Worst Case Scenario: What is It?

Mish

This article provides insight as to the way the Fed and all central banks think.

A worst-case scenario is a concept in risk management wherein the planner, in planning for potential disasters, considers the most severe possible outcome that can reasonably be projected to occur in a given situation.

The book Worst Case Scenario Extreme Edition provides hands-on strategies for surviving an elephant stampede, a 16-car pile-up, a mine collapse, and a nuclear attack. Discover how to take a bullet, control a runaway hot air balloon, break a gorilla's grip, endure a Turkish prison, free a limb from a beartrap, chased by a pack of wolves, or buried alive.

Alas, the book does not cover worst case Fed scenarios brought about by Fed policies.

Insight into Central Bank Thought Processes

The following video explains the way the Fed thought in 2006 and thinks again today regarding "worst case scenarios"

Please play the video. It's a real hoot.

The alleged "stress tests" in Europe and the US are bogus.

Currently, the ECB believes Italy will never leave the eurozone and the EU cannot break up.

The Fed does not believe they have blown another bubble.

The interesting thing is the Fed is the very purveyor of bubbles. They do not see it and never will.

The result is bubbles of increasing amplitude over time.

Fed Uncertainty Principle

Let's do another flashback,. This time to April 3, 2008 to my article Fed Uncertainty Principle.

Most think the Fed follows market expectations. Count me in that group as well.

However, this creates what would appear at first glance to be a major paradox: If the Fed is simply following market expectations, can the Fed be to blame for the consequences?

More pointedly, why isn’t the market to blame if the Fed is simply following market expectations?

The Observer Affects The Observed

If market participants expect the Fed to cut rates when economic stress occurs, they will take positions based on those expectations. These expectation cycles can be self-reinforcing.

The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg’s Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.

Fed Uncertainty Basis Principle:
The fed, by its very existence, has completely distorted the market via self-reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed’s actions. There would not be a Fed in a free market, and by implication, there would not be observer/participant feedback loops either.

Corollary Number One:
The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn’t know (much more than it wants to admit), particularly in times of economic stress.

Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

Corollary Number Three:
Don’t expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.

Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it’s easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

Hubris

It is the height of hubris for the central banks to believe they can prevent the worst case scenario from happening when they have no idea what the worst is.

Heck, central banks cannot even see obvious bubbles.

What's the Worst?

I don't know but how about a eurozone breakup, an Italian default, and simultaneous wars with Iran and a nuclear attack on or by North Korea, all happening at once.

Even then it's easy to add to that picture with something to make things worse.

I do not suggest my worst case scenario is about to happen or even likely. Yet, Italy can easily leave the Eurozone with disastrous consequences.

There could be a war scenario with North Korea or Iran. Trump could start a very messy global trade war with the entire world.

How about a $trillion derivatives blow-up?

The Likelihood of Unlikely

It's easy to make a case that any one of the above events are unlikely, but is it unlikely that all of them are unlikely?

Is the Fed prepared? The ECB?

Certainly not. Neither the Fed nor ECB sees obvious bubbles. Neither understands that things that "can't" happen, will happen.

If you don't have any Gold, I suggest reconsidering.

Mike “Mish” Shedlock

Comments (36)
No. 1-36
stillCJ
stillCJ

Editor

Seems to me like the derivatives blow-up could be the first most likely.

RonJ
RonJ

Whether it is a worst case scenario or not, something big is coming. In November 2014, the G20 changed the rules for depositors. In 2005, the bankruptcy rules were changed, just prior to the peak of the housing bubble. The G20 knows something big is coming.

Stuki
Stuki

Aside from possibly timing, there aren’t really any scenarios worse than the one we are in and have been in since ’71. The current trajectory inevitably leads straight to a Venezuela style wipeout, then dissolution, then violence, destruction and starvation. There’s really no way around it, in any society where spoils can be, hence are being, taken from those productive, for the benefit of the idle connected.

An all out nuclear war with Putin’s Russia may get us straight to hell faster. But as long as we’re stuck with an officially controlled Fiat currency, we’ll inevitably get there in the not too distant future regardless.

El_Tedo
El_Tedo

Is there a chapter on how to survive investing in a Hussman mutual fund?

