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A NEXIALIST N+E+W+S FEATURE: Blowing Bubbles
from L. Reichard White
Do you like the "A-ha!" experience?
Alan Greenspan (excerpts from Jackson Hole, WY speech, Aug. 27, 1999: The value ascribed to any
asset is a discounted value of future expected returns, even if no market participant consciously makes that calculation. ...
On such judgments of value rest much of our economic system. ...But history suggests that they also reflect waves of optimism
and pessimism that can be touched off by seemingly small exogenous [external] events.
The translation of value judgments into market prices is, of course, rooted in how people discount uncertain future outcomes. An
individual's degree of risk aversion may vary through time and possibly be subject to herd instincts.
It has become evident time and again that when events are unexpected, more complex, and move more rapidly than is the norm, human
beings become less able to cope. The failure to be able to comprehend external events almost invariably induces fear and, hence,
disengagement from an activity, whether it be entering a dark room or taking positions in markets. And attempts to disengage from
markets that are net long--the most general case--means bids are hit and prices fall.
We live in what is, for the most part, a stable economic system, where market imbalances that produce unusual outcomes almost
always give rise to continuous and inevitable moves back toward longer-run equilibrium. ...
But from time to time, this process has broken down as investors suffer an abrupt collapse of comprehension of, and confidence in,
future economic events. It is almost as though, like a dam under mounting water pressure, confidence appears normal until the
moment it is breached.
... the violence of the responses to what seemed to be relatively mild imbalances in Southeast Asia in 1997 and throughout the
global economy in August and September of 1998 has illustrated yet again that the adjustments in asset markets can be
Risk aversion in such an instance rises dramatically, and deliberate trading strategies are replaced by rising fear-induced
History tells us that sharp reversals in confidence happen abruptly, most often with little advance notice. These reversals can
be self-reinforcing processes that can compress sizable adjustments into a very short time period.
We can readily describe this process, but, to date, economists have been unable to anticipate sharp reversals in confidence.
Collapsing confidence is generally described as a bursting bubble, an event incontrovertibly evident only in retrospect. -Federal Reserve Chairman Alan Greenspan, "New
challenges for monetary policy," Jackson Hole, Wyoming August 27, 1999
James Dale Davidson & Lord William Rees-Mogg: This view [that the world economy still faces a
second and deeper stage of depression to come] may seem extreme and unwarranted. But exactly the same thing would have been said
in 1930. The leading economists of that day saw no hints that the economy was about to take a deep dive. It would be easy to
assume that this failure to forecast was due to a lack of knowledge that economists now have well in hand today. Not so. In fact,
even contemporary mainstream economists, using current forecasting techniques, were unable to predict the 1931 downdraft
retrospectively. This was reported in an atricle published in 1988 in The American Economic Review. -James Dale
Davidson & Lord William Rees-Mogg, The SOVEREIGN INDIVIDUAL, (New York, NY: SIMON & SCHUSTER 1997), p.17 & 18
"Prediction is very difficult, especially of the future." -Yogi Berra
Recognizing what actually happened isn't so easy either ....
At the end of 1929, the New York Times looked back on the year to identify its
biggest story. It was Admiral Byrd's trip to the South Pole. ... The smartest reporters in the world could not see the importance
of the stock market crash in 1929. ...
The economy had already turned down in August 1929. It was many months later, after the crash, after the Suckers' Rally,
after a slow year with no recovery, after the banks started to collapse, that people began to realize what had hit them. By then,
it was too late to prepare adequately.
... Even recognizing that a slump is underway is often beyond the vision of the authorities. Consider that the 1973--75 recession
began in November 1973, but, reported the Wall Street Journal, "as late as August, 1974, Arthur F. Burns, the Federal
Reserve chairman, was assuring Congress that the economy was still expanding. -James Dale Davidson & Lord William Rees-Mogg, The
SOVEREIGN INDIVIDUAL, (New York, NY: SIMON & SCHUSTER 1997), p.375
More Greenspan @ Jackson Hole: If episodic recurrences of ruptured confidence are integral to
the way our economy and our financial markets work now and in the future, it has significant implications for risk management
The problem for investors is they don't look beyond the third standard deviation:
Probability distributions that are estimated largely, or exclusively, over cycles excluding
periods of panic will underestimate the probability of extreme price movements because they fail to capture a secondary peak at
the extreme negative tail that reflects the probability of occurrence of a panic. Furthermore, joint distributions estimated over
periods without panics will misestimate the degree of correlation between asset returns during panics. ... Consequently, the
benefits of portfolio diversification will tend to be overestimated when the rare panic periods are not taken into account. -Federal Reserve Chairman Alan Greenspan, "New
challenges for monetary policy," Jackson Hole, Wyoming August 27, 1999
Why you should buy gold:
this article for this bright moment of truth: "Indonesian farmers had actually benefited during the [currency] crisis,
because their gold holdings counteracted the collapse in the rupiah." That's right. When you hold gold as your preferred form of
monetary wealth, you are a nation unto yourself. -Brown's sell-off depresses gold despite record demand, TownCrier (USAGOLD.COM
08/19/99; 08:10:40MDT - Msg ID:11516)
There's something very unusual going on in a part of the world's economy that you might not
watch closely. But it can affect you. The Bank of England announced that it going to sell a significant part of its gold reserves
Gold has traditionally been considered a reliable store of value contrasted to currency. Currency can be diluted just by printing
more of it. You can't do that with gold.
For the past decade or so, gold prices have been at historically low levels. Some holders of gold are becoming impatient with it
because it costs money to store, and produces no income. But it really shines when government printing presses start to roll.
Now let's look at what the Bank of England is doing. First, banks never advertise their movements in advance. Except this time.
Banks usually buy low and sell high. Except this time. When the Bank of England announced it was going to sell more than half its
gold for currency, paper with no value other than what's printed on it, it sent the market down further.
If you were going to sell something, you would want the highest price for it. The Bank of England is trying to drive the price of
gold down in anticipation of its selling. This doesn't make sense unless there's something going on behind the scenes.
Sorry, I can't tell you what's really going on. But I can alert you that something is going on and watch out, because it's
something big. If the Bank of England is dumb enough to sell its gold at bargain prices, we should step up and buy it. -Lionel
Waxman, SELLING LOW, Latest Flashpoint!, September 2, 1999 & thanx to Voltaire
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