Leggi in ItalianoFinancial markets are neither a casino nor a church — and understanding this is, I am increasingly convinced, essential for anyone who studies international law and national security. They are better understood as a distorted mirror in which human beings project what they think, fear, and hope about the future. To understand markets, therefore, is not only to understand numbers, interest rates, balance sheets, or economic models. It is also — and this is what I find most instructive — to understand human behaviour: fear, greed, hesitation, regret, imitation, and the constant attempt to anticipate what others will do next. The economy is not an exact science in the same way physics is, and recognizing this changes how we should approach it. Physics deals with phenomena that can often be described through stable and repeatable laws. Economics, by contrast, is a social science. It studies how human beings make decisions under conditions of scarcity, uncertainty, and changing expectations. Human beings do not always behave predictably. They change their minds, panic, become enthusiastic, imitate one another, and frequently react in ways that no linear model can fully capture.
For this reason, economic forecasts tend to fail precisely at the major turning points. This does not necessarily mean that economists are incompetent. It means that complex systems do not obey simple equations. The economy is made of institutions, expectations, incentives, political decisions, technological change, demographic structures, and collective emotions. Each of these forces moves at a different speed.
A useful way to understand this complexity is to distinguish between different layers of economic time. At the surface, there are events: monthly inflation data, employment reports, corporate earnings, central bank speeches, and political announcements. These move quickly, often from week to week or from month to month. Beneath them are economic cycles, such as the credit cycle, the inflation cycle, the deflation cycle, and the monetary policy cycle. These usually unfold over one to ten years. Deeper still are the structural forces of the longue durée: demography, technology, geopolitics, public debt, and the organization of the global economy. These evolve over decades or even centuries.
A common analytical error is to confuse these layers. A single month of high inflation does not necessarily mean that inflation has become structurally entrenched. A three-month stock market rally does not necessarily mark the beginning of a secular bull market. The investor must therefore learn to distinguish the noise of the surface from the movement of deeper economic currents.
Central banks and monetary policy
This distinction helps explain why the quantitative easing programmes introduced after the financial crisis of 2008 did not immediately produce consumer-price inflation, whereas the fiscal transfers and direct subsidies introduced during the Covid period had a much more immediate inflationary effect. Money that remains inside the financial system behaves differently from money that reaches households and is spent directly.
Central banks are the most powerful institutions in the modern financial system. The Federal Reserve in the United States, the European Central Bank in the euro area, the Bank of Japan, and the Bank of England set the basic conditions under which credit, liquidity, and expectations operate. They determine short-term interest rates, regulate liquidity, act as lenders of last resort, and try to manage inflation expectations.
A practical rule follows from this: investors should not fight the central bank. If a central bank credibly announces that it will lower rates, buy bonds, or support the financial system, it is dangerous to bet systematically against it. The central bank has theoretically unlimited resources. The individual investor does not.
When a central bank lowers interest rates, credit becomes cheaper. Companies can borrow more easily and invest. Households can obtain mortgages at lower cost. Existing bonds with higher coupons become more valuable. Equities tend to rise because future profits are discounted at a lower rate. The currency may weaken because investors seek higher returns elsewhere. When the central bank raises rates, the mechanism works in reverse.
Quantitative easing is the additional instrument used when interest rates are already close to zero and the economy still needs stimulus. In that case, the central bank buys government bonds and other securities directly in the market. This injects liquidity, lowers long-term yields, and pushes investors toward riskier assets such as equities and real estate. It is a massive intervention that changes the financial environment, often making markets function again after periods of stress.
Interest rates vary according to maturity. Short-term rates are strongly influenced by central banks. Long-term rates are determined more by markets and reflect expectations about future inflation, future growth, and risk. Under normal conditions, the yield curve slopes upward: longer-term loans carry higher rates because the future is more uncertain. When the curve inverts, and short-term rates exceed long-term rates, this has historically often preceded recessions.
A useful reference point is the Taylor Rule, which suggests that the appropriate policy rate should rise when inflation exceeds the central bank’s target and fall when the economy is operating below potential. In simple terms, the central bank should tighten policy when inflation is too high and loosen policy when growth is too weak. Such a framework should not be treated as a mechanical formula, but as a way to judge whether central banks are ahead of or behind the economic cycle.
Inflation and expectations
Inflation can arise from demand or from supply. Demand-pull inflation occurs when too much money chases too few goods. It is usually associated with excessive fiscal or monetary stimulus and with economies operating near full employment. The usual remedy is to raise interest rates and cool demand. Cost-push inflation, by contrast, occurs when production costs rise because of higher energy prices, raw material shortages, or supply-chain disruptions. In this case, raising rates may reduce demand but does not directly solve the supply problem.