JonSellers
JonSellers

The Great Depression is the worst case scenario. A simultaneous run on the banking system. Banks collapse across the board. Main Street corporations can't get money to make payroll and buy inventory. They collapse across the board. The masses of unemployed can't buy the basic necessities, and hundreds of thousands face starvation. The Fed knows that if you stop the run on the banks, the rest won't happen. That's all they care about.

El_Tedo
El_Tedo

Deflationists: The central banks will cut down every forest on Earth and print, print, print if anything approaching a great depression returns. It will quickly turn into an inflation event.

AWC
AWC

The Fed, Congress and the Administration, not to mention Wall Street, are all lusting for a major military conflict here. At the first snap of a "loss of confidence" twig, the tanks will roll. Don't kid yourself, they see the mess they made, and war is the only thing they perceive as the perfect cop out. Again, in the interest of "National Defense," they must be granted absolute consensus by the "Governed," to right all wrongs, and preserve motherhood apple pie and the corporatocracy. Zero in on the last sentence in Mish's article up there. This isn't about making a profit. It's about survival. Book it.

AWC
AWC

For reference, google up, (or better yet, Startpage up) a search on the national debt during WWII. THAT'S what the Fed is capable of.

Ambrose_Bierce
Ambrose_Bierce

Of course of all the bad things that can happen, what really matters is what about me? GI's in Nam had the five foot rule, never let anything bad get within five feet of you, bullets snakes trip wires. This place is hell just give me five feet. So figure out your perimeter and defend it.

hmk
hmk

Bank runs unikely FDIC good up to 250k then you lose the rest. I don't know what the insurance is on brokerage accounts in case of your broker going bust but money markets can lose value but you can keep brokerage cash in insured fund. I believe the next event will be a black swan situation unforeseen. Its difficult to make predictions, especially about the future. I don't think it will have anything to do with govt deficit spending, just look at Japan they are the world champions so far and know problems there yet.

aqualech
aqualech

The worst that can happen for tha average Joe is a giant bail-in, which I believe is being set up as we speak. I think is the only rational explanation for the lenders to have allowed the debt to grow to where it is. Low interest rates facilitated the lending. A lot of the tangential craziness was just yield chasing, and not part of the fundamental plan for the banks taking the wealth.

AWC
AWC

Brokerage coverage is SIPC. It insures whatever "receipts" you hold in the account against loss, but not value.

AWC
AWC

Co-mingling in Mutual Funds is another problem, for discussion another day.

AWC
AWC

See Jon Corzine on that one.

AWC
AWC
(deleted message)

In a worst case light, my version is, in a waterfall event, will the Fed be able to fill the illiquidity hole faster than it expands? Herein lies the crux of the inflation/deflation debate. My guess is, they will create some spectacular false flag event to drag folks back in front of their TV's and away from the ATM lines.

AWC
AWC

Risk? Well, Vanguard Funds alone constitute $4,000,000,000,000.00 in "assets." Multiply that by lord knows how many Fund Groups there are, but don't bother to add in derivatives. It won't make it that far ;-}

abend237-04
abend237-04

Thank you, Mish for this superb little reminder of just how expert our experts aren't. And anyone still in this 'market' should let your eyes slide to the lower right of the screen where the major exchange nums are scrolling by; I believe we'll all have an opportunity to see those numbers again, too.

msurkan
msurkan

There is nothing "uncertain" about the Fed and it's policies. The Fed acts in a completely rational and predictable fashion, of ALWAYS kicking the can down the road whenever and wherever possible to leave for the next unfortunate administrator to deal with. The Fed is nothing more than a political machine with a great deal of influence over the economy. As such, the Fed will behave like ALL politicians and take the easy path of avoiding hard problems. Nothing could be more predictable.

hmk
hmk
(deleted message)

That is the entire problem with the Fed. There should be NO mandates. They were originally created to be the lender of last resort to prevent a freeze up in liquidity.

