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The Appetite for Risk is Abating...



Recently I was corresponding with a sharp macro analyst and wanted to share some comments I made to her since they encompass themes we have discussed frequently here in the 'Ville.

Follow this meme and let it marinate in your head:

A US dollar based credit bubble affects the risk appetites for all dollar-denominated products in which speculators can, well, speculate. Thus, stocks, corporate bonds, Mortgage-Backed Securities, currencies and, yes, commodities, both soft and hard.

My contention is that it is not supply and demand from China/Asia/elsewhere that is primarily fueling commodity speculation - it is simply a massive USD-based credit boom. In a world awash in dollars, anything that can be speculated on in USD will be. The aggregate risk appetite - irrational as it may be (thank you Dan Kahneman and Amos Tversky) - is the motive, the USD credit boom is the means. The result is gold at 18-year highs, the CRB index near all time peaks, stocks, spreads, etc. all doing what they have done best: get riskier in the face of clearly mounting fundamental problems. The problems are moot; until, and unless, the appetite (risk-seeking behavior) and the food (USDs) diminish (even marginally) the whole process can continue ad infinitim.

But here is the interesting part. Our work is starting to suggest - strongly - that the motive, the appetite for risk seeking, is abating across the spectrum of real economic activity, and starting to abate in the 'speculative' realm. Simultaneously, 'real' (that is Austrian) liquidity is plummeting; the means - USDs - are getting fewer and fewer with which to speculate. Both of these processes have been underway since early fall in a measurable way.

And here is the subtle part. With the means (USDs) and the motive (risk-seeking behavior) in retreat, particularly 'hooked on credit' specs are now looking for derivative (that is secondary) sources to fuel their risk-taking. Enter the Yen carry trade.

We believe that is why we have seen the yen short positions we have seen. Importantly, it argues for more of the same once the yen trade gets crowded: a tertiary source of fuel to speculate will then be sought (Euro?). The entire process...from USD to yen to (Euro?) terminal. Why? Because the motive is weakening; risk AVERSION is becoming de rigueur (or perhaps risk seeking is exhausting - the effect is the same).

They are rifling throough the means like a gambling addict at the Palms; from their MasterCard to their Visa to their debit card.

The process eventually ends. With the USD and Yen behind us as sources, the candidates left are few.

The end is nigh.

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