Can Excessive Stimulus Lead to Systemic Confidence Loss in China and/or the West?


In a previous article, we have explained that governments and central banks from all around the world are embarking on what seems to be a one-way (monetary as well as fiscal) stimulus journey and that China will most likely not exactly represent an exception. In fact, a compelling case could be made that Beijing set the tone in terms of stimulus, at least as far as the 2020 situation is concerned, with them displaying a clear willingness to throw the proverbial kitchen sink at the problem and do whatever it takes to stimulate the economy.

Other countries followed suit (with many even let’s say out-bidding China) and in light of the fact that all players are embarking on a journey involving increasingly aggressive not just monetary but also fiscal stimulus, an important question arises… the elephant in the room, if you will:

Can’t there be consequences?

And, unfortunately, the answer is a resounding yes.

Those who have paid attention to the post-Great-Recession developments will most likely be quick to point out that despite record-breaking monetary stimulus (less so on the fiscal stimulus front, with monetary stimulus most definitely leading the way) and despite many economists claiming that alarmingly high inflation was just around the corner, those fears haven’t materialized… on the contrary.

As such, why should we be concerned this time around?

In the opinion of the team, perhaps the number one aspect market observers need to understand is that economics is not arithmetic. In other words, we cannot simply keep “adding a bit more” stimulus until we eventually have excessively high inflation, only to then quickly reverse course to enough of a degree that the problem goes away. In a way, similar to controlling the flow of tap water. Once again unfortunately, things do not exactly work this way.


One word: confidence.

The name of the game is understanding that markets are not algorithms or robots. If that were the case, we could simply tweak inputs in a linear manner until we get to the desired results. However, that is not how things work because there is the, drum roll please, human element involved. As such, markets tend to be far more emotional than the average observer gives them credit for, with the business cycle making that crystal-clear. From roaring bull markets where irrationally exuberant investors make recklessly risky choices to depressing bear markets where irrationally frightened investors are too scared to pull the trigger despite ample asymmetrical opportunities being right in front of them. Again: if markets were comprised of robots, asset prices would simply move in a linear manner but that is just not the case.

The more time you spend being involved in various markets, the more you notice that the confidence element is crucial time and time again. Therefore, it oftentimes matters more what people believe reality is rather than how things “actually” stand. This state of affairs can be confirmed by a wide range of investors who were “right” about a certain trend but hopped on too early, using too much leverage. As such, by the time the market caught up and they were indeed proven correct, their capital was long gone. As the saying goes, the market can remain irrational longer than you can stay solvent.

Once confidence is gone, whether for rational or emotional reasons, the rug is essentially pulled, no matter which asset or asset classes we are referring to. From bonds and shares to currencies themselves, “value” is driven by confidence to an alarmingly high degree. This makes any kind of prediction pretty much impossible, in light of the fact that as Isaac Newton himself pointed out, predicting the madness of the crowds isn’t the easiest or more rewarding of endeavors.

This term bears repeating: “rug pull” situations.

A lot of investors make the mistake of believing that even if confidence is lost, this will happen in a gradual and controlled manner, with them having more than enough time to react and position themselves properly. What they do not realize is that when confidence is eventually lost in a meaningful way, it all becomes a bit of a musical chairs game, with everyone rushing toward the exists and… well, there not being room for all of them. In the end, those who were too slow to react realize that the music stopped and there are no chairs left whatsoever or, to put things differently, that they are left holding the proverbial bag (illiquid assets or assets at such low prices that it makes little sense to sell at that stage) and hoping for a miracle.

Make no mistake: the very same principle is valid as far as confidence in anything from currencies, to governments, to central banks and even the “system” itself is concerned. The 2020 situation itself made it quite clear that while not lost, confidence in central banks has diminished quite a bit, with the market essentially demanding that monetary stimulus is matched by equally aggressive fiscal stimulus. As such, yesterday’s heroes (central banks, for example) can easily become today’s clay giants.

Can we be certain a post-2020 systemic confidence loss moment will occur?

Of course not.

Can we “predict” when it is likely to happen?

Even less so.

What we are, however, fairly confident (no pun intended) in is that should confidence loss scenarios unfold, it would be fairly naïve to assume that we will be in for a controlled demolition. On the contrary, expecting the entire process to be chaotic is the wiser approach in our view and furthermore, we firmly believe it would be irresponsible not to take such scenarios into consideration as far as the risk assessment dimension of your strategy is concerned. As always, the team of experts is here to be of assistance with just that, simply get in touch by visiting the Contact section of our website and we will do our best to help.

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