I am dismayed by how often the term ‘negative feedback loop’ is used incorrectly. The latest offender is Jeff Currie at Goldman Sachs who writes in a note to clients:
“The negative feedback loop is significant. The deflationary impulse created by lower commodity prices reinforces a stronger US Dollar, as witnessed by recent moves in FX markets that resulted in weaker commodity currencies. This decreases the cost of producing commodities in these countries through lower wage costs that are priced in the weaker local currencies. Further, this deflationary impulse reinforces a stronger US economy and higher rates. The higher rates in turn raise the cost of funding for emerging markets, which reinforces the need for emerging markets such as China to deleverage and deal with significant macro imbalances developed over the past decade. This ultimately reduces the demand for commodities, particularly those that are tied to investment such as copper and iron ore.”
The forces that Jeff writes about constitute a positive feedback loop, not a negative one. When one event (“deflationary impulse”) triggers other forces in the same direction (“raise the cost of funding for emerging markets” which “reduces the demand for commodities”), this is a known as a positive feedback loop, even if it relates to a “negative” event such as falling prices. A negative feedback loop is one in which one force triggers a force in the opposite (negative) direction. An example, to continue with the energy theme, would be falling oil prices that trigger an increase in demand for petrol and in turn higher oil prices.
Phew! Glad to get that off my chest….
Past performance is not a guide to future returns. The views expressed are those of Peter Elston at the time of writing and are subject to change without notice. They are not necessarily the views of Seneca Investment Managers and do not constitute investment advice. Whilst Seneca Investment Managers has used all reasonable efforts to ensure the accuracy of the information contained in this communication, we cannot guarantee the reliability, completeness or accuracy of the content.
Seneca Investment Managers Limited is authorised and regulated by the Financial Conduct Authority and is registered in England No. 4325961 with its registered office at Tenth Floor, Horton House, Exchange Flags, Liverpool, L2 3YL. FP15/91.