Friday, February 27, 2009

Government solutions are killing us

Citigroup Inc. said Friday it reached a deal that will give the government up to a 36 percent stake in the struggling bank.

As a result of the government's help, Citigroup is down 43% in pre-market trading.

I am reminded of a famous sports cliche. When a great player on a losing team requests a larger salary, the owner replies "If we can lose with you, we can certainly lose without you."

Thursday, February 26, 2009

Bye bye health care

Today's headline: Obama Wants $634 Billion for Health, Says More Needed

The result: XLV (health care ETF) down 5.0% today
Big losers include:
Abbott Labs (ABT) -5.7%
Amgen (AMGN) -9.4%
Bristol-Myers (BMY) -5.2%
Gilead Sciences (GILD) -5.0%
Medtronic (MDT) -6.1%
Merck (MRK) -6.7%

I must ask, is this man totally inept or is he trying to crash the stock market?

UPDATE: XLV down another 4.0% today. Financials (XLF) down 6.5% as Citigroup falls 39.0% thanks to the government giving them more help. With friends like these, who needs enemies.


The other day when talking to a friend about the stimulus bill, another friend interrupted saying that we can't do nothing like Hoover did. I quickly replied that Hoover raised taxes and started a trade war (I didn't get into Hoover's pro-union pro-minimum wage stance since it is a bit more complicated entire books have been written on that subject). I am amazed that people still don't understand that important part of our history.

This reminds me of what Ronald Reagan said: "The trouble with our liberal friends is not that they're ignorant: It's just that they know so much that isn't so."

I just read this on Wikipedia: "Franklin D. Roosevelt blasted the Republican incumbent for spending and taxing too much, increasing national debt, raising tariffs and blocking trade, as well as placing millions on the dole of the government. Roosevelt attacked Hoover for "reckless and extravagant" spending, of thinking "that we ought to center control of everything in Washington as rapidly as possible," and of leading "the greatest spending administration in peacetime in all of history." Roosevelt's running mate, John Nance Garner, accused the Republican of "leading the country down the path of socialism"."

We are repeating history here. The Democrats, led by Barack Obama, attacked Bush and the Republican for spending too much and increasing the deficit and debt (which is true). Immediately upon taking power, just like FDR and the Democrats of those, Obama and the Democrats drastically increase spending and the size of the deficit, making Bush and the Republicans look "conservative" next to them.

Why Government Stimulus Doesn't Work

Everybody is talking about the government stimulus plan. When asked about it, I normally respond "I hope it doesn't do too much damage." While the vast majority of people oppose the stimulus, they do so because they see the costs outweighing the benefits. On the other hand, I see no benefits and only costs.

In a private business transactions, both the buyer and seller benefit. If I go to the store and purchase a product, I the customer receive something I value more greatly than the money I spend, otherwise I would not enter the transaction. Even though I end up with no money, which really represents units of labor I have already performed, I actually profit from the transaction since, to me, the value of what I receive exceeds the value of what I give away. And the seller also books a profit, obviously, since that is a business's purpose for existing and his revenue exceeds his expenses. With both the buyer and seller profiting from the transaction, wealth increases.

On the other hand, government transactions have no profit motive for either the buyer or the seller. The government stimulus plan is really a government spending plan with a very small amount of tax cuts. When the government spends money, neither the government nor the taxpayers profits. The government generally spends taxpayer money on projects that would not otherwise get done. But why wouldn't these projects get done without the government? Because they are not profitable, of course! If the government does a project at a profit (where benefits outweigh costs), maybe a road or a stadium, that means that a project that would have been done privately has been usurped by the government, where the government will most likely execute the project much less profitably than private business. And to do these projects, the government amasses huge deficits each year, which a private business would call a loss. Without any motive for profits, which modern liberals claim to be a good thing, taxpayers lose money with each dollar they send to the government and the government makes losses on top of that instead of profits. With losses accrued by both the buyer (taxpayer) and seller (government), wealth is being destroyed.