AWC
AWC

The problem with the Fed is, it controls the nations currency. The wealth of the nation belongs to the people, not the Banks or the Government. End the Fed!

truthseeker
truthseeker

Just a wild even crazy speculation that the European Union will break apart into 10 nations at some point based on Daniel 7: 23. Then a brutal king will destroy 3 of these nations and you can read what happens after that, so that I hope that all of this takes place way into the future.

killben
killben

That video is just a SMALL bit of all the inane stuff Ben Bernanke spoke from 2005 to 2008. Actually what we should do is to put it together and play it whenever he stands up to make a speech or whenever he opens his mouth. But then even after that he may still not realize what a fool he had been! After all he had the Courage to Act!!

What's the Worst?

I don't know but...

how about a eurozone breakup - definitely on the cards I would say
an Italian default - it could easily follow the eurozone break up
A global recession - likely

What to expect from the central banksters -- Oh more Courage to Act!

Mike Mish Shedlock
Mike Mish Shedlock

Editor

The problem with the Fed is there should not be a Fed

hmk
hmk

Who would be the lender of last resort in the case of bank runs and liquidity crisis.

Maximus_Minimus
Maximus_Minimus

All very good points, only a few observations. 1. I don't think there was a self-reinforcing feedback: Wall Street regularly told Greenspan what interest rates it wanted, and the maestro always delivered. 2. Holding gold when all goes south is the worst thing to do: as hunger would spread, you will be robbed or killed as soon as you show your gold. Don't count on the population that existed during the Great Depression: this time is really different.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

@sechel - was the problem in 1907 the lack of a Fed or Fractional Reserve Lending?

Mike Mish Shedlock
Mike Mish Shedlock

Editor

A liquidity crisis can only happen with FRL. That's the problem. There does not need to be, and in fact shouldn't be "a lender of last resort". That compounds the problem.

hmk
hmk

In theory fractional reserve lending done with adequate down payment and good assets as collateral works well as long as there are leverage limits and adequate credit quality. Without FRL the economy wouldn't function very well at all. I don't think this is the issue.

theplanningmotive
theplanningmotive

No Mish. From 1857 the capitalists have recognised that without central banks to pick up the financial pieces capitalism has extreme difficulty resurrecting itself. For all it's faults the FED is necessary. But this is entirely the wrong question. The right question is whether the FED this time round, already laden, has the capacity to pick up the pieces this time round.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

By definition - Free market capitalism and the Fed cannot coexist!

Stuki
Stuki

In a panic where everyone hordes all money, I can buy the world, along with everything and everyone in it, for a penny. Which is a pretty decent incentive for me to limit my hording to, at most, all my money minus a penny…..

Of course, I’m pretty confident any reader of an investment blog would whip out two pennies and outbid poor, stingy me.. And so on and so on…

IOW, the whole “hording” problem is, like all Hobgoblins invented to scare people into accepting intrusive government by their anointed overlords, entirely imaginary.

Free people left alone to maximize utility, don’t just magically freeze up and starve to death on account of weird, theoretical constructs believable only by those too dense to bother looking into the silly assumptions said constructs rest on. America went from wilderness to the Greatest Country on earth without any Fed. So, obviously, lack of a Fed doesn’t cause some form of scary, magical “panic;” on anything resembling an existential scale. Prices on speculative goods rise and fall. Those who borrowed, and lent, against presumed collateral in such goods prior to a fall, may lose their money, lose their house, lose their food, lose their life. Like people have always done. And will always do. None of which is neither here nor there.

theplanningmotive
theplanningmotive

Fractional money did not emerge in the banking system in the first half of the 19th century but from industry and bill broking and before that from goldsmith's who discounted the receipts for the gold they were hoarding. The purpose of banks was to centralise individual hoards and central banks to regulate the issuance of notes based on those hoards to prevent over lending. If you suggest that free markets and central banks cannot co-exist history has many examples of the consequences of unregulated financial markets including 2008.

Pater_Tenebrarum
Pater_Tenebrarum

The 2008 crisis had nothing to do with markets being "unregulated" - in fact, mortgage lending was one of the most regulated industries in existence at the time. It had everything to do with the Fed's pumping and blowing another bubble after the bursting of the previous bubble (the tech mania). Other forms of government intervention - such as pushing the GSEs and banks to lend to non-creditworthy borrowers - also played a major role (mainly in terms of which sector the monetary bubble-blowing ended up being concentrated in).


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