Tuesday June 7, 2005 - 11:01:39 GMT
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Day 2: Dollar correction? Place your bets!
“Just as one day some primitive tribesman scratched his nose, saw rain falling, and developed an elaborate method of scratching his nose to bring on the much-needed rain, we link economic prosperity to some rate cut by the Federal Reserve Board, or the success of a company with the appointment of the new president ‘at the helm.’”
Nassim Taleb, Fooled by Randomness
This is from the Financial Times this morning…
“Alan Greenspan, Federal Reserve chairman, on Monday night highlighted the unusual behaviour of global bond markets, and acknowledged that investors might be correctly signalling a period of economic weakness ahead. …
"The economic and financial world is changing in ways that we still do not fully comprehend," Mr Greenspan said.
And it goes to the point we tried to make about economics yesterday—science it is not! If the world’s top economist doesn’t fully comprehend, how do we?
Now that we know science and economics are not, shall we say, closely linked fields, let’s take one step further toward the end of the diving board with the help of Benoit Mandelbrot, the fractal master, from his book, The Misbehavior of Markets [our emphasis]:
“…The implicit assumptions in all this: If one knows the cause, one can forecast the event and manage the risk.
“Wish it were so simple. In the real world, causes are usually obscure. Critical information is often unknown or unknowable, as when the Russian economy trembled in August 1998. It can be concealed or misrepresented, as during the Internet bubble or the Enron and Parmalat corporate scandals. And it can be misunderstood: The precise market mechanism that links news to price, cause to effect, is mysterious and seems inconsistent. Threat of war: Dollar falls. Threat of war: Dollar rises. Which of the two will actually happen? After the fact, it seems obvious; in hindsight, fundamental analysis can be reconstituted and is always brilliant. But before the fact, both outcomes may seem equally likely. So how can one base an investment strategy and a risk profile entirely on this one dubious principle: I can know more than anybody else?
“In response, the financial industry has developed other tools. The second-oldest form of analysis, after fundamental, is ‘technical.’ This is a craft of recognizing patterns, real or spurious… This discipline, in disfavor during the 1980s, expanded in the 1990’s as thousands of neophytes took to the Internet to trade stocks and insights. It truly thrives, however in currency markets. There, all major ‘forex’ houses employ technical analysis to find ‘support points,’ ‘trading ranges.’ And other patterns in the tick-by-tick data of the world’s biggest and fastest market. And in the fun-house mirror logic of markets, the chartists can at times be correct. Sterling/dollar quotes really can approach a barrier. But this is a confidence trick: Everybody knows that everybody else knows about the support points, so they place their bets accordingly. It beggars believe that vast sums can change hands on the basis of such financial astrology. It may work at times, but it is not a foundation on which to build a global risk-management system.”
Wow! Game, set, and match goes to Mandelbrot. His point, and though it may be refuted, makes eminent sense to us: Financial theory is badly flawed. One only need view reality to see theory get crushed daily. Mr. Mandelbrot believes there is a lot more risk in the system, at times, that we realize. Bingo!
So now we debate the risk and virtues of low long-term interest rates. Is it a harbinger of recession? Or will it juice the wheels of industry? And because it is so difficult to even forecast rates, let alone the eventual impact, lets all go one step further (we plead guilty) and use this flawed forecast to then decide how it will impact currency markets. We couldn’t make this stuff up if we tried.
Dollar correction day two! Or is it a new trend? Step right up and place your bets!
Black Swan Capital
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