As Winston Churchill said, "It is a socialist idea that making profits is a vice; I consider the real vice is making losses." As this "stimulus" package takes hard earned money from taxpayers and government bureaucrats waste the money away on unprofitable projects, remember that any plan which destroys wealth, as this plan does, is full of costs and has no benefits.

Wednesday, February 25, 2009


First Obama gets his $787 billion stimulus bill. Then he adds $250 billion for his foreclosure plan. After spending all that money, he promises to halve the deficit. But then today, Obama announces a 10-year, $634 billion health-care plan.

My calculator must be broken. It tells me that Obama is raising the deficit, not reducing it.

In this deep recession, how many people believe that our current government is too small and taxes are too low?

Sunday, February 22, 2009

Corporate Bond Deception Point

I never really understood the allure of corporate bonds. To me, it seems that corporate are simply a hybrid of equity and Treasury bonds. If Treasuries yield 6% and stocks grow at a 10% rate, corporates will yield something in between. Where in between depended on how much extra risk you were taking.

For years, corporate performed fabulously well. Investors got their above Treasury rate return with very few defaults. But this false sense of security did not last long. In the 18 months, many highly rated companies, such as the major financial institutions have seen their bond value sink as the risk of default surges. As a result, corporate bonds acted more like equities than Treasuries.

Let us look at LQD, the iShares iBoxx Investment Grade Corporate Bond ETF. The LQD has an effective duration of 7.16. By comparison, the IEF, which is the iShares Barclays 7-10 Year Treasury ETF, has an effective duration of 6.98. Nearly the same so a very good comparison.

Let's start by looking at the chart since LQD started trading 2002.

As you see, LQD rises pretty steadily for the first five years, outpacing the steady rise in the IEF, as expected. But when the stock market starts falling in late 2007, the LQD stops rising while the Treasury rally picks up steam. In the fall of 2008, corporate bonds crash nearly 20% before recovering most of the losses whereas Treasuries surged higher. All of a sudden, corporate bonds were acting more like stocks than Treasury bonds.

I think we can break this up into two periods. The first, July 2002 to June 2007, the LQD tracked the IEF very closely. In this period, LQD has a 93% correlation with the IEF but a negative 10% correlation to the SPY.

But from July 2007 to January 2009, the LQD shifted away from tracking Treasuries and towards stocks. In this second period, the correlation between LQD and IEF dropped to 56% while the correlation with the SPY rose to 38%.

Looking at that first period, we see that IEF had a total return of 32% while the IEF returned 21% and SPY rose 79%. To mimic the LQD, one could have put 80% of their portfolio in the IEF and 20% in the SPY. In the second period, the LQD fell 0.7%, not bad at all. But the 80/20 portfolio would have actually gained 9.3%.

During the entire period, LQD had an average annual return of 4.7% with a 9.3% standard deviation. On the other hand, the 80/20 portfolio returned a larger 5.3% with a standard deviation of just 5.9%.

Seems to me, that corporates are a bad deal for long term investors or for people relying on them for retirement income. The LQD though may be a great trading device for those who can predict when and how the correlations will change.

Friday, February 20, 2009

The Lost Decade

Everybody is trying to figure out what caused our current financial crisis. There are in fact many factors that led us to this place, including lack of private savings, high government spending and debt, and loose monetary policy.

But those factors have been around quite a while before we fell off the edge of this cliff. Many will argue that those factors alone are enough given enough time. While I agree with that, we did in fact have a moment in our recent history which led to the acceleration of our wasteful ways and made our current crisis a reality.

In 1998, Long Term Capital Management was sitting on top of the world. That is, until they got hit by huge losses. To avoid a total market collapse, or so we were told, the Fed organized the major banks to put in billions of dollars (now considered pocket change) and take over LTCM. To help the financial system and the new owners of LTCM, the Fed dramatically lowered interest rates, even though the economy was performing well and did not justify lower rates. It also created a moral hazard, whereby failing companies will get bailed out, encouraging risky bets knowing that the rewards will be huge but the risks will be limited as the government eventually bails out those that are "too big to fail." This combination of monetary inflation and moral hazard led to a rampant wave of speculation, first in the stock market with Internet stocks creating a bubble that ended in 2000, followed by a bubble in real estate, followed by yet another bubble in commodities.

