Model Showing Swings between Risk Tolerance and Risk Aversion

Risk Aversion/Risk Tolerance Visual Model

I have amateurishly enough drawn a model, or a visual aid below which shows how I conceptualise visually, at least, the dance between risk aversion and risk tolerance. This has been the model, and the inter-market relationship over the last decade. It visually demonstrates how US Dollar liquidity effects asset prices. The same model could also be applied to the Japanese Yen.

If we assume that the US Dollar is the nucleus at the center where low interest rates, and increasing US dollar liquidity, leads to a carry trade of sorts where money moves from the center to the periphery. As the periphery moves further away from the center so does the risk and the yield. This bids up assets which lay in these outliers, increasing the yield, and leading to speculative booms. This in effect is what seems to have been at play during most of 2009, and also from the period 2002-2007. This causes the US Dollar to weaken, and other assets to increase in value, hence we had the inverse relationship between stocks and commodities, higher yielding currencies and global real estate markets. However, when these bubbles burst as they inevitably do, the money spirals back to the center, leaving the higher yielding assets, and flowing back to the center, which is essentially US Dollar positive.

One only needs to have watched the events unfold since the start of 2010, with investor sentiment turning sour on Euro zone member countries due to the increasing likely hood that they will not be able to manage their fiscal deficits.

Below the diagram, I have posted a few charts to show this dynamic in action...








This chart shows the US Dollar Index, and its performance during bouts of risk appetite.

The next chart shows, how diminishing risk appetite impacted stocks, using the S+P as a proxy...

For me at least, this simple diagram enables to visually and conceptually understand the global macro dynamics that are at play in the global economy. By the way this is not to say I m long term positive on the USD. I am very bearish on all paper currency vis-a-vis hard assets, such as farmland,industrial commodities, agriculture and precious metals. The US is the reference currency, and rates are being held at incredibly low levels, the FED will continue to print money in the face of any adversity, the US administration will continue to increase spending and the budget deficit, and the unfunded liabilities in the US will eventually undermine the US Dollar. The problem is that other currencies are not much better, such as the Euro, Sterling, the Baltic states and in the long run the Japanese Yen. However all paper money will depreciate against hard assets.