The Anarchy Economy
So I leave the country for a week and all hell breaks loose. The Boston Marathon is bombed. The markets gyrate crazily. China, which has been growing like mad for the last two decades, announces a sharp slowdown in its growth rate in the first quarter of 2013. Gold, the ultimate hedge against instability and volatility, plummets, falling more than 13 percent in a couple of trading days. Apple’s stock, the apple of so many investors’ eyes, falls nearly eight percent during the week, contributing to a 28 percent year-to-date decline. (Here’s the ugly six-month chart.
Yes, volatility is back. The VIX, a tradable index that measures volatility in the stock market—a.k.a. the fear index—spiked more than 40 percent last Monday, only to plummet and then soar again in the ensuing days. In fact, it never really left.
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At the World Economic Forum in Davos in January, the big takeaway was that the rolling economic crises of the preceding years were contained. The global economy was poised for a year of decent growth. Global stock markets were buoyant, with America’s nosing to new records. The issues that had caused so much angst in the preceding year – concerns over America’s growth, worries over sovereign debt crises in Europe – had generally been put to rest.
Despite the tendency of economists and corporate executives to make bold, certain forecasts for the coming year, or coming two years, economic affairs generally don’t unfold in a rational, linear manner. We are constantly being presented with seemingly random events, flocks of so-called Black Swans. Underneath the most placid waters, there are vicious currents and tides, and underwater volcanoes that are constantly erupting.
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In late December – or even in late February – nobody would have predicted the procession of events that unfolded in late March and early April: the collapse of Cyprus; the apparent humbling of Apple; a sharp slowdown in China; a puncturing of a gold bubble; the rise and fall of a bizarre alternate currency called Bitcoin; Japan’s extremely aggressive move for quantitative easing in a belated, desperate attempt to spur inflation and growth; a horrifying attack on the Boston Marathon. Back then, the beard-strokers and chin-tuggers were fixated on the developments that seemed to be right in front of their faces, like the negative impact of the payroll tax and the sequester, or the prospect that the U.S. Federal Reserve might begin to curtail its easy money policies in the face of a strengthening jobs market.
Lakshman Achuthan of the Economic Cycles Research Institute notes that a great deal of economic forecasting consist of simple extrapolation from existing trends. But in the last few weeks we’ve seen a series of sharp discontinuities, events that don’t fit into an existing narrative. This volatility can be very damaging to individuals who make leveraged bets on the continuation of a strong existing trend. Like if you borrowed money to buy gold futures. Hedge fund manager John Paulson soared to prominence and phenomenal wealth by betting against subprime mortgages before the financial crisis, and then by plunging into gold after the crisis. As Bloomberg reported, the decline in gold so far this year has cost him about $1.5 billion personally. Investors in his concentrated gold fund have likely lost even more. A similar fate would have befallen those who borrowed against their homes to purchase calls on Apple stock last summer.
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April has also provided a case study in the volatility of the reputation and fame of others who rose to prominence in the financial crisis. In their best-selling book, This Time is Different, economists Ken Rogoff and Carmen Reinhardt exhaustively and dispassionately delve into the history of what happens to national economies in the wake of financial crises. Many of their findings – especially the fact that when national debt rises above 90 percent of GDP, economies slip into prolonged periods of slow growth – were seized upon as ironclad rules by the global claque of pro-austerity policy makers. Their research translated into phenomenal book sales and admiring features. But earlier this month, three scholars at the University of Massachusetts debunked several of the findings of Rogoff and Reinhardt. It turns out the original scholarship involved a crucial Excel coding error and omitted important data. With the econo-blogosphere abuzz, Rogoff and Reinhardt were forced to concede some errors and sheepishly walk back a portion of their conclusions. Pointing to a spike in Google searches for the two authors, University of Michigan economist Justin Wolfers tweeted: “first fame, then infamy.”
We shouldn’t be surprised by the shocks that routinely befall the financial markets and those who ply their trades in them. Discontinuities are part of life. In fact, each of the apparently continuous trends that suffered a fall last week was itself set into motion by a historical discontinuity. Twenty years ago, China burst from its period of self-imposed economic retardation. Ten years ago, Apple began its transformation from an also-ran PC maker to a world-beating tech titan. The changes in monetary policy after the financial crisis – another set of discontinuities – touched off the bull run in gold.
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Advances in information technology – security cameras, Bloomberg terminals, sophisticated seismic equipment – have led us to believe that we can have perfect knowledge of all the potential dangers that lurk out there, or that we can receive sufficient warning to take evasive action. And yet strange stuff happens all the time that takes investors and traders completely unawares. Worse, the IT revolution has also created a much greater capacity for humans to conjure surprising events into being.
Monday morning saw a relatively calm opening to a new week. Stocks were up a little, down a little, not doing much of anything. And yet soon after the opening, there was some strange, random, out-of-the-blue activity in the stock of one of the world’s most valuable companies. In the space of a few seconds, as Howard Lindzon of Stocktwits shows in this helpful chart, Google’s stock fell from $796 to $775. Instantly, nearly $7 billion in value disappeared, only to reappear over the next several minutes. By late afternoon, Google’s stock was trading a few points above its opening level and closed at about $800, as if the bizarre fall had never happened.
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In the financial markets, scary volatility is always with us. Especially when it seems to be entirely missing.
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