Thanks to the government's loose money and the moral hazard, the economy over-leveraged itself and speculated on get rich quick schemes (options on Internet stocks, buying multiple houses with nothing down no interest loans) instead of saving and investing in solid profitable business ventures.

Today, the Dow hit its lowest point since October 1997. Back in 1998, the government supposedly saved the day with its actions. But the wave of speculation, bubbles, and crashes that resulted have created a lost decade for American equity investors.

Tuesday, February 17, 2009

The five political economic systems

Since so many are confused by what are the different economic systems, here are my five political economic systems based on the three factors of production: land, labor, and capital.

Aristocratic: The economic system favoring land owners is one I call the aristocratic system. In this system, the legal system and government are created and administered by the land-owners. The laws are obviously crafted to benefit them and used to keep the vast majority of people working the land for a very small share of the production. One example, from which the name is derived, is pre-Revolution France where land owners were exceeding wealthy and granted titles while the general populous were peasants living to work the aristocrat's land. The early 19th century Southern US economy with the plantation owners and slave is another example, as it Czarist Russia with the lord-serf relationship.

Socialism: Socialism is the economic system where all factors of production are controlled by "the people," thus eliminating any specific land or capital owners and, therefore, all economic benefit goes to the labor component. Additionally, since all land and capital are now owned by everybody and everybody, in theory, works to their full ability, all production is split evenly between the people regardless of the job or effort put in.

Mercantilism: When the government creates laws benefiting owners of capital, such as factories, this is called mercantilism. Mercantilist systems have protective tariffs to discourage cheaper imports from competing with local production. They will also have export duties on raw materials to keep manufacturing costs low. Obviously helping producers, it hurts consumers through higher prices for goods.

Capitalism: Capitalism is the system whereby the government avoids any economic intervention and allows the three factors to compete freely. The term capitalism implies that this system benefits capitalists, exactly what Marx wanted when he invented the term. Now, we often call it laissez faire or free market capitalism to ensure that the listener understands that what is meant is a government that does not interfere with the economy.

Interventionism: Sometimes, the government will interfere in the economy with the goal of maintaining equilibrium between the three factors. This can come about in one of two ways. In the first way, political parties will each push their programs which counter each other. Party A passes a law benefiting land owners while Party B passes a law benefiting workers, thus offsetting each other. The second way is through sudden action. In the early 20th century, in order to combat socialism, the fascists gained control of many government. They created big government, not necessarily to benefit one party over another, but to stop the socialists from benefiting labor over all others. With intervention, we get a complicated system that generally evens out, though the result is a big cumbersome government. The government bureaucracy makes the economy less productive and the people worse off.

Look at the violence inherent in the system

Unfortunately, four of these political economic system lead to violence, as we have seen throughout history.

The aristocratic system creates an environment where land-owners fight for control over more land. More land equals more wealth and more production, so the competition to own as much land as possible is intense. Furthermore, if a land-owner gains enough land, he can become a lord or king, ruling over both the land in his possession and the people who live and work on it. Eventually, two or more kings will fight to create their own empire.

Socialism results in war wherever it appears. Right from the start, socialism requires the confiscation of land and capital from their owners. The owners of land and capital, not willing to give up their possessions, are thrown in jail, banished, or killed. Furthermore, this oppressive system must be maintained forever to prevent an intelligent and industrious worker from saving money and starting his own business. History has proven that socialism also results in international wars. Given that socialism requires internal violence, it is no stretch for that violence to applied internationally. The goal of socialism is the overthrow of the capitalists and to impose shared ownership of property by the working class. This goal knows no borders. Polish workers have just as much right to equality as the Russians and the Russian socialists will use their strength to help the Poles achieve that goal, whether they want to or not.

