Power & Market

These hot, lazy days of summer have investors lulled to a comfortable slumber with a foot firmly on the gas pedal. The July 25th Almost Daily Grant’s reported that BofA strategists, going all the way back to 2008, determined that “it has never cost less to protect against an S&P 500 drawdown of 5% or more over the next 12 months, as higher rates and low implied volatility and correlations have presented ‘a historic entry point for hedges.’” The folks at BofA also emphasized that market doomsday insurance is even cheaper than in 2017, when “several records for complacency, including the lowest VIX in history,” were established. 

Mark Spitznagel and his crew of traders at Universa Investments are likely buying this cheap insurance with both hands, with the intent to cash in with the stock market’s next cratering. Spitznagel and his collaborator, the much more public Nassim Nicholas Taleb are the subjects of Scott Patterson’s Chaos Kings: How Wall Street Traders Make Billions In The New Age Of Crisis. 

Spitznagel is well known in Austrian economics circles as a fan of the free market school and critic of central bank intervention. His 2009 piece in the Wall Street Journal, began “Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today.” Also, his book The Dao of Capital contained plenty of what Patterson calls “Austrian diversions.”

Taleb is a best selling author of books such as The Black Swan and AntiFragile. He recently appeared on CNBC’s Squawk Box predicting a crash. Although he did say and never claims he knows exactly when the crash is coming. He did recommend avoiding real estate and AI-related stocks. 

Patterson weaves together a very readable story of how Taleb and Spitznagel met and the frustrations of selling tail-risk hedging to a Wall Street that held the collective belief of Modern Portfolio Theory, diversification of high and low risk investments in a portfolio provides protection from an unknown market calamity. Buying deep out-of-the-money puts (right to sell at a certain price before a certain date) on exchanges is frustration drawn out for years in most cases. The puts expire worthless and Spitznagel must have the fortitude to continue implementing what is the vast majority of the time a money-losing strategy. But, when the crashes come, the returns are enormous. Meanwhile, “Universa traders found the job hard and often tedious. Coming in every day–and losing money–for years.” (emphasis original)

There are exciting episodes in the book chronicling Spitznagel’s group trading in a frenzy to cash on, for instance the 2010 Flash Crash. Universa booked a $1 billion gain on the crash which lasted a half an hour. The story of pension behemoth CalPERS terminating Universa’s tail-risk hedge in January 2020, just prior to the COVID market meltdown in March, which would have provided the California pension fund a 4,144 percent return will make CalPERS members pull their hair out.

But while the theme of the book is the future is unknowable and becoming more so, Patterson’s story wanders into Taleb’s pandemic, environmental and future of democracy predictions for a good share of the book. For Taleb fans, Patterson provides plenty of the iconclast’s views. An epidemic is the greatest risk to mankind according to Taleb. And forecasting the future is the biggest mistake people make in managing risk. Exposure and sensitivity to extreme events are what matters. 

Taleb points out that the human brain craves order and “so we impose patterns, structures, fragile frameworks onto a world constantly roiled in chaos,” writes Patterson. Taleb wrote in The Black Swan, “The more you summarize the more order you put in, the less randomness. Hence the same condition that makes us simplify pushes us to think that the world is less random than it actually is.” (emphasis original) 

Sure to annoy some liberty-loving readers is a quote of Taleb’s from twitter about the government’s response to COVID. “Libertarians’ are…incoherent,” Taleb wrote in May 2020, “they deny stores the right to require masks & constrain their freedom yet ask for freedom… Nothing to do with libertarianism: rather a collection of marshmallowbrained psychopaths and misfits taking their hatred of humanity too far.” Whoa. 

Near the conclusion Patterson writes that by late 2022 Universa was providing crash protection for $20 billion in assets. The highest in its history. With the markets screaming higher this year more protection is needed, but there are those like the gentleman running CalPERS in 2020 who must learn the hard way. 

Last week's decision by the Federal Reserve to pause on interest rates left many unanswered questions, despite reporters raising them during the Q & A session. While the average person may be skeptical that the Fed can control inflation by simply raising interest rates, it’s still a position the Fed holds onto dearly.

The problem is that Chair Powell cannot reconcile the discrepancy between (price) inflation readings surpassing the 2% target and the decision to halt rate increases to “fight inflation.”

Using their own data, he confirmed:

In May, the 12-month change in the Consumer Price Index came in at 4.0 percent, and the change in the core CPI was 5.3 percent … Nonetheless, inflation pressures continue to run high and the process of getting inflation back down to 2 percent has a long way to go.

And eventually, he went on to say:

Inflation has not really moved down. It has it is not so far reacted much to our to our existing rate hikes. And so we're going have to keep at it.

