Early and Wrong??

In my post of Sunday, January 29, 2012 Is Anyone Thinking About Japan I wrote, "Let's keep our eyes on the East, Japan and China in particular, for clues to the next phase of the financial crisis." Eighteen months have passed since that observation and nothing too dramatic has happened yet in Japan or China that would, in isolation, constitute a threat to the global unrecovery.

The highly interdependent second and third largest economies of the world are going in opposite directions in order avoid or to postpone the inevitable economic pain that is inherent in cyclical and secular adjustments. The actions of both countries have contributed to increased volatility in their respective financial markets and economies, which of course are connected to other financial markets and more importantly, to other economies. 

Japan is attempting to stimulate and inflate to devalue and to reduce, in real terms, its unsustainable debt load. The BOJ is engaged in one of the greatest monetary policy experiments ever seen of which the medium and long term outcomes and consequences are anything but certain. 

The PBOC is allowing, if not causing, tight monetary conditions in order reign in runaway credit creation by non bank entities which threaten the health, stability and sustainability of centrally planned economic growth.  The chinese "economic miracle" has resulted in badly misallocated capital and the authorities are trying to address this problem though moral suasion and limits to short term funding for non banks.  China would like to rebalance its economy with a growing emphasis on domestic consumption over exports and capital formation. Here, like in Japan, the outcome and consequences of these policies is highly uncertain.

When central bankers and central planners meddle in financial markets and market economies (or quasi market economies) they pervert the price discovery mechanism and distort the risk and liquidity premiums that are fundamental to the efficient allocation of capital and resources. In the near term interventionist policies can alleviate some pain or create apparently favorable market conditions (QE induced rallies) but in the longer term these policies create complacency at the cost of superficial and incomplete analysis of underlying micro and macroeconomic activity and risks.

I'll speculate that fundamentals eventually will matter again and when they do it will be imperative to have estimated how much systemic risk, because of the mispricing of risk, has been created by manipulative policy.  Start your (independent) analysis early.  Where are we? How did we get here? Under which conditions are the current  risk premiums and valuations sustainable? And most importantly how much can I lose if I'm late to the party and wrong?