“Monetary policy (set by central bankers like the Fed) insidiously plays with our time preferences and our very ability to engage in economic calculation. The greater the distortion, the greater the destruction needed to correct it.” Mark Spitznagel

“Blaming wild market volatility on the ‘animal spirits’ of the herd mentality takes the focus off where it belongs: on the action of government. Instead of functioning as instruments of information, signaling to entrepreneurs how and when to best serve consumers, interest rates are perpetually manipulated by central bank actions to the point of being meaningless. Artificial interest rates become a deceptive feint by which entrepreneurs succumb to malinvestment, because they believe there are more resources (i.e. savings) in the system than there really are.” Mark Spitznagel

“I think Mr. Spitznagel’s analogy comparing our government’s forestry management to our government’s (the Fed’s) management of monetary and economic policy is simple, logical and persuasive. Based on my experience and study, I am starting to believe that the establishment economic thinkers have it wrong and that these ‘Austrian-school’ economists (and their supporters like Mr. Spitznagel and Mr. Paul) have it right. Even an establishment economist like Stanford’s John B. Taylor has made calls for more objective monetary policy and an end to the Fed’s 1977 dual-mandate (arguing to eliminate full employment and focus only on stable prices). He is essentially making an “Austrian-school” argument with these common sense proposals to end the Fed’s subjective and highly distortive monetary policy. My view is that the (well-meaning) 1977 amendment to the Federal Reserve Act, to include the ‘dual-mandate’, could (unintentionally) be one of the most important, but least understood, causes of our bubbles and busts and financial crises. And conveniently, this conflicting dual-mandate makes the Fed completely unaccountable for the results of any of its actions; because they can always say in hindsight, well ‘we were more focused on jobs’ or ‘we were more focused on stable prices’ or ‘we had to balance between the two’.” Mike Perry, Former Chairman and CEO, IndyMac Bank

Excerpts from “The DAO of Capital” by Mark Spitnagel:

 The Yellowstone Effect

 “In a natural forest (without the practice of forest management), the endless tug-of-war battle of succession for available resources is  part of an elaborate homeostatic process, whereby the angiosperms can outperform (at least at first) the competition, while the conifers take root in the out-of-the-way places, rocky and inhospitable, where few can survive. Once areas of the angiosperm forest become overgrown, they become prone to small wildfires; when fire breaks out, the land is cleared and the way is opened for the patient conifers…nature’s great fire opportunists…to reseed. This is the continuous, intertemporal turnover of the forest’s succession. Not only are wind-borne seeds brought to the fire-cleared land, but the resin-coated serotinous cones of many confer species have been opened by the flames and the intense heat of the fire. The system has natural regulators that control unsuitable growth and help to keep it balances with available resources, the ‘savings” of the forest.”

 “The fires, therefore, is not merely destructive, but must be viewed as a catharsis, a cleansing process….an agent of creative destruction…As Murray Rothbard would says, the fires ‘is the recovery process’, and, ‘far from being an evil scourge, is the necessary and beneficial return’ of the forest to ‘optimum efficiency’.”

 “Forest fire turns especially deadly , however, when smaller blazes are suppressed, creating the illusion of fire protection…..Smaller, low-intensity fires manage the forest with great expediency.”

 “Paradoxical, yes, but forestry practices of old that have regained respect of late underscore the importance of letting small fires burn in order to manage the forest, and to prevent the bigger ones that inevitably and cruelly result from attempts to stop fire. Suppression now undeniably leads to greater destruction later on.”

 “Nowhere in the history of forestry was that evil more savagely felt than in Yellowstone National Park in 1988, when nearly 800,000 acres…..well over one-third of the park….burned and/or suffered fire damage. It was a catastrophe of unprecedented proportion in the history of the National Park Service, and its root cause 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 in 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 was 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 the 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. A lattice of unwarranted and anemic growth (what was ill-seeded from the start and never had a chance of reaching maturity) became a grid that linked and transmitted the costs of the forest’s distortion to a much wider area than would have been affected by a series of natural, smaller fires over the years. It was the Yellowstone Effect.”

 Lesson From the Distorted Forest

 “The disastrous Yellowstone fire of 1988 leads to the conclusion that 100 years of fire suppression…a zero-tolerance approach to stamp out even naturally occurring, low-intensity blazes….had made the forest dangerously prone to catastrophe.”

