Banks Are Causing Deflation

Last year I have predicted that 1% stimulus package enacted by Bush will do nothing for the economy. That prediction has unfortunately proven to be true. Economy now is in a much worse shape. Last quarter GDP contracted at annual rate of 4%. Unemployment has risen sharply. Even in California where I live, home to most vibrant investment, start up and high-tech community, the unemployment is now at 9%.

I have also argued that banking standards had to be lowered not tightened and that interest rate be reduced or caped. In September 2008, I have written that banks should be only bailed out if the interest rates were capped. Opposite has happened. Banks received funding but has not resumed any lending. Mortgage rates stayed the same despite fed rate reduced to virtually zero. Banks are saying that they are helping home owners to work out mortgages but in fact they are sending work out packages that are more onerous than existing mortgage. Many of the home owners are upside down on their mortgage, which means the can't sell, move or refinance. As a result housing crisis is accelerating, more foreclosures, more wealth destroyed and more people are suffering.

Fear of inflation has been replaced with fear of deflation. How is possible you would think with so much of government's injection of money? I suspect that the reason is that the banks are "sitting" on it. By not lending, banks are effectively reducing money supply thus causing deflation.


One way that monetary expansion can occur is to get around the banks - such as direct funding of specific projects, which is the aim of Obama's stimulus package.


So, will the Obama's package which is about 10% of GDP work? In such a deep crisis, I am afraid it may not be enough. In addition to government spending, credit must be made to flow again.

Obama's administration, has authorization to use second have of TARP money. They need to put restrictions on the use of those funds to be directed towards reducing lending rates and reducing lending standards (now even people with excellent FICO scores are refused credit).

The banks that do not sign up to this plan should be allowed to fail.

Trading Resumed and Why I Never Achieve Hypothetical Trading Returns

I secretly resumed trading Best Market Chances and Have Fun as they have again proven resilience. If I had stuck with these two systems all last year despite heart stopping drawdown period my investment of $50,000 could have grown by $70,000. Instead I barely got some gains. I still have not figured how much. When I do, I will sure to publish.

Following are the main factors of such huge discrepancy

1) Fear. Whenever trading system does something you don't expect you think its broke. Statistically there is much higher likelihood that the system is broke then a simple drawdown. So you pull the plug.

2) Technology. Routing trading system through my computer at home was a big mistake. Lots of lost orders due to multiple hardware, software and communications issues. Now I use OpenECry, the broker which receives orders directly from Collective2 web site. No problems yet.

3) Money Management. Using Have Fun I could be trading two or three contracts and still have the same volatility as Best Market Chances. Instead I succumbed to fear and traded one.

4) I did correctly killed two systems before they took me down. More fear!

Another issue that I worried about was slippage. However, at least with these two systems slippage was not a huge factor. So you can pretty much get close to the performance reported by Collective2.

Ok, now that I fixed the technical issue, my conclusion is that fear is the main culprit responsible for missing gains. But it also responsible for avoiding big loss.

So as everyone else this trader is driven by greed and fear!

Therefore, if I new the system would not break, I would be able to make a sizable gain. However, if I blindly trusted the system I would most likely suffer a sizable loss. So my returns are determined in large factor by my ability to distinguish a system that undergoes a sizable drawdown versus complete break down.

Few words about vendor communications. I like to communicate with the vendor and get an idea of his reasoning. However, most vendors would like to believe that their system is sound even in the overwhelming evidence to the contrary. Many will continue trading and sending signals until the system completely blows up. This is wrong, vendor should pull the plug at some point and save his subscribers from catastrophic losses. Instead some vendors keep assuring subscribers to hang on and point to previous record of accomplishment.

Think about this analogy - you are driving in a car and tracking your progress on the map. You can go slower or faster, but you pretty much able to plan how long its going to take you somewhere based on your average speed. This what happens when we consider a trading system: if you selected a system at some point in time it was because a particular system did not blow up yet. You can look at the stats and decide that this is the vehicle for you to take you into the future. You figure, sometimes it will go fast, sometimes slow but on the average it will gain so many $ / month and you will get to your destination.

Let's say there is a detour in the road and you have to backtrack and take a different road. Now the distance to your destination increases. This is similar to your system is going through a drawdown. Hopefully, you will get through the detour and will be back on your way sooner or later. Your system sooner or later will get out of the drawdown. Keep in mind that time to your destination is determined not so much by your average speed before the detour but how big the detour really is. It could delay you by half hour or by 12.

Now consider a tornado in your cars path. It lifts your car and throws it across the two lanes of high way into the ditch and the car is completely totaled. Miraculously you come out of it unscathed! Every, second after that you average speed begins to fall like a rock. A this point using previous statistics simply does not make sense. Same thing goes for a trading system, there could be something about the market that has changed, and the system that worked over some period of time met its demise. It could be a new regulation, it could be a new large trader that entered the market, it could be some other subtle way that markets interact with each other. Staying with it after that point would make as much sense as sitting in a totaled car and waiting for it to get moving again.

Recognizing your situation and making human decision is the main reason why we can not achieve the hypothetical returns shown on Collective2 and other similar web sites.

Finally fewer homes built then needed.

As I have written last March there are approximately 1.2 M new households created each year. Now 4 years after the housing market peaked in 2005 we are seeing new construction fall bellow what is needed. New housing starts are now at 0.6 M which is about 50% of household growth. Keep in mind that it takes awhile for a new start turn into a new completion. And completions still have not fallen as much as starts: the latest figures show 1 M completions. (Still less then household growth).

At this rate it will still take several years to work of the inventory of homes that were built in access of demand but the tide has turned.