I recently read a book about the life of Beethoven, the composer, and what caught my attention was that he nearly lost his life when doctors of the time advised to cure his deafness by bloodletting! Apparently Mozart, Charles II and many others were not so lucky. Even George Washington “bled” until he died – ostensibly as a cure for strep throat.
Bloodletting was a common medical practice for thousands of years until the 18th centurye century for all kinds of ailments (here). Today, the technique is still used for some diseases, most commonly those related to an excess of iron in the red blood cells (the technique is called bloodlettingand the diseases for which it is currently used are hemochromatosis, polycythemia and porphyria cutanea tarda – I’m not a doctor of medicine, so you’ll have to look this up). So yes, bloodshed makes some sense for specific ailments. But to use it as a solution to everything, due to a lack of understanding of biological mechanisms, seems downright crazy in retrospect. But we cannot read history backwards. Given what the doctors knew at the time and given the principles of medicine (the four elements: earth, wind, water, fire), it was the optimal, perhaps the only solution known to the doctors of the time.
Fortunately, we have made medical progress. By making a patient healthy, the technique relied on the (pseudo) science of the time. In most cases, the patient’s fainting from blood loss was considered the signal to stop, hopefully before the patient fell or died. In many cases the remedy was really worse than the disease.
One theory behind phlebotomy was that many diseases were caused by an overabundance (excess) in the blood, and these could be eliminated by removing the blood. The bloodletting aids include “lancets”, “fleas” and yes “leeches”. The practice was not limited to one culture or country – on the contrary, it has been considered established medicine since historical times. And, of course, academic papers and books were written to support the practice. The practice persisted for centuries because of “the dynamic interaction of social, economic and intellectual pressures” (here).
Current economic theory and central banking seem to repeat the story in parallel, as central bank hubris and economic dogma of the day lead people to believe that excesses in the economy can be cured by asset price deflation or financial bloodshed. The Fed, and other central bankers like the ECB who blindly followed the Fed over the edge in asset purchases and massive stimulus, now seem to have decided that the only way to restore “balance” to the economic body is to to get some blood flowing, so to speak. Without admitting that they have made a colossal error of judgment and decision-making in recent years, they have now deviated 180 degrees from market-friendly policies and, come what may, have embarked on a course of stricter terms. In fact, they are now “lucky” that the markets are falling as they get tighter, and the bloodshed won’t stop until the market is close to fainting…which may happen sooner than most people expect. A major crash in financial asset prices has already occurred in 2022, as a bubble has sprung up from the excessive stimulus of recent years. But since the patient still looks healthy, the bloodshed may not stop just yet. Is there more to come, and if so, what can we do about this self-inflicted pain resulting from pseudoscience in policy making?
First, how do we know that the central banks are engaged in “pseudoscience”? As a scientist by training, I can make some suggestions (see also this excellent article).
First, pseudoscience shows a remarkable indifference to facts and in many cases uses anecdotes and personal experience instead of facts. Second, pseudoscience begins with improbable but attractive hypotheses. Third, pseudoscience refuses to put its claims to a meaningful test. Fourth, it contradicts itself. Fifth, it creates an intentional mystery where no mystery exists. Sixth, it makes extraordinary claims. Seventh, it makes a lot of use of a made-up vocabulary where terms have no definitions, unambiguous or imprecise definitions. Eighth, pseudoscientific explanations are by scenario, rather than by mechanism. Ninth, pseudoscience appeals to magical thinking. And finally, pseudoscience appeals to the criteria of the scientific method while denying its validity in the present context. We could go on… but a quick rundown of the speeches by Powell (Fed), Lagarde (ECB), and Kuroda (BOJ) demonstrates most of these facets.
Over time, and fortunately, the scientific method of creating testable hypotheses, collecting data and using common sense resulted in stopping bloodletting as a solution to most diseases. It was replaced by scientific medicine by understanding the mechanics, biology, chemistry and functional relationship of the components. A technical solution, if I may. But many generations were bled to death to get to this point.
The next time you hear a central banker tell you that they will do everything they can to control inflation (rate hikes and quantitative tightening), you are essentially relying on their assurance that the symptom (inflation) is a full description of the problem ( structural imbalances), and if they raise rates enough, they will eliminate both the symptom and the cause. We know that neither human bodies nor economies work that way. You can’t cure a cold by taking antihistamines, you just make the symptoms disappear temporarily.
And as for medicine, two years ago, when barber surgeons performed most of the bloodshed, there is a risk that the credibility of the central bank building will collapse if people realize that the operating principle was based on pseudoscience.
If this is a risk, what should investors do?
As investors unable to fight the dogma that currently drives central bank behavior, the choices are clear. First, we can refuse to be guided by the decisions of pseudoscientists by taking less risk by investing in tools traditionally backed by central banks but now the target of bloodshed; for example, liquid stocks, bonds and perhaps also housing. In other words, investors must refuse to become sick patients who agree that bloodshed is the only solution. Second, insure where possible against that sudden collapse of credibility and markets; that is, hedge, while hedging is still affordable. And third and last, be ready to invest with liquidity for the “pivot”, which will, of course, be expressed in new, mysterious language. For example, something along the lines of: “we pay attention to market forces”. That could very well be a signal that the bloodshed is coming to an end, that is, that the patient is almost dead.
For the first time in my memory, central bankers have admitted that asset price inflation exists, and to lower actual inflation, asset prices must be deflated. As an asset owner, I would recommend getting your own scientifically proven risk management, liquidity and hedging drug before agreeing to fall victim to financial bloodletting.