Ready Player One
The past five days have been unique as we have seen something that no one would have imagined before. A mob of retail traders (aka “WallStreetBets”), interacting on social media platforms like Reddit, and willing to “exterminate” hedge funds by forcing a short squeeze on names like GameStop or AMC. A collective frenzy similar to a group of hungry whitetip reef sharks hunting fishes in the rocks.
Rage Against the Machine?
I am not here to pass a moral judgement on whether short selling is good or bad. I do believe that it is a necessary activity to pressure mismanaged (or even fraudulent) firms, or to calm down excessive trends on capital markets. Of course, one could question the methods of some iconic fund managers – for instance those who communicate on their bets and thus create a self-fulling sell-off – but capital markets still need buyers and sellers to be able to function normally.
What is striking is not necessarily that some people got angry against short sellers, but the fact that creating the conditions for absurd squeeze on zombie companies has now become the new black. Of course, we already saw people aggressively buying shares of companies which filled for Chapter 11 (e.g. Hertz), but the power of the retail army during the past days has never been so scary.
If significant funds like Point72 suffered significant losses and needed support from authorities, it would be quite ironical, as it would remind the bail-out of LTCM in 1998, which was the beginning of the never-ending easing monetary policy that we have experienced since then.
In other words, the financial system may be now threatened by what it has contributed to create during the last twenty years. With zero rates, infinite quantitative easing, and record stimulus plans, the US authorities have unleashed a monster which is never saturated. Said differently, they have just lost control.
What is going to happen after that? Maybe, the redditors will find other targets and provoke more insane moves. Maybe they will start betting on other assets. What about commodities? Imagine the economic and humanitarian consequences if energy, materials, or food prices go vertical just because some people are playing with a huge gamma squeeze.
When will US authorities realize that manipulating money is extremely dangerous? When will the Fed stick to its mission of maintaining financial stability?
In my last posts, I already explained that ultra-dovish measures come at a cost. I cited asset hyperinflation, commodity inflation, and dollar depreciation as examples of negative externalities (see Achtung Baby and New Year Is Coming). From that perspective, the GameStop episode is another striking illustration of distortions created by infinite money printing.
The Final Countdown
The problem with nonlinear systems like financial markets is that people see no reason to worry as long as a critical point is not reached. “So far so good.” However, when that critical point is reached, it is too late to start worrying.
When do we reach that point? When does the game stop?
This is likely to occur when the Fed is forced to capitulate (i.e. raise rates and/or become more hawkish). Of course, this is not what they want right now, but as long as they continue to ignore the bubble, extreme behavior will not stop, with uncertain consequences on the financial system and the economy.
And of course, if Jerome Powell decides to step in the right direction, then the stock market will crash.
At this stage, no good can come from that. Many people have spent the past months warning against moral hazard, reminding that there is no free lunch in economics. But the Fed has chosen to ignore them, and even to call them “conspiracists”.
The countdown is on. And it there is no doubt that this clown show will end in tears.