Gary Kasparov, Deep Blue, and Jerome Powell Walk into a Bar
Sep 16, 2022
In 1997, the world of chess reached a tipping point. It was then that IBM’s Deep Blue beat world champion Gary Kasparov in a six game match under tournament conditions. It was the first time in history that a computer beat a human and ever since, the mass computational power of computers has reigned supreme over any one individual player. We can learn a lot from that event.
Markets are essentially massive computers. The more liquid the market, the more advanced and efficient it is in pricing. No one person can outsmart it. No one person can consistently predict it. No one person can match its efficiency. So why then do we continue to believe one person or small group of people in a multi-trillion dollar market are actually responsible for setting interest rates?
There is an interesting aspect to the bond market, unique from all other tradable assets. We tend to quote bonds based on interest rates, despite them trading in dollar values. Therefore, when the Fed comes out and says something to the effect that they will set rates at 2, 3 or 4%, we don’t think much beyond that. However, interest rates are based on bond prices, therefore, when the Fed says rates will be a certain level, they are effectively setting the price for bonds. They are asserting a form of price control if we are to accept the Fed actually sets rates. Therefore, ask yourself, if the Fed told you how much bonds are worth in an open market, would any of us accept that? If so, why would there even be a need for a market?
It’s time we recognize the Fed for what they actually do and don’t do. What the Fed can do is act as a liquidity provider. Much like they did after the housing crisis, they can pump money into the economy. Or conversely, they can take money out of the economy. However, where that money goes once it’s in the system is up to the market. The Fed may hope their actions lead to certain goals with respect to interest rates, but the market is the one ultimately making that call.
Evolution takes place at an accelerating pace. In 1996, Gary Kasparov tied Deep Blue when they played their first chess match. Just a year later, computational power overcame the abilities of one person and we haven’t looked back. The collective wisdom and efficiency of the market is greater than that of any of person or small group of people. The notion that interest rates and by extension, bond prices themselves can be controlled, is antithetical to the very existence of a liquid marketplace.
It’s time we make the change to accepting the Federal Reserve as a liquidity provider and nothing more. Markets set prices and those prices translate to rates. Just like people made Deep Blue, people also make markets. That computers and markets are more efficient is okay. It means we’ve played an active role in accelerating efficiency and that is a good thing.
Special Projects writer Josh Fabian contributed to this article.
Did you see this week's episode of Truth or Skepticism, We (almost) Solved The Fed's Biggest Problem? Check it out.
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