Friday, March 02, 2007

Dr. Realove learns to love the Great Unwind

In the Kubrick movie Dr. Stranglelove, the appropriately named title character explains how to love the bomb. I'd like to explain how one might come to love the Great Unwind, or as Bill Murphy calls it, the derivatives Neutron Bomb, by way of an analogy.

One of the aspects of dieting, at least in B.F. Skinner's view of how man works, that makes it difficult for the longer term obese to maintain is their conditioned love of the insulin rush and the feeling of fullness. While they don't like carrying around the extra weight, many just can't give up the desired sensation of a full belly.

Financially speaking, the powers that be cannot give up their love for "full," by which I mean, overpriced paper markets. Despite the fact that the Chinese market was up, even after the 9% decline, over 100% y/y there seemed to be a fear that any substantial decline in any context was bad. The vigor with which the Gold market was hit can be thought of, in our fat (or phat depending on one's hipness) analogy, can be imagined as a disdain for and campaign against healthy nutritious meals. Nope, no moderation allowed, if we think of Gold as money we just might have to think of money as limited.

Perhaps the adrenaline junkie's (and I have some familiarity with this affliction) need might be more appropriate as these junkies and the markets both like being "up." And just like an adrenaline junkie, the markets only exhibit risk averse behavior after experiencing pain and once the wounds begin to heal and the pain is forgotten, the need for a fix once again becomes too difficult to ignore.

But, as has been my wont of late, I'm stretching the metaphor beyond application so I'll get back on track.

One theme I was trying to describe with yesterday's Franken-derivatives essay was the notion that a derivatives collapse would be an unmitigated evil. I'm not arguing the actual collapse and immediate aftermath will be any more pleasant than the first few months of dieting is, but the ultimate effect is most desirable. Once the Great Unwind is past, as opposed to the many temporary pauses caused by financial market indigestion, only to begin anew, we will find that our markets work much more smoothly- the parasite will be brought back down to manageable, i.e. symbiotic size. One key feature will be the reduction in the ever increasing intermediation tax or "vig" levied by the financial market makers to keep their derivatives bubble inflated.

We need to stop taking lessons from Dr. Strangeloves, who wish us to love the derivative bubble and get back to a real love of a financial system that works well, by which I mean doesn't seek to create reality on its own but instead is content to be a model of what is. The virtues of a fairly priced market are roughly analogous to a truthful statement, which, as Thomas Jefferson famously opined, does not need the support of government. Neither should the market.

For now though I'll continue waiting for the Great Unwind, with precious metals in hand, not so much for the schadenfreude (although I admit there will be some of that), but for the eventual effect.

Just as a healthy eater learns to enjoy broccoli, and fruit for dessert while losing a taste for fat drenched meals, so too can financial market players and policy makers learn to enjoy stable markets and precious metals as stores of value while losing a taste for increased leverage. All it takes is alignment of the immediate mental associations with the ultimate effects, fit bodies and well functioning financial systems.

An unrelated afterthought on Kubrick: I'm a big fan of his films, and, after some reflection, especially enjoyed Eyes Wide Shut. I wonder if it was a touch of his ironic genius for Kubrick to cast Cruise and Kidman as the married leads. There was no need for them to act, they were living a life of Eyes Wide Shut, which is a metaphor with much wider application in our times or will be when the final act is revealed. I wonder if Kubrick foresaw the divorce. I'll bet he did.