Sunday, January 15, 2012

Disconnects by the decade - economics missing some big moves

It seem as though each decade faces some key risks which the markets get wrong. If you are able to forecast correctly what others miss, you will be able profit handsomely. The six decades could be characterized as the following: 

  • Underestimating fixed exchange rates - the 1960's. While Bretton Woods international financial system does not fail until the early '70's, the problems of fixed exchange rates and inflation start to develop great fractures in the global economic system during this decade. The dollar dilemma becomes evident. 
  • Underestimated inflation - the 1970's. The commodity supply shocks coupled with loose monetary policy lead to the Great Inflation and stagnation of the '70's. The destruction of fixed income investments and poor equity returns lead to a defensive decade. 
  • Underestimated the Fed's fight of inflation - the 1980's. The tight monetary policy from Paul Volcker with the deregulation revolution were the highlights of the '80's Still breaking inflation and the long bond rally made all the difference for the decade even with the '87 crash which was not a long-lasting drama.
  • Underestimated of market resilience and the Great Moderation - 1990's. The emerging markets saw large market failures in '94 and '98. The European and sterling managed floats were destroyed, but the real story was one of Moderation and success. However, the decade ended with the internet bubble. The key issue was the macroeconomic complacency that monetary and fiscal policy could solve all problems.
  • Underestimated mortgage risks, bubbles, and the Great Recession - the 2000's. The first decade of the new century was one of deflation fears which led to the mortgage bubble. Deep business cycles were thought to be a thing of the past given the views developed surrounding the Great Moderation. The end result of policy complacency was the failure of '08. 
  • Underestimated sovereign risk  - the 2010's. The current decade will be the destruction of the risk-free asset concept. The idea of market safety assets will end and a new era of financial repression will take hold of the globe.

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