The Dillian Loop is really just an elaborate argument for laissez-faire, the idea that constant interventionism in a complex system yields results that are highly unpredictable and often deleterious. In this writer’s opinion, the best possible response to the housing crash, the financial crisis, the Great Recession, would have been to do—nothing.
Liquidity Gone, Never to Return
Back when I was trading 10 years ago, liquidity was abundant. You could sell infinite amounts of stuff without having any impact at all. Bond desks nowadays are reduced to trading odd lots and sitting around the rest of the time, while compliance reads their email.
You can regulate the markets a million different ways, but the last thing you want to do is screw with liquidity (a financial transactions tax would reduce what’s left of the capital markets to rubble). The government doesn’t realize that it alone is responsible for the liquidity problems and that additional regulation will only serve to reduce liquidity even more. I wouldn’t be surprised if 40 Act high yield mutual funds disappeared in a few years, which by the way, would mean a higher cost of capital for everyone.
That can’t possibly have any negative economic consequences.
But since we are caught in the Dillian Loop, what is the chance that we will get out of it? I’d say very slim. I’d say we could easily spend another 10-20 years in the Dillian Loop. The only thing that gets you out of the Dillian Loop is when you reach rock bottom, the point of maximum pain, and people are so disgusted with years of ineptitude that they are willing to try something different.
They might even get so desperate, they will try capitalism.
Jared Dillian is editor of Mauldin Economics' The 10th Man.