Most of the wars fought between the early 16th century and mid 19th century were fought over mercantilist policies, including the imperialist desire for colonies. The Spanish empire established colonies in the new world to get their precious natural resources, especially gold and silver. But more common, such as with the British and Dutch empires, was to establish colonies for which to trade. The colonies were forced to trade only with the home country, thus benefiting the home country. The famous war between England and the Spanish armada was fought over trade. Most of the wars between England and France were as well. The Spanish-American war was fought for the right to trade with the Philippines and West Indies. But mercantilist wars are not just between two competing countries. In the mid-1800s, the North outgrew the South in both population and economy. Gaining seats in Congress and the Presidency, the North imposed high protective tariffs on finished good imports and duties on raw material exports. Thus, the North made finished goods more expensive for the South and Southern crops, such as cotton and tobacco, went down in price. The result was the Civil War.

Interventionism, being a mix of the previous three systems, can cause wars in any of the above mentioned way. But interventionism also creates an ongoing internal war for control of the government. With a large government precariously balanced evenly between the three factors, a single party gaining enough power can quickly change the laws to its own benefit. In the US, the political system was designed to make it extremely difficult for any single faction to gain complete control. When the mercantilists gained control in the mid-1800s, full scale civil war broke out. Most of the time, people live peacefully in the interventionist system, but it must always result in war when one faction eventually gains too much control. Obviously, when a single faction gains majority control of government, international war also becomes more likely as they advance their policies. As mentioned above, the mercantilist wants to conquer colonies, the socialist wants to spread socialism, and aristocrats want more land. And each will pursue that through war if they gain control of the government. In fact, it is not necessarily required for one faction to gain total control. If two factions agree, even if for different reasons, that the invasion of a foreign country is beneficial and those two factions combine make up a majority, the war will occur as those two factions will outvote the third faction and any capitalists in government.

Capitalism is the only system designed to bring lasting peace. In a capitalist system, the government has just four goals: to protect our life, liberty, property, and peace. Without a government that influences everything we do, political factions have little reason to exist. Gaining control of the government will not enable one faction to benefit themselves as the government has very limited power. There will still be crime, as there is in any system, but two capitalist countries simply want to trade freely with each other and have no reason to fight each other. In fact, the capitalist country has no desire to make war on any country, even socialist, mercantilist, interventionist, or aristocratic countries. The capitalist realizes that free trade is the best method, but also that a war to open up trade with an unfree country is unproductive. Not only will the war most likely cost more than the benefits accrued, the capitalist country must in fact give up capitalism to fight this "pro-capitalist" war. In order to fight a war, the government must raise taxes to pay for it, employ soldiers to fight, and buy equipment. Thus, any war requires the government to infringe upon the people's life (dead soldiers), liberty (draft, taxes), property (taxes, military equipment), and peace (war). War is therefore impossible in a truly capitalist system.

However, countries based on the other economic systems may attempt to conquer the capitalist country to benefit themselves. As mentioned above, one of the four goals of the capitalist system is peace. Capitalist countries need some method of defending their life, liberty, and property from foreign attack in order to maintain peace. Primarily, having a method of defense acts a deterrent, causing enemies to think twice before breaking the peace. Secondly, the defense must be used to repel any attack that would make the conquered less free.

Friday, February 13, 2009

Laws and sausages

As Congress votes on the stimulus bill today, without even having read it, I am reminded of this quote disputedly attributed to Otto von Bismarck: "If you like laws and sausages, you should never watch either one being made."

Wednesday, February 11, 2009

Open immigration in a welfare state

Ludwig von Mises has a brilliant argument for open immigration policies in a section called "Freedom of Movement" in his book Liberalism. While open immigration in a liberal world is definitely something to fight for, we unfortunately don't live in that world yet.

Our country and the world would benefit from increased immigration, but not if we extend free health care and other benefits to immigrants. In our current welfare state, each immigrant becomes a burden instead of an advantage. Furthermore, those most likely to immigrate are not the hard workers who wish to take advantage of America's freedom and economic opportunities. Instead, it is those looking for a free ride on America's generosity.

In an ideal world, in Mises's liberal world, open immigration would make us all better off. But in our current welfare state, allowing open immigration would bankrupt our country.

Tuesday, February 10, 2009

Only the government can save us now

In yesterday's nationally televised speech (I missed Chuck because of this, damn them!), President Obama said "the federal government is the only entity left with the resources to jolt our economy back to life."

