Return-free risk

Voltaire said it best: ‘Doubt is not a pleasant condition, but certainty is absurd.’ Investors seeking certainty — safety, in other words — are in for a shock: there is no longer any such thing.

How did we get into such a terrific mess? Rather than rehash the causes of the financial crisis and the current depression, there is a two-word answer: central banks. There was once a more innocent age when central banks performed a sole function: they acted as lenders of last resort to the banking system. To avert a banking panic, central banks would lend to solvent institutions, backed by solid collateral, in times of need. Note those key phrases: solvent institutions, solid collateral. They no longer really exist either. And somewhere along the line, over-mighty central banks succumbed to ‘mission creep’. In the words of veteran financial analyst Jim Grant, the US Federal Reserve, for example, now finds itself not just backstopping American banks, but also ‘steering, guiding, manipulating the economy, financial markets [and] the yield curve… it manipulates and pegs interest rates; it is all over the joint, doing what so signally failed in the old Eastern bloc.’