“Those whose job it is to manage risk today tend to focus on the things to which probabilities can be attached and shrug their shoulders about everything else.” Niall Feguson, Oct. 2023. Decent note from historian Niall Ferguson in Bloomberg this month. He touches on the issue of unintended consequences and applies some familiar sarcasm to the issue: “Nobody could have predicted the Treasury market’s collapse of the last two years – apart from every critic of artificially low interest rates since John Locke.” It is a shame that he never explicitly refers to Sharpe World. Worst Bond Collapse in…

In what could prove to be a pivotal month, September saw a swath of central banks pause at what many hope will be the end of the historically swift monetary policy tightening cycle. The Federal Reserve led the pack (along with the BOE, RBA, SNB and many others) to put on hold, at least for now, further hikes in their policy rate. As usual it was all rather blandly stated in the official FOMC statement. “The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the…

In our discussions last month about entropy, we introduced the term “arrow of time”. https://convex-strategies.com/2023/08/15/risk-update-july-2023-it-will-not-work/ “Like with all things that live in non-ergodic, path dependent space, time dependence matters. Something that may be a low probability in a limited specified time horizon, is a certainty over the course of unbounded time.” “This goes back to the concept of Self-Organized Criticality, aka Sand Pile Theory. The low entropy accumulating pile of sand only appears stable. It wants to transition to its high entropy state, the post avalanche equilibrium of disorder as the sand chaotically spreads out across the table. To paraphrase…

It was a busy cycle for policymakers to close out the month. The Federal Reserve raised their Fed Funds target another 25bp, from 5.25% to 5.50%, and reiterated their commitment to battling inflation. “Inflation remains elevated.” “The Committee is strongly committed to returning inflation to its 2 percent objective.” https://www.federalreserve.gov/newsevents/pressreleases/monetary20230726a.htm We got a similar vibe from the ECB who also hiked rates by 25bp. “Inflation continues to decline but is still expected to remain too high for too long.” “The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for…

“Do you know the secret of life? One thing. Just one thing.” Curly Washburn. City Slickers, 1991. We find this a very useful, and accepted, philosophy when it comes to risk management of any activity where there is “skin-in-the game”. The real world of social domains is dominated by path dependent, non-ergodic processes. In a non-ergodic process, where time-averages diverge from ensemble-averages, the “one thing” to be avoided is that thing that we cannot recover from. In the endless array of path dependent activities that we humans undertake, there is almost always an obvious outcome that we know to avoid:…

If we ever had the means and resources to launch our own academy of finance and economic higher learning, we might dub it Common Sense University and, without question, would appoint Bill White as the Dean. “One important issue is that we have no agreed model of the interlinkages that affect how financial crises unfold, and thus no way of calculating the probability of a financial crisis. It may in fact be impossible to agree on such models since financial systems are complex, adaptive systems likely to have multiple equilibria and highly non-linear outcomes.” William White, “International Financial Regulation: Why…

What role do central banks play in such philosophical concepts as “the social contract/compact” and the “consent of the governed”? That’s a pretty big rhetorical question, even for us. Central banks are either part of or, at the very least, a creation of government. Broadly speaking, they operate on behalf of the “consent” granted government to manage the creation and control of money and credit (classically speaking, inflation). In today’s world that entails, most specifically, the oversight of fiat currency systems (ie. no longer any sort of hard currency backed by, say, gold) and fractional-reserve banking. Both of those, fiat…

Last month, in our February 2023 Update, “Sharpe World is Nefarious”, we posed this question: “If a bank loses money in accrual books and can continue to fund the losses with government guaranteed deposit support, does it make a sound? https://convex-strategies.com/2023/03/16/risk-update-february-2023-sharpe-world-is-nefarious/ Apparently, the answer is yes. Eventually. Way back in our August 2021 Update, “Self-Organised Criticality”, we laid out how we saw “solvency” as the core fragility of the system and how, much like with the assurances of the “well trained and equipped Afghan National Security forces”, assertions would be made as to the safety of the financial system once,…

“…being accommodating toward anyone committing a nefarious action condones it.” Nassim Taleb in the Prologue of “Antifragile: Things that Gain from Disorder”. We like to think that we live up to the principle implicit in the above quote. As regards Sharpe World!™, we will not accommodate it. We do not condone bad actions and practices in the worlds of economics and finance. In this spirit, we link the following speech by outgoing Bank of Japan Deputy Governor Masazumi Wakatabe. Deputy Governor Wakatabe is not a particularly relevant player in what passes currently as BOJ monetary policy and whose term is…

Way back in our June 2021 Update we noted the insistence of several central banks to stick with their historically extreme monetary policy settings, despite clear indication that their traditional metrics of economic circumstances were running at the hottest end of historical norms. We led off with this quote from the Poet Laureate of Economics, Bill White. “The Fed says it will no longer react to anticipated higher inflation but only to actual higher inflation. Yet they are failing to react to actual higher inflation because they anticipate it will decline. Perhaps the real framework is anything that justifies not…