What resources does the federal government have exactly? The government is in debt to the tune of trillions of dollars and expected to run a more than one trillion dollar deficit before this "stimulus" plan is added to it. The government has no resources to use. But it does have the power to tax, borrow, and inflate. Regardless of which method it uses to pay for its grandiose schemes, it is the American people who will pay for this, whether we want to or not.

If the American people will bear the burden, the government should just let us keep our money and spend/invest it as we see fit. But the government has other ideas. The government will spend our money and then take credit for fixing the problem. And if the problem doesn't go away, they just say that they didn't spend enough and propose a new even larger stimulus plan.

Monday, February 9, 2009

Mises on public works

"It is obviously futile to attempt to eliminate unemployment by embarking upon a program of public works that would otherwise not have been undertaken. The necessary resources for such projects must be withdrawn by taxes or loans from the application they would otherwise have found. Unemployment in one industry can, in this way, be mitigated only to the extent that it is increased in another. From whichever side we consider interventionism, it becomes evident that this system leads to a result that its originators and advocates did not intend and that, even from their standpoint, it must appear as a senseless, self-defeating, absurd policy."
Liberalism, Ludwig von Mises

Sorry, but not really

Today, Alex Rodriguez admitted to steroids use from the period 2001-2003. My problem with this is that we've been talking about steroids for years and he kept quiet hoping nobody would find out he was doing them as well. Now that he's been outed, he admits his guilt and says he is sorry.

This reminds me a lot of President Obama's cabinet picks. They "forget" to pay their taxes until they are caught. Then they finally admit their mistakes and hope everybody will forgive them.

A-Rod and these cabinet nominees are not sorry they broke the law/rules. They are only sorry that they got caught.

Kerry: Government knows best

John Kerry: If you put a tax cut into the hands of a business or family, there's no guarantee that they're going to invest that or invest it in America. They're free to go invest anywhere that they want if they choose to invest.

This is the perfect illustration of the difference between individualism and collectivism, private property and government. If the government allows us to use our money as we see fit, we obviously will seek to maximize our returns. Each individual will determine whether he should spend that money, pay down debt, invest the money in the stock market, or invest it overseas. In this way, each person will maximize his own happiness.

The government thinks it is smarter than the citizens it rules over (Hayek's fatal conceit). Thinking it knows what is good for the people, the politicians and bureaucrats decide what to do with our money. But their "one size fits all" solution is guaranteed to make only some people happy. Politicians, unlike individuals, try to maximize the happiness of "society" and not of each individual. In reality, a good politician will please just over 50% of the people in order to get reelected. And that's the good politician. The bad politician will actually make the majority of people worse off.

In this "financial crisis," the government should stop trying to help the people, which is guaranteed to hurt a large percentage of the population. Give us our money back and let us decide how best to spend or invest it.

PS This is from a purely economic standpoint. Even if the government were able to help each individual to the maximum effect, we are still ignoring the loss of liberty we have suffered as the government takes our money and decides how to use it. How many of us would sell our freedom for a few dollars? We sacrifice our freedom in exchange for the government's programs that the promise will help us. If the government delivers, what we have lost, our freedom, far outweighs what we gain. But since the government consistently overpromises and underdelivers, we in fact sacrifice our freedom for government programs that make us worse off.

Wednesday, February 4, 2009

Subsidized Housing

AP: "The Senate voted Wednesday night to give a tax break of up to $15,000 to homebuyers in hopes of revitalizing the housing industry, a victory for Republicans eager to leave their mark on a mammoth economic stimulus bill at the heart of President Barack Obama's recovery plan."

We got into our current financial crisis because the government created too many incentives for home ownership, such as the mortgage interest deduction, subsidized interest rates, the Community Reinvestment Act, and others. These subsidies and incentives created a real-estate bubble which inevitably burst, bringing down the entire world economy with it.

Instead of letting house prices fall to their real value, the government wants to prop them up. They are simply repeating the same mistake that caused this problem.

"Insanity: doing the same thing over and over again and expecting different results." Albert Einstein

Losing our high paying jobs?

I have something to add to my previous post.

