Wall Street warns – get ready for the cobra effect!

Wall Street warns – get ready for the cobra effect!

The unprecedented injection of money into global economies could lead to a giant collapse, according to Wall Street pundits.

Of cobras and mice

The Cobra effect concept comes from an anecdote dating back from British colonial times in New Delhi, India. At one point, the British government officials were terrified of venomous cobra snakes roaming around the city. To solve the problem, they came up with an idea: an offer to Delhi's people. For every dead cobra, people would get paid.

The consequence? After killing snakes for a while, New Delhi inhabitants built an ingenious scheme to make more money: they started breeding cobras. When the government found out, the bounty was called off. However, the cobra breeders set the snakes free. And the cobra population increased, instead of going down.

Something similar happened in Hanoi, Vietnam, in the times of the French colonial period. The rat population could not be controlled, so the rulers introduced a bounty scheme for...rat tails. Pretty soon, Hanoi was full of tail-less rats running around. The bounty hunters never killed them: they just cut off their tails and released them back into the sewers to continue to breed. More rats equaled more income. People never fail to amaze when it comes to inventivity.

Both stories say the same thing: when a solution turns out worse than the problem, we're looking at the cobra effect. Sometimes well-intended measures lead to disastrous results if people don't put enough effort into researching and thinking about possible repercussions.

The connection with the financial markets

Recently, Wall Street spotted a connection between the cobra effect and the world of investing. And traders should worry, or so it seems.

According to marketwatch.com, veteran investor Larry McDonald declared something that caught everyone’s attention: "We believe we are at the early stage of the biggest cobra effect in the history of economics. As the massive monetary and massive fiscal stimuli (over $15 trillion globally) conjoin to save the economy from a deflationary depression, they will cause a hyperinflationary economic collapse instead."

McDonald added that if governments will change the course of their policies and ease the stimulus measures, the world will experience severe depression. In other words, the markets will get hit by hyperinflation, prices for goods and services will skyrocket, and economies will collapse. Larry McDonald was among the first financial analysts to warn the world about the sub-prime mortgage crisis that led to the economic crisis of 2008.

Digital journalist Jeffrey Marcus expresses a similar point of view, discussing how the Fed record fund injection led to a Cobra effect. In a piece for seekingalpha.com, he notes that the "consequence" of Fed's actions wouldn’t necessarily reverberate in the stock market. The real problem could be with the economic growth, which could potentially slow down fast.

However, Marcus appears more preoccupied with what asset managers might do should the economies fall. He believes they will stick to what they have always done: continuing to invest in ways that offer their clients the most significant returns. And that will most likely create a bubble, which usually busts, concludes the journalist.

In the meantime, the markets aren’t doing too bad

For the moment, things do appear to be in a good place for the American markets. Both the tech-heavy #Nasdaq and #S&P 500 are trading at all-time highs. The European and Asian markets give tangible signs they’re on the right track as well.

Whether or not the cobras will bite anytime soon, that’s something only time will tell.

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Sources: economictimes.indiatimes.com, marketwatch.com, seekingalpha.com.

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