Much can be said about the futility of doing the same thing over and over again and expecting different results. In the Fed’s case, it’s the hope that the rate hikes which began last year will somehow work this year and beyond.

The Fed's decision to pause rates triggered a wave of reasonable inquiries, such as:

I'm curious what gives you and the Committee the confidence that waiting will not be counterproductive at a time when the monthly pace of core inflation is still so elevated?

Followed by another reporter who asked:

… what's the value in pausing and signaling future hikes versus just hiking? … So why not just rip off the Band-Aid and raise rates today?

The Chair’s responses to these questions lacked clarity. On one occasion, he said the focus was on "determining the extent of additional policy firming," while at other times, it became a matter of speed, saying "it's common sense to go a little slower" in the current circumstances.

Nonetheless, where he struggled to articulate the process, he excelled in explaining the outcome, showing strong conviction, and providing assurances that everything will turn out fine. In his own words:

But we have to get inflation out of 2 percent, and we will.

Reiterating to the world:

… we're committed to getting inflation down. And that's the number one thing.

As far as policy is concerned:

At the same time, our main focus has to be on getting the policy right. And that's, that's what we're doing here and that's what we'll do for the upcoming meetings.

Powell's tough sell came to an end, marked by the customary evasion of the real issues and the promise of further data review and deliberations. All of this is aimed at reassuring us everything will be fine because the appropriate policy will be implemented. However, the details of how this works remain unclear, placing significant reliance on both public trust and ignorance.

While the Fed maintains that the current stance is a temporary pause, followed by rate hikes, it is worth remembering that neither a pause nor a hike will carry much weight once rate cuts make a comeback in the not-too-distant future.

Everyone is blaming Jerome Powell for something these days, like the stock market selloff that followed the Fed Chair’s testimony to Congress this week. But do these critiques suffer from a lack of depth? On Wednesday, Fortune published an article showing how mainstream academics view the Fed. Various quotes foreshadow what the general public is up against, starting with the headline:

‘It really shouldn’t be this way’: Top economist Mohamed El-Erian blames the Fed for bad messaging and stock volatility

According to Fortune, this “top economist,” was quoted saying:

Yet once again remarks by Federal Reserve Chair Jerome Powell fueled considerable volatility in markets that could risk both economic well-being and financial stability.

El-Erian continues:

Rather than overwhelmingly pricing in an increase of 25 basis points as previously signaled by the Fed, the markets moved the odds in favor of 50 points, which would reverse the downward shift in hikes the central bank prematurely made just a month ago.

More experts are cited. According to the head of Citadel, Ken Griffin:

The variance of the message over the last couple of weeks has been incredibly counterproductive.

The article’s author also gives a fool's hope to coming out of this crisis without a recession, thanks to remarks made by the Fed:

Historic data also points to how recessions have rarely been avoided after interest rates touched levels as high as they are currently. It’s possible that the Fed defies that, according to Philip Jefferson, a member of the Fed’s Board of Governors.

Per the Governor, “the current situation is different” because now we have:

… supply chain disruptions, a drop in the number of people working or seeking jobs, the Fed’s increased credibility to fight inflation, and its concerted efforts to reign in on high inflation rates.

One of the problems is that taking economic advice from a mainstream economist, a billionaire hedge fund manager, and a Fed board of governor is akin to writing a research paper about an experimental drug funded by a drug company; one should be wary of bias. These three individuals all have a strong vested interest in keeping the current central banking system running for as long as possible.

The comments made by El-Erian are highly superficial, and ignore the inherent problem, the Fed's very existence, and its ability to move markets with just one policy decision or even just a simple comment. At best, mainstream economists will talk about the Fed hiking rates too slowly, or too little too late, but they’ll never talk about the Fed being the culprit behind the depreciating currency, destruction of price signals, or how it benefits the rich over the poor.

As for Ken Griffin whose net worth fluctuates on a daily basis in and around $32 billion, it's safe to say his primary concern when it comes to central bankers is their ability to help his portfolio. His life has undoubtedly been enhanced due to the Fed’s easy money policies.

Meanwhile Governor Jefferson is likely compromised since he is literally on the Fed’s payroll, and the Fed doesn’t care much for intellectual diversity. His supply chain argument ignores disruptions due to the increase in the supply of money and credit. Plus, it’s now several years since lockdowns. Blaming the labor market also could use more depth, but they’ve hardly gone into this. Lastly, his notion that the Fed has more credibility now and is also more concerned with fighting inflation is a terrible slight since it diminishes the credibility of his predecessors.

Mainstream media falls under the same State apparatus who cares little for a voting age population who understands economics, central banking, currency debasement, nor how the Fed causes the problems it claims to solve. Ultimately, Powell testified to Congress, then a few wealthy and powerful people levied superficial shots. Nothing meaningful was shared to the public since no one at the top wants to do what needs to be done: Stop the Fed once and for all.