Not only will executives leave the public financial industry due to these wage caps, many will move overseas where they can work at Swiss, Japanese, Chinese, or tax-haven banks at much higher wages.

President Obama wants to save the taxpayers a few dollars, though the salaries of these executives are nothing compared to the two trillion dollar deficit he is creating. But the costs will outweight the benefit as these high paying jobs move overseas.

Capping wages has negative effects

From AP: "President Barack Obama on Wednesday imposed $500,000 caps on senior executive pay for the most distressed financial institutions receiving federal bailout money, saying Americans are upset with "executives being rewarded for failure.""

While this might sound like good news for taxpayers, it is worrying. Why would a qualified executive go to work for one of these financial firms instead of working at a hedge fund, private firm, or industrial company where he can earn much more? As a result, financials firms will have trouble recruiting the executives they need.

"There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen." Frederic Bastiat

Obama sees the money taxpayers will save in the short-term. He is a bad economist. A good economist also sees the negative long-term effect of this market distortion.

Tuesday, February 3, 2009

Cycle of Economic Violence

"The Senate voted Tuesday to give a tax break to new car buyers, setting aside bipartisan concerns over the size of an economic stimulus bill with a price tag edging above $900 billion."

Why are the Democrats in Congress trying to help sell more cars? Don't they know that these are pollution machines? I thought the Democrats would rather use the money on "green" projects. When you are throwing around money, I guess you can do both.

As all Austrians know, every government solution creates a new problem for the government to solve. This mass transit vs. automobile argument is the pinnacle of government problem creation and solving. First the government builds roads and gives a tax break to encourage car purchases. Then some people complain about the pollution and "urban sprawl" that the subsidized roads and cars helped create. To fix this problem, they fund mass transit projects and restrict oil production to cut back on pollution. This discourages driving and auto purchases, especially when oil spikes up to four dollars a gallon because no new refineries or oil fields have been opened in decades, requiring the government to help the auto companies through tax breaks, loans, bailouts, and increased gas production. All of a sudden, people start driving again, hurting mass transit and increasing pollution, starting the cycle over again.

People complain about the "cycle of violence" in wars. This subsidizing of both automobiles and mass transit is a cycle of economic violence that destroys billions in wealth.

Monday, February 2, 2009

More tax evasion

First Secretary of the Treasury Timothy Geithner. Now, Health and Human Services nominee and former Senate Democratic Minority Leader Tim Daschle failed to pay more than $120,000 in taxes.

Somebody please explain to me why I shouldn't evade a hundred or a thousand dollars worth of taxes when our "leaders" evade ten or a hundred times as much.

Why Trading Systems Don't Work

Years ago, I built a trading system. For years, it worked very well, beating the market by significant amounts before the current market turmoil which began in late 2007. In 2008, the system stopped working and I lost a lot of money (though I didn't fully "blow up"). As a result of losses greater than any period I had back-tested or forward-tested, I no longer have confidence in my system.

Even when my system was generating big profits, I often questioned how one can be sure that his system will continue to work. Unfortunately, I ignored these doubts. But now that these doubts have been confirmed, I believe that it is either impossible or extremely unlikely to develop a winning trading system.

I won't be looking at problems with trading systems, such as curve fitting, but "problems" with the market that kill trading systems

Backtest Period

I used to laugh at people who backtested just 10 years. I had backtested my systems 50+ years so I could include a number of bulls and bears. But the decline of 2008 was nothing like anything in the past 50 years, though the 1973-74 bear market is a close similarity. And the double dip of 2000-2003 and 2008, where the market fell 50%, recovered the losses, and immediately lost 50% again is definitely something we hadn't seen since 1929-37. But even if I backtested back that far, that would only include one such period. In order to model the market, I'd need multiple similar periods to create rules to trade by. To include many market panics, bears, and depression, I'd have to backtest well into the 1800s. But economic and financial data from that period is sparse, making it impossible to develop a trading model that will work in the long run.

