Currency and markets: governments are conducting a financial engineering experiment


The global economy is reeling from coronavirus shutdowns, and governments are implementing innovations that could serve as potential bailouts. Huge changes are coming, and this presents opportunities for those who are able to take advantage of them.

When engineers built the cathedrals of Europe, erecting their buildings to the glory of God, they weren’t sure if their designs would work. The economy is in this state today. As governments rack up mountains of debt, too many of these structures seem as likely to fall as the walls of Notre Dame without their ad hoc buttresses.

Globally, there have been startling economic responses from governments to fill the chasms opened up by the global shutdowns.

Quantitative easing, which ironed out the financial crisis of 2007-2009, has again been used, but it is only one of many central government “innovations” that have been rolled out. The United States, for example, handed out free money left and right, and it increased the money supply at the start of the lockdown by an annualized rate of 100%.

There is no consensus on the likely outcome of all this; the wise opinion is divided between the two on the ramifications of the governments which go “all in” to attempt an “Evel Knievel” leap over the economic abyss created under our societies. Will it be inflation or deflation?

Old-school onlookers are understandably freaked out by the scrolling wall of fresh money and giant inflation in the way; gold and bitcoin reacted accordingly. Yet the new financial engineers scoff. Printing money doesn’t cause inflation, they say. You can print as much as you want until it creates inflation, then drain the money with taxes to stop inflation in its tracks if it raises its head. This new economic architecture stems either from pride or from genius and runs the risk – in any case – of needing numerous flying supports for its buildings.

The markets go their own way on these issues and, unlike economists, the markets are always right. When they are wrong, they are always right. When they’re wrong, it’s your mistake not to understand why they’re right. Even when you’re right and the markets are wrong, it’s best to give the market the benefit of the doubt. As the saying goes, when the market is wrong, it can stay wrong much longer than you can stay solvent.

Then there is the issue of “implied volatility,” which is an options market notion. The options market is the most sophisticated market of all, where buyers and sellers negotiate the right to trade at a future time. Options is a game professionals play with math, while amateurs play cocooned in their stories. It usually doesn’t end well for amateurs.

There is a value in options, called “implied volatility,” and one can think of it as representing the gap between where the price should be and where it is. It’s a measure of the unknown unknowns, monsters the market entails are lurking out there, and the wilder the times get, the bigger those bogeymen get.

The implied volatility of today’s global economy is exorbitant.

Setting aside the unknowns about the actual path of the virus and the emerging response to it, what has happened is enough to blanket the future in a dense “fog of war” the likes of which have never been seen. than the lives of older people. .

At this point, you might expect me to write something terrible and catastrophic and you have to forgive me for my last columns, which were necessarily Cassandra-esque. Yet volatility breeds change, and change can be progress.

We need to focus on this – although change can be a double-edged sword, we need to be on the safe side and hold the gun, rather than having it attack us. Most of us are very well placed to benefit from the huge changes to come. If not us, then who?

Take heart; volatility and implied volatility do something interesting for options. This makes them more valuable. A big part of an option’s value is its volatility, as is the time between now and when it expires. As the volatility decreases and the time until the end of the option’s life gets shorter, the value depletes.

So here we are – volatilities at huge levels with a time horizon beyond calculation. Indeed, our options are rich.

You might wish for a less bumpy ride, but that doesn’t sound like an all-cost option. The devil will take over, but engineers and technologists are at the forefront.

As I write, decentralized finance – an offshoot of blockchain and cryptocurrency technology – is rapidly exploding in the financial boom and bubble of 2021. For those software engineers navigating this byzantine technical challenge and make a fortune, all the misery and chaos of our times will be but a distant detail. Recession, inflation, depression and deflation won’t even affect their lives as much as the high-pitched buzzing of a mosquito.

It’s a hard lesson to learn: no matter how tough times are, how bad the situation is, how bleak the outlook, somewhere there’s always a party going on. It is our responsibility to find it and knock on the door. If not us, then who?

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