 “In nature, as in the economy, there must be a free transfer of resources between higher-order and lower-order production. When human intervention interferes with nature’s cycles, the system’s natural homeostatic, negative-feedback forces are weakened.”

 “In 1995, the Federal Wildlife Management policy recognized wildfire to be a crucial natural process and called for it to be reintroduced into the ecosystem.”

 “As I observed in a 2011 piece in the Wall Street Journal, central bankers, too could learn a thing or two from their forestry brethren.”

 “The federal government has another ‘fire suppression policy’ that started, coincidentally, just a few years before the Yellowstone blaze, with the 1984 Continental Illinois ‘too big to fail’ bank bailout. This was followed by Alan Greenspan’s pronouncement immediately after the 1987 stock market crash that the Federal Reserve stood by with liquidity to support the economy and the financial system. In its actions in the 1980s, the Federal Reserve telegraphed the world that it would no longer tolerate fires of any size…which heralded the birth of the ‘Greenspan Put’.”

 “In the financial forests of our own making, suppression is particularly problematic…and even deadly. Excess and malinvestment thrive for a time, only to be destroyed by ravages caused by their own vulnerability. Yet, as we will see, such high-intensity ‘fires’ (of the forest and financial varieties) will free up and redistribute resources; in the case of the market, it releases capital to areas previously avoided due to the myopic distortions of monetary intervention.”

 “Central bankers and interventionists need to stop approaching the system as one driven by random shocks, because this mind-set leads them to manipulate and attempt to control the system…..a cycle that destroys far more in the long run than it saves temporarily. The longer their erroneous thinking persists, the more out of balance things become, until there is a tinderbox of malinvestment, ready to ignite in a massive, uncontrollable inferno. Density (overgrowth) and uniformity (too much of one thing…) are evidence of malinvestment in the economy, exceeding the amount of available resources. Investment cannot exceed savings any more than seeding in the forest can exceed land, nutrients, water, and sunlight…but under these interventions, the system acts as if that’s what is happening. This is what makes the boom so delusive and ultimately illusory.”

 “Here, we encounter the profound paradox that government interventions systemically achieve the very opposite of their intended goals. So governments, unlike entrepreneurs, try as they might and despite perhaps good intentions (I’ll give the Paul Krugmans of the world the benefit of the doubt), simply cannot achieve their intended outcomes by interfering with the operation of the system.”

 “Governments and central banks undermine the natural homeostatic process by short-circuiting the governors and adaptive teleological processes in the system. Suppression of the market’s natural homeostatic tendencies…such as proclaiming things to be ‘too big to fail’ or by cutting interest rates when stock markets take a dive…only make things worse by artificially propping up assets that should be allowed to fail, and free up resources for another, perhaps more productive attempt.”

 “Suppression makes the cure that much worse than the initial ill, until exponentially more damage is done…”

 “Blaming wild market volatility on the ‘animal spirits’ of the herd mentality takes the focus off where it belongs: on the action of government. Instead of functioning as instruments of information, signaling to entrepreneurs how and when to best serve consumers, interest rates are perpetually manipulated by central bank actions to the point of being meaningless. Artificial interest rates become a deceptive feint by which entrepreneurs succumb to malinvestment, because they believe there are more resources (i.e. savings) in the system than there really are. Monetary policy insidiously plays with our time preferences and our very ability to engage in economic calculation. The greater the distortion, the greater the destruction needed to correct it.”

 “The financial crisis of 2008 could have been the wake-up call that, like the Yellowstone fires of 1988, alerted so-called ‘managers’ to the dangers of trying to override the natural governors of the system. Instead, the Federal Reserve, with its head ‘ranger’ Ben Bernanke, has deluded itself into thinking it has tamped down every little smolder from becoming a destructive blaze, but instead all it has done is poured the unnatural fertilizer of liquidity onto a morass of overgrown malinvestment…making it even more flammable. One day….likely sooner than later…it will burn, and when that happens, the Fed will be sorely lacking in buckets and shovels and must succumb to the flames.”

Posted on October 1, 2013, in Postings. Bookmark the permalink. 1 Comment.

  1. This is an outstanding analogy, reminding us that we “should never fool Mother Nature.” Balance in nature as well as the financial markets is best achieved when left primarily to its own forces and cycles. As we have seen and are witnessing again, excessive intervention is delaying, and inflating, the size and pain of the next conflagration.

    Mark Nelson 3256 Sitio Tortuga Carlsbad, CA 92009 760.473.7558 mnelson.doit@gmail.com

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