Inflation may emerge gradually, like toothpaste squeezed slowly from a tube, or it may remain apparently absent for a long time and then appear suddenly, like ketchup that refuses to come out and then bursts out all at once. The decisive issue is expectations. If workers, firms, and consumers stop believing that inflation will return to target, they begin to behave as if high inflation will persist. Workers demand higher wages, companies raise prices to protect margins, and the process feeds on itself. Once this spiral begins, it is difficult to stop without a recession.
Expectations therefore matter as much as facts. If everyone believes inflation will be high, inflation may become high because everyone acts accordingly. If everyone believes inflation will remain low, behaviour will tend to keep it low. This is why central banks communicate so carefully and so frequently. They do not merely manage the economy; they manage beliefs about the economy.
When interest rates rise, the discount rate also rises. Future profits are therefore worth less today, and equity valuations tend to fall. This is why stock markets often suffer when central banks raise rates. The effect is particularly strong on companies whose expected profits lie far in the future, such as high-growth technology firms.
Bull markets are long upward trends, usually supported by economic growth, rising profits, low rates, and optimism. Bear markets are declines of at least twenty per cent from previous highs, usually caused by recession, falling profits, high rates, or panic. Corrections of ten to twenty per cent are normal even during bull markets.
Currencies, commodities, and the dollar
Currencies are a game of mirrors. Exchange rates depend on interest-rate differentials, trade balances, risk appetite, and the status of certain currencies as safe havens. If the Federal Reserve offers a much higher interest rate than the European Central Bank, capital may flow toward the dollar, strengthening it. If the United States imports much more than it exports, the dollar should in theory weaken, although in practice the dollar’s global role complicates this mechanism.
The dollar is special because it is the world’s reserve currency. Commodities are priced in dollars, much global debt is denominated in dollars, and international transactions are often settled in dollars. This gives the United States what has been called an “exorbitant privilege”: the ability to borrow on exceptional terms because the world constantly needs dollars. This privilege may gradually erode through dedollarisation, but such a process is likely to be slow rather than sudden.
Commodity markets often move in long cycles. Periods of low prices discourage investment in extraction and production. This eventually creates scarcity, which pushes prices higher. High prices then attract investment, eventually producing oversupply and lower prices. Global rearmament, the energy transition, and deglobalisation may all contribute to a new upward commodity cycle.
Gold is one of the most misunderstood assets. It produces no income, pays no coupon, and generates no earnings. Yet it can rise in very different scenarios. It tends to protect purchasing power during inflation, benefit from a weak dollar, act as a safe haven during geopolitical crises, and become attractive when real interest rates are negative. Its paradox is that it can function both as a defensive asset and as an asset linked to structural change. The environment in which gold tends to perform poorly is one of high confidence in the financial system combined with positive real rates.
This last point is crucial. Markets anticipate; they do not wait for confirmation. Equity markets often bottom before the real economy stops deteriorating. The investor who waits for definitive proof of recovery usually buys too late.
A well-known empirical observation in business-cycle analysis is that the deeper the recession, the stronger the subsequent recovery tends to be. The post-2009 expansion illustrates this logic. A severe recession was followed by one of the longest bull markets in modern financial history.
Credit, crises, and Minsky
Credit is both the engine and the brake of the modern economy. It allows firms to invest before they earn revenues, households to buy homes before they accumulate the full purchase price, and states to spend today against future tax revenues. But credit can also create bubbles. When rates are low and banks lend easily, asset prices rise. Rising asset prices increase collateral values, which allows more borrowing. Optimism grows, leverage rises, and prices climb further.
Hyman Minsky formalized this logic. Periods of prolonged stability generate instability because they encourage excessive risk-taking. The Minsky moment arrives when a small shock breaks confidence. Selling begins, prices fall, collateral values decline, lenders demand repayment, forced sales accelerate, and the downward spiral becomes self-reinforcing.
The opposite of credit expansion is deleveraging. When everyone tries to reduce debt at the same time, demand contracts. Asset prices fall, collateral values decline, banks lend less, and the economy weakens further. This is the deflationary mechanism that transformed the 2008 recession into the Great Recession.
