In 1988, Yellowstone National Park went up in flames. In the worst catastrophe in the history of U.S. National Parks, nearly 800,000 acres of forest and surrounding areas were scarred by the uncontrollable blaze. The root cause of the inferno, as Mark Spitznagel recounts in his book The Dao of Capital, was fire suppression:
“The spread of fire-suppression mentality can be linked to the establishment of forest management in the United States, such that by the early 1900s forests became viewed as resources that needed to be protected - in other words, burning was no longer allowed. The danger of this approach became tragically apparent in Yellowstone, which was recognized by the late 1980s as being overdue for fire; yet smaller blazes were not allowed to burn because of what were perceived to be risks that were too high given the dry conditions. And so smaller fires were put out, but in the end could not be controlled and converged into the largest conflagration in the history of Yellowstone. Not only did the fire wipe out more than 30 times the acreage of any previously recorded fire, it also destroyed summer and winter grazing grounds for elk and bison herds, further altering the ecosystem. Because of fire suppression, the trees had no opportunity or reason to ever replace each other, and the forest thus grew feeble and prone to destruction... In 1995, the Federal Wildland Fire Management policy recognized wildfire as a crucial natural process and called for it to be reintroduced into the ecosystem... Central bankers, too, could learn a thing or two from their forestry brethren.”
In recent years, every market retreat has prompted central bankers to wriggle forth with fresh promises of suppressed interest rates and projectile money creation. I remain convinced that the great “policy error” of the Federal Reserve doesn’t lie in the future; in some mistake that might be avoided by good foresight or data-dependency. No, the great policy error of the Federal Reserve is long behind us; in the misguided insistence on sustaining yield-seeking speculation, overvalued financial markets, and dramatic expansion of low-grade covenant-lite debt. The third speculative bubble in 16 years is already well-developed, and the consequences are baked in the cake.
The danger of constant fire suppression is that it fosters the illusion that the entire forest is a controllable object, while actually weakening its capacity for resilience. Likewise, the danger of relentless Fed intervention is that it fosters the illusion that the financial markets are under the tight control of monetary policy, while encouraging malinvestment that amplifies the severity of the ultimate consequences. Nothing has been learned from 2000-2002 and 2007-2009, when even persistent and aggressive easing was incapable of holding back the inevitable collapse of malinvestment. The market plunges that completed those market cycles essentially represented the mass recognition by investors that they had badly miscalculated. Each successive bubble encourages them to forget that lesson. Now, we don’t doubt that central bankers will continue their recklessness. Rather, what investors should understand is that easy money actually only supports the market when investors are already inclined toward speculation (something I’ve previously demonstrated in both U.S. and Japanese data).
Until about mid-2014, Fed actions fueled persistent yield-seeking speculation, helping to drive the financial markets higher despite historically obscene valuations (on measures best correlated with actual subsequent 10-12 year market returns), strenuously overbought conditions, and lopsided bullish sentiment. Since mid-2014, however, the speculative impact of central bank jawboning has been increasingly short-lived. The main reason for this diminished carry-through is that investors actually shifted subtly toward greater risk-aversion more than 18 months ago; a shift that we inferred from deteriorating uniformity and broader dispersion of market internals across a broad range of individual stocks, industries, sectors, and security types, including debt securities of varying creditworthiness (when investors are inclined to speculate, they tend to be indiscriminate about it).
