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The Law of Unintended Consequences

A few years ago a wonderful video circulated chronicling the reintroduction of wolves into Yellowstone National Park since cattle ranchers had hunted them to extinction in the 1920s. As the wolves became more established, they rebalanced the deer and elk populations which had become excessive and for years caused overgrazing. With fewer deer and elk, trees and shrubs were able to take root and reestablish rivers that had become meandering from erosion, beaver populations came back and built damns in these rivers that allowed native fish species to thrive. Bears and foxes fed on these fish. More flowers brought back birds and butterflies that had not been seen in years, and even the bald eagle population soared.

Consider this story alongside another: Russia invades Ukraine and the bearded dragon population explodes in the English countryside. Per a recent Wall Street Journal article:

For weeks now, there has been a steady increase in the number of owners giving up exotic pets or releasing them into the suburbs. Spiraling energy prices—in some instances double what they were a year ago—have propelled the cost of maintaining the reptiles’ heated environments to levels that are pinching budgets.1

Dramatic changes to complex adaptive systems manifest in unknowable ways, and human intervention rarely happens in a vacuum. A top land predator is hunted to extinction and the local fish population suffers. A war breaks out and exotic lizards are released into the wild in a distant country.

This brings us to our current economic environment: the Federal Reserve is intent on bringing down inflation by raising rates and tightening financial conditions. For years an ecosystem has built up around an environment of ultra-low interest rates and easy lending, and now we will see what happens as the Fed removes these accommodations. The first-order effects are already showing up in the most interest rate sensitive parts of the economy such as housing. But what are the second- and third-order effects?
20220906-chart-1Experts and policymakers often think they can force a result by tweaking the system with less regard for the downstream effects. We have no idea how individual agents will respond to tampering, but we should expect things to change – potentially for the better, perhaps for the worse, but something will be different. As Charlie Munger acknowledged in the 2021 Berkshire Hathaway annual meeting: “If you’re not a little confused by what’s going on you don’t understand it. We’re in unchartered territory.”

At times like these, it is most important for investors to remain patient, open-minded and flexible. We are in uncharted territory, and while we may need to lower our return expectations or extend our time horizons, we cannot lose our wits.

Important Disclosures & Definitions

1 Wall Street Journal, “Dragons, Lizards and Cobras Pop Up in England’s Suburbs”, 08/28/2022

Fed Funds Rate: the target interest rate set by the Federal Open Market Committee (FOMC). This target is the rate at which The Fed suggests commercial banks borrow and lend their excess reserves to each other overnight.

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

ALPS Advisors, Inc. is affiliated with ALPS Portfolio Solutions Distributor, Inc.

ALPS Portfolio Solutions Distributor, Inc., FINRA Member.

APS002098 11/30/2023
 

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