OpEdNews - Page 8 of Article: What If you Called 411 and The Crash Answered?

When the Market receives a Random Shock, the yield curve twists discontinuously from The Crash Trigger to the Yield Curve of Keynes' Liquidity Trap.

Irrational Exuberance:

The inverted yield curve is the result of investors buying overpriced long-term assets.

It is the result of what Alan Greenspan termed Irrational Exuberance.

"Clearly, sustained low inflation implies less uncertainty about the future,
and lower risk premiums imply higher prices of stocks and other earning assets.

We can see that in the inverse relationship exhibited by
price/earnings ratios and the rate of inflation in the past.

But how do we know when irrational exuberance has unduly escalated asset values, which then
become subject to unexpected and prolonged contractions as they have in Japan over the past decade?

And how do we factor that assessment into monetary policy?

We as central bankers need not be concerned if a collapsing financial asset bubble does not
threaten to impair the real economy, its production, jobs, and price stability.
Indeed, the sharp stock market break of 1987 had few negative consequences for the economy.

But we should not underestimate or become complacent about the complexity of
the interactions of asset markets and the economy. Thus, evaluating shifts
in balance sheets generally, and in asset prices particularly,
must be an integral part of the development of monetary policy."

Chairman Alan Greenspan
The Challenge of Central Banking in a Democratic Society.
At the Annual Dinner and Francis Boyer Lecture of
The American Enterprise Institute for Public Policy Research,
Washington, D.C. December 5th, 1996

Greenspan Conundrum:

The inversion of the yield curve tends to increase, even faster of late, it is the famous Greenspan Conundrum.

It is the cause and consequence of Irrational Exuberance:

"There is little doubt that, with the breakup of the Soviet Union and the integration of
China and India into the global trading market, more of the world's productive capacity
is being tapped to satisfy global demands for goods and services.

Concurrently, greater integration of financial markets has meant that a larger share of the
world's pool of savings is being deployed in cross-border financing of investment.

The favorable inflation performance across a broad range of countries resulting from
enlarged global goods, services and financial capacity has doubtless contributed to expectations of
lower inflation in the years ahead and lower inflation risk premiums.

But none of this is new and hence it is difficult to attribute the long-term interest rate declines
of the last nine months to glacially increasing globalization.

For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum.

Bond price movements may be a short-term aberration,
but it will be some time before we are able to better judge the forces underlying recent experience."

Chairman Alan Greenspan
Federal Reserve Board's Semi-Annual Monetary Policy Report to the Congress.
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate.
February 16tn, 2005

Discontinuity:

The inverted yield curve is an unstable equilibrium because the long-term rates are undervalued.

It runs against the optimization of risk/return of portfolios and the self interest of financial institutions:.

"I made a mistake in presuming that the self-interests of organizations,
specifically banks and others, were such as that they were best
capable of protecting their own shareholders and their equity in the firms."

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