The dynamic that’s taking shape between public markets and central banking is more interesting by the day. And the role played by technology in compounding the effect is not to be discounted. Beyond its fascination value, however, the ripple effects of financial flows that appear isolated are actually quite broad and substantial. Even in the remotest corners of private investing, the public markets are the constant manipulator: The secondary market hiccups and the IPO market shakes, the one public vehicle stumbles and a variety of private sources bruise, and the converse on the way up for these. We can’t forget the Sequoia RIP slides, for instance, which were not the result of anything intrinsic to venture capital but were rather the domino effect of damaged institutional (L.P.) portfolios spilling into adjacent spaces. And yet that same venture firm’s huge bet, subsequently, on a vague startup so soon after the ominous slides had been circulated, can’t be too many steps removed from a public market that also had reversed its course by that point.

Regardless of where you stand in relation to capital flows, therefore – and we all stand somewhere in relation to these, whether we realize it or not – it is important to pay attention to the public markets. In doing so, price levels and swings tell only half the story, and perhaps even the less meaningful half. The other part consists of all the variables behind the volatility – volume and its implied signals, economic data that sometimes elicits wild reactions and other times not, global causes and effects, or effects that sometimes precede causes – the list is long and growing. Which brings us back to the opening statement at the top of this page, about the relationship between monetary policy, technology, and markets. It is increasingly like a game played between sides that are brilliant and simple from one moment to the next, and it’s a game that might baffle even the most expert followers.

Last week the Fed pre-announced an intention to think later about the possibility of monetary stimulus, which may or may not take the shape of quantitative easing programs we have seen from them in the past; and the market pre-tanked and then immediately post-thought better of it and decided that the Fed announced something significant after all. Ever since, the market appears to have maintained that thought: Good economic news is bad, as it pertains to monetary stimulus potential, and bad news is good. The Fed, each day, throws in a spark or two to maintain the fire. The point has come, in fact, where it is only this correspondence between anticipated Fed action and market reaction thereto (even if only to the anticipation) that is the sole driver of any price movement. And there is something even more noteworthy: Individual stocks – not all, but many, a statistical mass – are trending towards the mean and rising or falling in accordance with the market index rather than any specific fundamentals. This is where technology factors in.

The technology of high frequency trading that is based on headline scanning algorithms and the pursuit of whatever may be left of price differentials and opportunities from one microsecond to the next, is no doubt a contributing factor to the environment described. That these systems have controlled a growing portion of the daily trade in the past few years is no secret, nor is it particularly difficult now to guess the reaction of these to various types of headlines. With that in mind, the Fed’s strategy to communicate or not communicate direction, and the direction itself, take on an added layer of consequence (or lack thereof), and the Fed is surely mindful of the angles. The reality that these consequences would ripple into individual stocks regardless of their particularities, and into private investments regardless of their direct relation to public markets, and into business borrowing and other asset classes, this is a facet of the game to which none can remain indifferent.

The subjects raised remind me, somehow, of a news story about an artificial intelligence project in which two computers were programmed to chat with each other. The results were at once quirky and logical, if that’s possible to imagine. So too, nowadays, the changing dynamic between markets, external drivers, and internal systems is speaking to us in a new language. The onus of adjustment is with us.

When capital risk ceases to be about repayment and becomes a matter of liquid refinancing, capital categories and return hurdles converge. This is only an observation. It was covered in a previous article here. When refinance rather than repayment is at the crux of capital markets, analysis shifts from fundamental to technical. More precisely, the fundamental is less about intrinsic asset value and more about market liquidity as a way to perpetuate its funding. As this occurs, the investment consideration is mainly about exits and trading scenarios, and when such resources are ample the only consideration is the market’s willingness to participate. In short, capital flow becomes more truly a capital cycle, and a recycle, which is a healthy situation as long as the wheel continues to spin.

The thought must have occurred to Chairman Bernanke as he prepared for his annual and increasingly sensational appearance at Jackson Hole, WY. At this time last year the idea hadn’t yet jelled, perhaps, or maybe the time wasn’t ripe. In any case, the concept of quantitative easing was very literally, very somberly, framed. It was an actual infusion of liquidity of many hundreds of billions of dollars, (after a while we lost count). This year, a more evolved, more subtle, almost more genial manifestation seems to be in the making. The new and improved idea is that quantitative easing doesn’t need to be real – doesn’t need to be… quantitative – in order to achieve its goal. It needs only to be suggested. (The operative word is easing, I suppose.) Perception is reality, after all, especially when perception is institutionally sanctioned.

Thus, given a capital market context in which technical is the new fundamental, in which liquidity drives refinancing and exits and trades in a cyclical flow of passing the baton, the market only really needs some soothing phrases, as it were, a letter of intent, for its liquidity to continue moving. Such a signal was today delivered, and the market did indeed respond appropriately. The signal, (I paraphrase), was this: We stand ready to act, and, as importantly, we have the necessary weapons. Our weaponry is in fact so ample that not one but two (2!) full days of FOMC discussion will be necessary to fit all the verbiage. I’m only guessing now (i.e., no longer paraphrasing) but maybe next time around three days will be needed, and then four? Well… anyway… these signals have weekend constraints.

Until then, the wheels may have been pushed with sufficient force to create some semblance of momentum… which in turn will flow and trickle into the IPO pipeline (that has been building) and the venture capital market and other seemingly disparate parts of the economy. If these and other segments continue to move, a time may come when further prodding is no longer required. That, we suspect, is the Fed’s true hope (and ours). But these wheels can sometimes be fickle. Sometimes they turn one way, sometimes another. Sometimes they stop or veer off to the side. We’ll all monitor the situation closely (as will the Fed).

