throw of the dice on the part of desperate central banks, is a policy that originated in Japan. The Bank of Japan adopted the practice in March 2001, in response to a financial crisis that erupted over a decade earlier. (Japan’s stock market had peaked in 1989 – the Nikkei 225 index having topped out at 38,000 in December of that year. After a major property and stock market bubble during the 1980s, Japan’s markets crashed. For the next quarter of a century, Japan would wrestle with a deflationary crisis that would go on to crush prospects for growth, listed equity valuations and bond yields. Japan is still dealing with that economic legacy. The inevitability of Mr Ito’s conclusion, cited above, turns out to have been grimly correct. But during and immediately after banking crises, there are no free marketeers. The Japanese monetary malaise, with an attendant policy of negative interest rates, has now managed to infect much of the rest of the developed world.) So for a four-year period the Bank of Japan bought government bonds from commercial banks and flooded those banks with liquidity. The BoJ would subsequently extend its programme to the purchase of asset-backed securities along with listed stocks. The intention was that commercial banks would use this new liquidity to extend loans to the private sector and stimulate the Japanese economy.
Richard Koo, Chief Economist of the Nomura Research Institute has this to say about Japanese QE:
“At the risk of belabouring the obvious, imagine a patient in the hospital who takes a drug prescribed by her doctor, but does not react as the doctor expected and, more importantly, does not get better. When she reports back to the doctor, he tells her to double the dosage. But this does not help either. So he orders her to take four times, eight times, and finally a hundred times the original dosage. All to no avail. Under these circumstances, any normal human being would come to the conclusion that the doctor’s original diagnosis was wrong, and that the patient suffered from a different disease. But today’s macroeconomics assumes that private sector firms are maximizing profits at all times, meaning that given a low enough interest rate, they should be willing to borrow money to invest. In reality, however, borrowers – not lenders, as argued by academic economists – were the primary bottleneck in Japan’s Great Recession.”
Ben Bernanke himself, shortly before leaving office at the US Fed, observed with a type of pomposity that only an economist could possess, “The problem with QE is it works in practice, but it doesn’t work in theory.” But there is, of course, no counter-factual. We will never know what might have happened if the world’s central banks had elected not to throw trillions of dollars at the world’s largest banks and instead let the free market work its magic on an overleveraged financial system.
The Japanese experience casts a long shadow. It is sometimes difficult to appreciate just how much psychological, let alone financial, damage Japan and its investors have endured since the collapse of its late 1980s ‘bubble economy’. One estimate has it that, in terms of the subsequent loss of wealth suffered by domestic property and equity prices, the Japanese economy was effectively hit by the equivalent of not one but two American Great Depressions. Given that measures like GDP growth and unemployment held up in Japan remarkably well over the period in question, and that Japanese society never once threatened to disintegrate into lawlessness or violence, you have to wonder whether the West can only dream of the level of stoicism that the Japanese have displayed. (Given the pace at which the West appears to be committing fiat homicide and green econo-suicide, perhaps we will soon all find out.)
Years of QE, ZIRP and now rising interest rates leave financial markets globally, however, in a condition that can, in early 2023, fairly be regarded as extremely risky. Perhaps “risky” is itself not the most accurate adjective. Consider this presentation by Gerd Gigerenzer, director at the Max Planck Institute for Human Development and Director of the Harding Centre for Risk Literacy in Berlin. Mr Gigerenzer distinguishes between risk and uncertainty, as follows:
RISK: How should we make decisions when all relevant alternatives, consequences, and probabilities are known? *requires statistical thinking.
UNCERTAINTY: How should we make decisions when NOT all alternatives, consequences, and probabilities are known? *requires smart rules of thumb (heuristics) and intuition.
How best to describe financial markets ? Modern portfolio theorists would describe them as risky. We would describe them as acutely uncertain. In this interview between Gerd Gigerenzer and Michael Covel, the following magical phrase pops up:
“The art of knowing what one doesn’t have to know.”
Since we are all drowning in information but starved of knowledge, it helps to be able to filter all the myriad distractions of ‘Finance World’ and crass legacy media newsflow down into a circle of core investment competence and then never depart from that circle. For ourselves, that circle of competence comprises three types of assets:
As you may know, we also manage bespoke investment portfolios for private clients internationally. We would be delighted to help you, too. Because of the current heightened market volatility we are offering a completely free financial review, with no strings attached, to see if our value-oriented approach might benefit your portfolio -with no obligation at all:
Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’. You can access a full archive of these weekly investment commentaries here. You can listen to our regular ‘State of the Markets’ podcasts, with Paul Rodriguez of ThinkTrading.com, here. Email us: email@example.com
Price Value Partners manage investment portfolios for private clients. We also manage the VT Price Value Portfolio, an unconstrained global fund investing in Benjamin Graham-style value stocks and specialist managed funds.
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