‘Anti Fragile’

By way of John Mauldin, my inbox received these thoughts by Louis-Vincent Gave as part of an article entitled Why Are Bond Yields So Low?

Some points of interest…

An inherent level of systemic risk? Most people intuitively feel Karl Popper’s observation that: “In an economic system, if the goal of the authorities is to reduce some particular risks, then the sum of all these suppressed risks will reappear one day through a massive increase in the systemic risk and this will happen because the future is unknowable”. In other words, suppress risk somewhere and it comes back with a vengeance to bite you on the derriere at some later date. Look at 2008 as an example: we cut up credit-issuing risk into tiny parcels and distributed it across the system through securitization, only to see the banks take on a lot more leverage and ultimately sink their balance sheets on instruments they failed to understand. Hyman Minsky summed up this inherent contradiction well when he stated that “stability breeds instability”. In other words, the more stable a thing is, the temptation rises to pile on leverage, which makes that “something” more unstable on the back end.

This is the whole point, that it is permissive policy that instigates bad financial behavior (encourages ever riskier speculative activity), not that the policy itself is the culprit where the inevitable unwinding (the bust side of the boom-bust equation) of speculation is concerned.

The notion of Anti-Fragile: the above brings us to the Nassim Taleb notion of “anti-fragile”: just as a parent who overly cocoons a child prepares that offspring poorly to function in the wider world, so policy-makers intent on cushioning the private sector from every shock in the economic cycle are doing the overall system a massive disservice. By preventing the build-up of immunity, or the ability to thrive in crises (i.e., anti-fragility), policymakers sow the seed for a greater crisis down the road (hence the repeated cycle of crises).

Safe in Daddy’s arms since 2008 and now coddled and nurtured by Mommy.  There are supposedly serious commentators out there loudly lauding the idea that Ben Bernanke saved the financial system.  Well, he and now she are doing it again.  But the root elements are the same as what Greenspan did early last decade.  They have simply offloaded risk from speculators to a bond market (in this case Treasuries vs. various commercial credit vehicles in the last cycle).  Either way, the goal is risk ‘ON’ (and it is).

Lay the blame on zero interest-rate policy (ZIRP): following on the above, not only does ZIRP allow the survival of zombie companies (which drags down the returns for everyone) but it most certainly affects investors’ behavior. Firstly, by encouraging banks to play the yield curve and buy long bonds, rather than go out and lend. Secondly, because almost all investors hold part of their assets in equities and part in cash or fixed incomes. And in a world in which fixed income instruments yield close to nothing, the tolerance for pain in other asset classes probably diminishes all the more. 

In other words, get out of savings and into assets.  But when the inevitable corrections come in asset markets there is little income to be found in fixed income.  If Grandma gets chewed up and spit out in the process?  So be it I guess.