Seeds of Destruction

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Karl Marx wrote that contradictions in capitalism would lead to its own destruction…

Hoary old Karl was wrong about a lot of things—the withering away of the state perhaps his most idiotic statement of many, but capitalism’s ‘internal contradictions?’

His timing might have been off, but his point was right on the money.

But then, I’ve always thought that Uncle Karl was more of sociologist than an economist.  His deepest insights applied to some parts human nature, and of course, were blatantly wrong when applied to others.

But internal contradictions of capitalism were one he got right.

Take High Frequency Trading (HFT) for example…

Rationality redefined

In the old days, market values of companies, i.e. stock prices, were based upon the perceived value of the company itself.

Valuations were based upon fundamentals of a company.  Stock prices—and movements--were more or less rational.

But today, with HFT’s trading a stock position ten million times a nanosecond, trading stocks has ceased to a rational exercise…

Or, better said, the rationality has been redefined from value to immediate profit.

As I have said before in The Gorrie Details, today, a firm’s stock price is now de-linked from the fundamental value of the firm itself.  And as traders say, there are good companies and good stocks, but one often has nothing to do with the other.

The fact is, the vast majority of stock trades today are not done based upon the value of a company.  Over 70% of all stock trades are HFT programmed trades, as in computer programmed trades that are momentum driven.

As you might imagine, HFT favors volatility because with volatility comes momentum in either direction.  And as anyone knows who has owned a stock, mutual fund or ETF, a certain level of volatility comes with the territory in the stock market anyway.

Volatility and stability undermine market

Some market volatility is normal, and is an expression of a market inefficiencies

But if a little volatility is good, then a lot should be better.  MUCH better.  And it is…for HFTs.

HFTs actually generate their own, artificial momentum, which raises the volatility level and thus, raises profits.

And since HFTs came on the scene, stock market volatility has greatly increased.

This has led to greater profits, but also to greater market manipulation and wider market swings.

Downward momentum of a stock’s price can result in leveraged shorting, which causes greater pressure for the downward trend and becomes a self-fulfilling event.

Pressure grows for that firm to rescue its stock price, but all momentum and perception run toward price failure for short term profit.

This kind of volatility happens all the time and undermines the stability of the market.

So the downside of HFT is quite dangerous. Too much market volatility leads to instability which kills both investor and consumer confidence and threatens the whole system.

The stock market is not the only market with HFT.  It has taken over the currency and commodity markets as well.

Breaking the world’s piggy bank

The only market it has not penetrated is the one market known for its stability…a stability that is relied on to maintain its appeal to investors around the world.

Of course, I’m talking about US Treasury Bond market.

US Treasury bonds are the world’s piggy bank.

It’s where kings and presidents, dictators and prime ministers, all park huge amounts of money when they want it to be safe.

The US Treasury market represents the very stability of the US economy itself and the safety of its debt.

That may all change with the new HFT program coming when one of the world’s biggest hedge funds launches its new bond fund.

The Man Systematic Income Fund, to be put out by The Man Group of the UK, which has $58 billion under management, will feature High Speed Trading as its primary means of generating profit.

This should cause Federal Reserve chief Ben Bernanke’s beard to turn even whiter than it already is.

It’s bad enough that the perception of the US stock markets is that they are little more than casinos for elite insiders and computer programmers…

But to submit the US Treasury market to such volatility and instability is utter madness.

The motive is, as always, profit…

But once a downward spiral on US bonds is triggered, who knows if that market will ever come back?

High speed traders will insist that they have controls on the programs that execute the trades, but do they really?

The law of unintended consequences would seem to be just waiting to come into play here…

And with the US Bond market at the mercy--if that is the right word--to highly leveraged, HFT programs…

That very reality itself may well generate volatility and instability in the market.  It may well cut the confidence out from under US Treasury investors before anything bad actually happens.

It’s like seeing the driver of a vehicle you’re in open a bottle of scotch…When that happens, what do you do?

You get out of the vehicle before it crashes.

The world’s largest economy is wobbly enough right now…

The last thing it needs is more wobble.

Any instability in that market will further erode any confidence that may remain and may cause the collapse of the market and our economy at large.

Funny isn’t it?

Communism came and went in Russia, and Marxism was declared dead…

But 120 years later, Marx’s insight into some areas of human behavior is still dead on.

He knew that there would be some capitalists willing to do anything for profit…

Even at the expense of the system itself.

And as we see, he was right.

But hey, if you can make a few bucks on the way down, why the hell not?

And those are…The Gorrie Details.

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