Fiat money is a form of currency that has value only because… It is an asset of commercial exchange determined by perception, supply and demand, and such even more esoteric and delicate variables like a central authority and support. A common way to understand the concept of fiat money has been to contrast it with money that is backed by something real (rather than the conceptual list just referenced). Typically, at least in historical discussion, the real asset backing such money is gold. Gold doesn’t back money anymore, but it remains a valuable commodity that is in limited supply and is, in theory, interchangeable with currency. Many have argued that gold is worth more than money – which is debatable – but it is certainly worth more money than it was worth last week, last month, last year, and many years ago.

The antithetical positions of gold and fiat money have become so etched in public discourse that it now almost goes without saying that ownership of gold is ownership of substance, while ownership of (fiat) money is something at the mercy of economic and geopolitical flux. This, at least, is how many of my generation had been trained to think, as a matter independent of market value and price volatility. So when we are presented with a passing observation – buried in the depths of an editorial about bullion and tonnage and other such phraseology associated with physical gold – that “the gold ‘physical market’ is approximately 100 times the size of the amount of actual underlying metal by which it is purportedly backed,” we do a double-take. We read the passage one more time, just to make sure we didn’t miss a typo.

Now, I am very much an amateur in these matters. I know about the precious metals’ market precisely what is necessary to be dangerous, not more and not less. And I can’t vouch for the accuracy of the cited passage or reliability of its source, (although the online publication where the subject article was found is among the most widely read blogs on matters financial and economic). So taking it for granted, rightly or wrongly, that it is accurate to say that the amount of physical gold is equivalent to only about 1% of all the gold that’s “owned,” we have to wonder what happens to the other 99% of “owned” gold.

Which ruminations lead one eventually to wonder what would happen if some large quantity of physical gold should be demanded at once from whatever place of safekeeping it resides. Granted, a substantial demand is necessary to cause trouble and it’s unlikely this would occur in one shot. But if the point of gold, from the perspective of monetary discussion, is its substance and reality, then what would such an enormous supply and demand disruption signify? On one hand it may be argued that the value of the asset will be that much more firmly rooted in scarcity, and the few who are in possession will benefit more. On the other hand, however, are we not really talking about a precious metal that isn’t even backed by its own standard? Is gold, in actuality, guided by a fiat of its own?

As we approach the annual conference at Jackson Hole this week, most recently famed for an influx of fiat money that lasted through the quarter just ended, the contrasts and thoughts presented herein should be considered. We ought not be too harsh on money supply, just as we ought not be too sure about gold supply. Here too, as in many other subjects, absolutes are few and nuances are relative.

There has been some misunderstanding in regard to the U.S. sovereign rating downgrade by Standard & Poor’s and the market reaction to it. There has been bafflement about both the rating agency and the market that has reacted to it, in both cases calling into question rationality and consistency. On one hand, there is the suggestion that markets are behaving irrationally in boosting the value of U.S. Treasury securities after these were downgraded from risk-free status, and on the other hand, the credibility of the rating itself is being challenged, as markets are – on the surface – moving in ways contrary to it. That the two positions, often held by the same source, are in conflict, is not an objection worth making just yet; at least not before the more interesting (and maybe even important) argument is presented, to show that the rating downgrade and market reaction are not only both consistent but rational.

The best way to understand a complex system – say, global finance – is to reduce it, or aspects of it, to a single unit. Let’s assume, for illustration, that there is only one asset that represents the world, and that this asset is financed with two basic forms of capital: debt and equity. Let’s also assume that an agency, the role of which is to analyze the risk of debt securities used by this asset to fund itself, has issued a negative signal to the marketplace. (In our example, again, the market comprises only financial securities supporting this one asset, which is the only asset in the world, and there is only straight debt and straight equity behind it.) Now, when the risk profile of debt in this scenario is indicated to have risen, what does this assessment tell us about the risk profile of equity on a relative basis? And what is the rational decision for a market with only two choices, the debt and equity of one valuable asset?

As we consider the limited alternatives, let’s remember our bankruptcy law and basic corporate finance: equity ranks behind debt, and debt ahead of equity. When an asset deteriorates in value, equity is the first to feel it, and when the value of debt diminishes, the value of equity will have diminished more. When the risk profile of debt is challenged, by extension the riskiness of equity is challenged more. Assuming that the risk aversion of the market is consistent over time, and given that risk and value relate inversely, investors will in this scenario want to sell equity and buy debt – these being their only two choices – because on a relative basis to each other this is the only rational course to take. Ironically, thus, the value of debt will rise, due to supply-and-demand dynamics in the market, even though the original trigger was a negative comment about debt.

This was an extreme scenario, based on an impossible illustration. In actuality, there is much more than one asset and there are many security classes and ways to invest in all of these. But by the same token, the market didn’t move as drastically in actuality as it would have moved in the single-asset example presented. And the United States is not just any asset among many, but arguably the most substantial of all assets in the world. It is, in short, dominant, and closer to the profile of our scenario than any other. When a rating agency deems it necessary to cut the rating of U.S. debt, the rating agency is by extension raising the risk profile of all securities associated with this sovereign, and there are very few securities in the world that either directly or indirectly are not connected to the United States economy. For this reason, there has been a rotation out of the riskier classes and into the safest tranche, just like in the example provided.

Returning now to the original objection raised by many observers, about the market’s irrationality and the rating agency’s credibility, once we understand that the market has in fact behaved rationally in the current circumstance, then we can also see that it has in fact taken the rating agency and its opinion quite seriously and paid these both high tribute. By the time some of you will have read this, that other entity taken seriously in the market – even if lacking credibility to some – will likely have acted in a way to move it, and this will probably also involve headlines that will be taken at face value initially – and reacted to accordingly – before philosophical discourse takes hold.