Survivorship Bias

My trading system was based on the US stock and bond markets. Why? Because that's where I live and that's the biggest market. But what if I had lived in England in 1914? England was still the financial capital of the world at that point, but was about to lose that status. Or what if I lived in Japan in 1989 which was growing like crazy but about to stagnate for an entire generation. Or Argentina or Southeast Asia before they blew up? You can't select one country that happened to thrive and ignore the losers because you don't know which will thrive and which will die in the future.

This problem could be solved by trading in many countries around the world. If your system is correct and goes long the best and short the worst, you would actually benefit from the fact that many countries don't survive. But trading foreign markets was not really possible until modern telecommunications became affordable a couple of decades ago. Even so, trading overseas is often expensive, difficult, or impossible if the country restricts foreign ownership of stock. Over the past 20 years, China has certainly been the top performing country, but for many years foreign ownership was illegal and even now it is restricted.

Changing Rules

Creating a trading system based on the last 50 years of data implies that the rules of the last 50 years would stay the same. That is obviously not true. Over the last 50 years, interest rates never went negative, until they hit zero and actually went negative in 2008.

Statistical probability states a market is so unlikely to move 10 standard deviation that we should simply ignore that possibility. At least, that is what we were told. But then the market did exactly that in 1987. Long Term Capital Management also suffered one of those "hundred year events" in 1998. The "black swans" occur much more frequently than standard statistics assumes.

Besides market rule changes, there are also legal changes. In 1933, FDR confiscated Americans' gold bullion and broke any contract based on gold instead of the dollar. After World War II, the dollar was again fixed to gold until Nixon took us off that quasi-gold standard. As a result, currencies floated against each other and currency trading boomed. These legal changes had great impact on how markets acted and how trader could profit. Old systems stopped working and new ones must be developed.

Maybe the biggest rule change of all was the closure of the stock market for 4 months after the breakout of World War I in 1914. A profitable trader would have lost four months of income and had his capital tied up. How many traders today would be able to survive an extended market closure, even though that possibility is so unlikely with electronic trading.

And then there is government manipulation. The power to set interest rates, most often lower than they should be. The power to print money. Selling gold from our reserves in order to push down its price. Wars to gain control of natural resources. Repurchase Agreements and Reverse Repurchase Agreement to temporarily move the stock market.

What is to stop the government from shutting down the stock market or making gold bullion or any other investment illegal? How will the government manipulate the market today or this year? Your system, which is always correct, could say one thing and that thing would have occurred if the government didn't manipulate the market against you.

When one looks at 2008, the rules have certainly changed. Interest rates are being set at artificially low rates of 0% for the Treasury Bill and about 2% for the Bond. Banks are being nationalized. The federal government's spending and budget deficit is rising to record peace-time levels. No trading system could have predicted these events and the effect they would have on the market.


Long-term statistical trading systems don't work. As Jesse Livermore/Larry Livingston says in Edwin Lefevre's Reminiscences Of A Stock Operator, "A man may beat a stock or a group at a certain time, but no man living can beat the stock market! A man may make money out of individual deals in cotton or grain, but no man can beat the cotton market or the grain market." A trading system may make money for a while, but no system can "beat" the market. As a result, long term systems are a waste of time and short term system must be kept on a short leash, trading them while they work but being prepared for them to stop working at a moment's notice.

Frank Shostak concludes his "What is Wrong With Econometrics?" with: "Rather than viewing econometric models as a sophisticated technique that can discover the hidden truth about the economy, we should regard them as clumsy and expensive extrapolative devices, which have nothing in common with reality. Anyone who decides to use models as an analytical tool or a forecasting device runs the risk of seriously confusing himself." In the same article, he cites Mises, "As a method of economic analysis econometrics is a childish play with figures that does not contribute anything to the elucidation of the problems of economic reality." The same, I believe, would be true about trading systems.


If you want to trade the market, you have to look beyond the statistics and throw out what has worked in the recent past. You need to study history going much further back. Study the Great Depression and its causes. The Panic of 1907. The many panics of the 1800s. The history of previous empires and their falls. Most importantly, study Austrian economics. With Austrian economics, you will see how the government caused our current crisis. And you will learn how the current government intervention is doing more harm than good. And you will learn how capitalism, if it is allowed to work, will lead to further prosperity.