A Hedged Economy is an Economy that Believes in Nothing

Most think that the last decade was characterized by excessive risk-taking in the economy.  While I do admit that as an economy we took on tons of debt, I think our problem was that we tried to avoid all risk whatsoever.  The increasing desire to be completely hedged of all risk has resulted in a economy that essentially believes in nothing – and that’s a bad thing.

Exhibit A Output Price Hedging

Today Barricks Gold announced that it has reduced its hedges and now is fully levered to the price of gold.  Well that’s nice considering it’s a fucking GOLD miner.  If you decide to get in the Gold mining business, one would think that you have some belief that Gold is something that people would want and you would want exposure to such a thing – or else why mine for the shit to begin with?

“Oh we don’t want our business to experience the volatility in Gold prices”, they will say.  Fuck that you pussy, you’re a Gold company not a hedge fund (and we will get to them later)

Exhibit B – Credit “Enhancement”

One of the first shoes to drop was the the bond insurers such as Ambac and MBIA and climaxed with the CDS mess known as AIG.   Why did this all happen?  Because investors were too pussy to take credit risk without someone holding their hand and telling them it is safe.  A good capitalist economy has investors that believe in the investment or project he is funding.  An economy scared of its own shadow uses credit “enhancement”, instead of taking good old-fashioned risk.  Ironically enough, we ended up holding a bag of blown hedges.

Exhibit C – Market Neutral Investing

Market Neutral Investing is to risk taking as John Mayer is to Rock Music.

While I hate all the “bubble-calling” going on I’m going to say that the next bubble to pop is something I call the market-neutral asset class.  This isn’t a real asset class, but basically a bunch of hedge fund strategies that seek to avoid market risk.  It’s my belief that many of the obscure, derivative products designed over the last few years have been invented to meet the demand for this asset class, as traditional, underlying assets couldn’t support the volume needed for its existence.  Need to conduct convertible arbitrage? Not enough convertible debt out there? Fuck it – here’s a CDS.

All this market-neutral investing, by definition is a belief in nothing.  We have thrown tons of money after these supposedly risk-free arbitrage strategies rather into entrepreneurs who actually want to put money at risk in the market.  And while I guess there are some positive externalities, such as liquidity (and its effect on ability to raise capital), there are positive externalities to sports gambling as well.  Put all our capital to work in strategies that hedge spreads at various sportsbooks across the countries and you’ll see tons of bookmakers and some new sports leagues sprout up and small economies develop around them, but it is certainly not the best use of our capital.

A hedged economy is an economy that believes in nothing.  Although we have failed, what has crushed us has been our desire to invest capital in a fantasy land where risk does not exist instead of investing it using good old fashioned risk taking.


  1. This is an interesting take on what is an increasing problem. I think this behavior comes out of being risk-averse, but also from a belief that we can tame risk. We believe people in the past who were exposed to these unhedged risks were primitive. We understand risk better and have the tools to tame it. Our models are smarter.

    It seems like financial crisis was another case of Icarus trying to fly to close to the sun.

  2. zerobeta

    Definitely, and there is a place for risk management and hedging within the economy, but when you have obscene portions of our capital looking to eliminate risk you have capital simply being squandered.

  3. Nice work, Justin. I can fall victim to overhedging at times, but I remind myself that my lifechangers have been the few opportunities that were “unhedgeable”. I’m now balls to the wall unhedged on building my new firm, as are you :). Keep up the good work

  4. This is an old theme of mine from mid-decade writing at RealMoney. Good post — the idea is still valid. Not everyone can lay off risk; the world as a whole is still 100% net long at the end of each day. Can’t be anything but that.

  5. Roberto

    Do you consider diversification a hedge? I do. It benefits my risk adjusted return.

  1. 1 Thursday links: spread shrinkage Abnormal Returns

    […] Justin Paterno, “A hedged economy is an economy that believes in nothing.”  (Zero Beta) […]

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