We just concluded a national, state and county election season where crime and economic volatility were at the forefront. These issues are likely to occupy the minds of voters in municipal elections across the country this year.

Staying strapped

Though economic stability is more important to public safety than it’s often given credit for, it’s not quite the deterrent as a perp knowing that the good guys can protect themselves. A recent altercation here in San Antonio is a good example.

While working in a smoke shop in my area of town, a clerk was confronted by a would-be thief who entered the store and hopped the counter. No doubt a startling turn of events, the clerk was ready.

The failed robber was later found wearing bullets from the clerk’s gunshot as change for the business he actually got at the store.

We Americans are blessed to have the human right to defend ourselves enshrined in the constitution. Guns are however, admittedly intimidating. There’s no playing around with them. As such, many people choose not to carry, or even own them, and that’s OK. That’s their prerogative. 

But none of us should allow hypocritical politicians to pack heat, or have taxpayer-funded bodyguards, while they turn around and restrict how we protect ourselves. And it’s not only that we’re protecting, but also our freedom.

That’s a notion that has proven far more fragile in public officials’ hands in the last few years than previously imaginable.

Freedom

When we’re born, there’s a world of opportunity before us. Unfortunately, that starts to erode once we’re ready for kindergarten. 

The vast majority of us are limited to one degree or another, to attending the closest K-12 schools that take our property taxes for funding. While wealthier families are able to eat that bill and send their kids to private schools, or homeschool them, too many of us are stuck in low-performing schools.

In adolescence, kids are then hindered from entering the workforce by measures like the minimum wage. An employer cannot afford their lack of marketable skills at the government-mandated rate. Therefore, the opportunity for young, prospective employees is delayed.

And that’s just one government impediment: employment taxes, mandated leave, favoritism shown to bigger competitors, etc. This reached a natural conclusion, in brutal fashion, with the lockdowns of recent years.

When we face this constant barrage of regulations and taxation, the cost of choosing a life of crime goes down. People may not think about it in those terms. However, when this way of life is ingrained almost from day one, how can they be expected to? 

Many criminals are simply bad apples, but government creates its fair share, too.

Policy

More immediately problematic is making the cost of actually committing a crime lower. That is the effect some portions of “cite & release” programs have. 

Imagine two children playing with their toys. one walks over to the other and snatches a doll out of her hand. The parent responds in one of two ways: the aggressor gets a “verbal warning,” or is put in a corner after being scolded. 

Which reaction is more likely to result in a repeat offense, and which one is more likely to end up with better behavior?

Stealing a few hundred dollars’ worth of merchandise, or running off without paying computer repair, shouldn’t result in the same penalties as assault, murder, etc. But when the perpetrator spends no time behind bars or is not compelled to make his victim whole again, we’re likely to see more aggressions. 

Even if such policies persist, we should give more thought to simply increasing law enforcement.

A lean police force

A key to any peaceful, prosperous society is an enforceable rule of law, and the protection of property rights. A disciplined police force has a part to play.

A police presence gives many citizens, regardless of demographic, peace of mind. It allows them to go about their business, engage with others socially and/or commercially. When and if things go sideways however, we’re our own first line of defense (see above).

Ideally, the police are there to deescalate and investigate. It’s important here to remember that they are under no constitutional duty to protect us. The events in Uvalde were a stark reminder of this.

That’s just one reason we should be cautious when calling for more police officers, especially when some police chiefs say they’re well-staffed already.

Moreover, to the extent that opposition to (recent) council policies exists, do we want greater enforcement of them? As pro-government forces fatten the budget, milk the taxpayer and expand the city’s reach, do we want to contribute to and enable that? 

Like the citizenry they serve, most police officers are solid folks. What happens though, when they’re replaced by more “mental health” officers? We’d end up living out the movie “Demolition Man,” with future governments putting the muscle behind tax collection to they make sure to get theirs.

In a way, this implicitly signals surrender on trying to correct criminal behavior at its source. 

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We do our best by our kids. We rightfully see them as an opportunity to make society better. We correct bad behaviors. We educate them. We make sure they’re respectful. 

It’s inevitable however, that some tragically fall through the cracks, and are then more likely to veer off onto the wrong side of the tracks. This is where we have an opportunity to step up.

Mentoring or fostering kids can make a difference. Some heroes go so far as to navigate the adoption process thicket to give kids in troubled circumstances a new life. It doesn’t even have to go that far. 

Some families with a gaggle of their own to look after have an open-door policy where their kids’ friends can come and go almost at will. If these friends have issues they’re trying to escape from, a welcoming, harmonious household can show them the possibilities and offer hope.

We need to start digging deeper to radiate that harmony more broadly, rather than deal with the predictable outcome of giving policymakers more power.