Mittwoch, Februar 10, 2010

Think About It...

Contemplate this: if George Soros, the man who brought the Bank of England down to its knees on 16 Sep 1992, warns against speculating against the Dollar, this can only mean one thing.

That Soros is moving against the Euro. He can't afford to have a speculative movement against the Dollar because he is shorting the Euro: if the Dollar were to weaken, then Soros loses, and loses big.

This helps to explain some of the speculation against the Euro, with the difficulties in the PIGS countries (Portugal, Ireland, Greece, Spain) providing an excuse.

Jim Rogers, a former partner, sees it differently: the Dollar is on its best way to becoming a permanently weak currency, based on US debt and debt burden (as well as the need to improve the international competitiveness of US products).

So, who is right?

No one, of course: the markets will tell us over the next several months. I fear that Soros, who is supremely confident in his own abilities, will find that even he cannot move markets in a direction that they are not ready to move in for any length of time.

And this is something else to understand: speculation against the Euro is being executed by derivatives, via futures markets. Such markets exist because there are expectations about future movements and current values. Any sort of exploitation of differing values is simply called arbitrage: it is the mechanism by which discrepancies between, say, interest rates between countries are equaled out. Arbitrage is extraordinarily useful for the world economy, not because you can make lots of money (you can), but more importantly, it removes those discrepancies over time before they can become large discrepancies.

Think of it this way: you can go get your car tuned up whenever it is running a little ragged. This might happen every six months, maybe every couple of years, but when it does, it's not always a simple resetting of the timing belt, but rather the motor was running poorly because there was a problem that had been ignored and had developed to the point where it made the motor run poorly.

Now, with a modern engine, you don't have tune-ups. Why? Because the motor is being constantly tuned. Modern, fuel-efficient motors with low emissions can't be tuned by hand: they are computer-controlled and problems are found before they develop into larger problems. If the computer - which monitors the motor more or less continuously - can't reconcile the problem, then the computer tells you this: it also tells you exactly what the problem is and what has to be done. Back in the good old days of mechanically controlled motors, diagnostic work was an art form, with master mechanics able to feel what was wrong with the motor simply by putting their hands on the motor while it was running (I've seen this myself). Today it is a science, with the computer controls providing mechanics with detailed analysis of literally dozens of parameters, in some cases developed as expert systems from those master mechanics after they retired.

Arbitrage in all its sundry forms is the constant tuning of the world economy, removing inefficiencies and smoothing things out. The differences can be very small, but with large enough sums, as the Germans say, even small animals make shit (i.e. for the humor-impaired, even a few basis points difference can give you substantial returns if your capital is large enough). This ensures the smooth running of the world economy: small differentials are quickly corrected before they can develop into even minor problems, let alone major ones. Going back to a world where arbitrage didn't do this means going back to the world of Bretton Woods and the ludicrous idea that politicians and their lackeys know better where exchange rates and interest rates should be than markets.

Now, those who desperately want money to spend on pet projects (i.e. NGOs, Quangos, governments and sundry other parasites) continue to talk about imposing a tax on financial transactions. The talk doesn't die because it sounds simply fabulous: impose a trifling small tax on non-retail transactions and collect, literally, billions, all for a good purpose like fighting poverty (although we all should know that it really goes to finance the careers of those involved).

Instituting such a tax appears to be painless, appears to be trifling. But it does affect arbitrage: it reduces the attractiveness of such small differential deals, reducing the gains thereof. As a result, arbitrage doesn't function as smoothly, since the differentials between markets have now to become greater in order to reap the same rewards.

And this is a good idea? It might be brilliant for the NGOs and those reaping the rewards of a Tobin Tax, but it is, in terms of market efficiency and stability, thoroughly and completely negative. If such a Tobin Tax were to be instituted world-wide, financial discrepancies will take longer to be adjusted, making the corrections more costly and less effective.

It is as if you were to introduce a rounding-up error into the correction mechanisms. Do this for an engine and you will see very small positive feedback loops as adjustments appear first when the errors are large, instead of being caught immediately. The positive portion of the feedback loop comes from the system adjust in smaller steps than the resolution of the error detection.

You can never achieve system stability with positive feedback: it always tends to expand or promote the feedback effect, and is always, ultimately, destabilizing.

The NGOs need a positive feedback introduced into the system of international finance in order to tap it for funds: by doing so, they sow the seeds of destabilization. Think about it...

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