Financial crises tend to pass through five phases. The first is denial. The problem exists but is minimized. Authorities reassure the public, and markets move without clear direction. The second phase is panic. Something breaks the dam. Liquidity disappears, volatility explodes, and investors sell indiscriminately. The third phase is intervention. The central bank activates its implicit put, promising to do whatever is necessary. The fourth phase is the appearance of green shoots. Data do not yet look good, but they stop getting worse. Markets rise before the economy recovers. The fifth phase is recovery. Growth resumes, profits improve, and optimism returns. By then, much of the market gain has often already occurred.
The image of premature burial is useful in market analysis. A market may appear lifeless, but it may only be in a state of suspended animation. The investor who mistakes temporary paralysis for death risks missing the recovery.
Market psychology
Market psychology is dominated by fear, greed, and regret. Fear produces indiscriminate selling. In panic, investors sell even good assets simply to escape. Fear is contagious and nonlinear: stop-losses, margin calls, and forced liquidations create cascades. Yet fear also produces the best buying opportunities, provided the investor has a robust analytical framework and is not merely reacting to surface events.
Greed produces bubbles. Investors buy because others are buying, and rising prices become their own justification. Every bubble has a story explaining why the old rules no longer apply. The story often contains an element of truth. The problem is not necessarily the story; it is the price paid for it. A good asset bought at any price is not a good investment.
Regret is subtler. Investors do not simply maximize profit; they try to minimize future regret. If they do not buy and the market rises, they regret missing the rally. If they buy and the market falls, they regret entering too early. In bull markets, the regret of not participating can become stronger than the fear of loss. This is the mechanism behind FOMO and explains why bubbles can last longer than expected.
The logic of regret also applies to central banks. A central banker may accept slightly higher inflation if the alternative is the regret of having caused an avoidable recession. Decisions are therefore not purely technical. They are made under uncertainty, with policymakers weighing different possible future regrets.
The metaphor of Rashomon is also useful. The same market event can be interpreted in incompatible ways by banks, regulators, analysts, investors, and political authorities. There is rarely a single truth. Markets are the aggregate of competing narratives. The investor who understands why others think differently gains an informational advantage.
Geopolitics and markets
Geopolitics has become increasingly central to markets. For a long time, many investors treated markets and geopolitics as separate spheres. That separation has become much less credible. Wars, sanctions, energy crises, strategic competition, supply-chain fragmentation, and trade restrictions now affect inflation, growth, investment decisions, and portfolio construction.
Geopolitics affects markets through several channels. The first is energy. Conflicts involving oil and gas producers can interrupt supply, raise energy prices, increase inflation, force central banks to raise rates, and damage markets. The second is trade. Tariffs, sanctions, and supply-chain fragmentation increase production costs and generate supply-side inflation. The third is confidence. Geopolitical uncertainty delays investment decisions and slows growth.
In a geopolitical regime, the portfolio also changes. Assets such as commodities, gold, energy, defence stocks, and short positions on long bonds become more relevant. Growth technology stocks with high valuations, long-duration bonds, and countries dependent on imported energy or strategic goods become more vulnerable.
Portfolio construction is not primarily about finding the securities that will rise the most. It is about managing risk so that the investor can survive adverse scenarios and participate in favourable ones. Diversification does not simply mean owning many securities. It means owning assets that behave differently under different conditions.
Several practical investment principles follow from this framework. Investors should not fight the central bank. They should buy fear and sell euphoria. They should remember that markets anticipate rather than confirm. They should focus more on direction than on perfect timing. They should distinguish short-term signals from long-term structures. They should treat consensus as a map of possible future errors. They should recognize that every bubble has a persuasive rationalization. They should pay attention to the risks that nobody is discussing. They should manage regret, not just returns. And they should remember that liquidity is not a failure to invest; it is an option to invest later under better conditions. Liquidity is often misunderstood. Holding cash or short-term bonds is not the same as doing nothing. It means preserving optionality. In certain phases of the cycle, the ability to buy when better opportunities appear is itself a valuable asset.
All the pieces of the system are connected. The central bank sets interest rates. Interest rates influence credit. Credit affects investment, growth, employment, wages, consumption, and asset valuations. Asset prices affect wealth, and wealth affects consumption. Consumption feeds back into inflation, and inflation influences central bank policy. The mechanism is circular, delayed, and nonlinear. Monetary policy may take six to eighteen months to affect the real economy. At certain points, the system can break. External shocks such as pandemics, wars, and banking crises can interrupt the expected sequence.
The investor’s task is not to understand every detail of the system perfectly. The real task is to identify where the economy and markets are within the mechanism, which forces are dominant, which risks are underestimated, and how the portfolio should be positioned accordingly.
