In a wide range of animals, including humans, the ability to detect, observe, and immediately respond to the fear of other members is essential to survival. When a herd of gazelle run from a lion, it’s not because most of the gazelle have even seen the lion, but rather because they respond in sequence to the fear signals provided by nearby members. Some animals even respond to the behavior of other species. That essential survival response is mediated by a part of the brain called the amygdala.
In extreme cases, the fear response can lead to aggression and self-harm. One of the ways to remove the fear response is to surgically disconnect the amygdala. The procedure is known as an amygdalotomy. In mentally ill patients that experience such profound, unwarranted, and persistent fear that they become self-injurious and suicidal, amydalotomy is sometimes used as a last resort. It is not used in less severe patients, because the procedure itself makes the person more susceptible to risks that threaten survival, by blunting appropriate and adaptive responses to danger.
In my view, by aggressively intervening in the financial markets, at valuation levels that are still nowhere near run-of-the-mill historical norms, the Federal Reserve has performed an amygdalotomy on the investing public. The Fed has encouraged a maladaptive confidence that risk does not exist. This overconfidence of investors is itself a threat to their survival.
As Stanley Druckenmiller recently argued, much of the risk that the U.S. economy presently faces is itself the result of years of misguided Federal Reserve policy:
“Corporations overborrowed and overleveraged going into this. Corporations took their borrowing from $6 trillion to $10 trillion. In my opinion, this was all the result of free money, despite many, many opportunities to normalize from 2012 to 2020.
“The Fed is there to solve a liquidity problem, but is not in any way capable of solving a solvency problem. You have companies like airlines that because of the free money I talked about, they spent 97% of their free cash flow on corporate buybacks. It was common all over corporate America – financial engineering.
“Yes, it wasn’t their fault that coronavirus happened, but I’ve actually been saying for years, none of these companies are going to be able to survive in a recession, given the borrowing they’re doing, and it’s reckless.”
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