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
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.
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