The Tell: The ‘cobra effect’ will have a ‘disastrous and unimaginable’ impact on the market, Wall Street vet warns

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As the story goes, there was once so many cobras in Delhi that there was a bounty placed on each dead one delivered to the government. At first, it worked. But then, entrepreneurs began breeding cobras for the income, and the authorities had to cancel the program. The breeders then released their snakes — whoops! — and the cobra population exploded worse than ever.

That is what’s known as the “cobra effect,” and, as Wall Street veteran Larry McDonald explained, it’s playing out right now in regard to the unintended negative consequences of public policy and government intervention in economics. Basically, the solution is worse than the problem.

‘Basic economic assumptions, or structures, will turn out to be much more fluid than policymakers can anticipate. Therefore the results will be disastrous and unimaginable.’

— Larry McDonald

“We believe we are at the early stage of the biggest cobra effect in the history of economics,” McDonald wrote in a post on his popular Bear Traps Report blog. “As the massive monetary and massive fiscal stimuli (over $15T globally) conjoin to save the economy from a deflationary depression, they will cause instead a hyperinflationary economic collapse.”

He went on to say that if the government were to figure out that such a collapse is coming and decide to change the course of its policies, then a deflationary depression will follow — one “much more severe” than if the powers-that-be hadn’t intervened at all.

“How far has the world turned in twelve months?” McDonald wrote. “The ‘Iron Chancellor’ in Angela Merkel has formally capitulated this week, agreeing to issue common debt on a large scale. We’ve gone from a ‘black zero’ — Germany’s austerity obsession — over to fiscal handouts to mathematically unsustainable debtors in the periphery.”

In the U.S., McDonald said, those calling the fiscal shots are basically overlooking several economic principles that will ultimately have a far-reaching impact on investors.

“Basic economic assumptions, or structures, will turn out to be much more fluid than policymakers can anticipate,” he said. “Therefore the results will be disastrous and unimaginable.”

The good news, per McDonald, is that “we’ll survive and thrive after the adjustment process.” But until then, investors would be wise to remember: “Hell hath no fury as a cobra breeder scorned!”

Stocks weren’t exactly thriving during Wednesday’s trading session, but they were mostly in the green, with the Dow Jones Industrial Average DJIA, +0.31% , S&P 500 SPX, +0.13% and tech-heavy Nasdaq Composite COMP, -0.09% all slightly higher.