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Why Nobody Beats the Smart Money

10/14/2011 8:00 am EST


Andy Waldock

Founder, Commodity & Derivative Advisors

So-called “transparency” in the markets has actually created a heightened edge for big institutions, which can leverage their resources and huge pools of money to exploit government and central bank policies.

Effective trading in the markets has historically taken one of two routes. The first route understands the macroeconomic landscape that allows producers of copper in Argentina to sell it to China as they develop massive infrastructure projects.

The second route has been through providing market liquidity. This has involved acting as an intermediary in the production-to-final-use chain. Grain elevators are a good example of this.

Both of these endeavors entail risk on the traders’ behalf. Over the last 20 years, a third type of trading has taken center stage: the institutional guarantee. 

The institutional guarantee is risk free and sold to the voting public under the auspices of governmental transparency. The public has the right to know what the next stimulus program, jobs program, interest rate policy, trade sanctions, etc. are going to include, as well as when and how they’re going to be implemented. It is our right as voting citizens to be included in the decision making process.

There are two realities that emerge from this process. The illusory feeling of inclusion is really the maximum benefit the general public can receive from this information. The tangible effects of these programs have little effect on any of us, individually. We may get a stimulus check or at some point be able to refinance our homes, but the push for full disclosure has very little tactile impact on our lives.

The second reality is that institutions with massive capital can leverage government and Federal Reserve policy into an artificial backstop. Transparency is actually causing more problems than it solves.

Institutions who have teams of lawyers and accountants to dissect the latest minutes from Capitol Hill or Ben Bernanke’s latest testimony before Congress filter through it with magnifying glasses to find exactly what loophole there is to exploit.

See related: Trade Like a Hedge Fund Manager

The exploitations of these loopholes combined with the expected accountability of the government to back up their policies has been creating economic bubble after economic bubble. There is no incentive for legitimate market strategy or need for allocating a portion of a portfolio to speculative markets when a guaranteed return can be had through leaning on economic policy.

This has always been part of the way business has been done. Historically, it was limited to a few people or firms with the right board members or being part of the right social circle. The deals had potential for huge gains.

Think of westward expansion and the railway industry or the creation of entire neighborhoods of public housing. These deals were independent, local, and a small part of the overall capital pool. The information age has diminished the profit margin on these deals if for no other reason than to keep public uproar to a minimum.

The institutional-guarantee trader has simply swapped out declining profit margins for increased leverage. This has funneled more and more capital from all over into smaller pockets of profitability, therefore metamorphosing smaller, non-related pockets of exploitation into something global and systemic. This is how we ended up with the current global banking crisis.

There will always be people who are better informed or who make better decisions; that’s the way it’s supposed to be.

Using analytical skills to make a dollar is the American way. My suggestion is that our own thirst for information may be hindering the effectiveness of policy decisions. When Paul Volcker put the clamps on inflation, his intentions were clear, but the Fed’s implementation of that strategy was announced in the papers after actions were taken.

This protocol eliminated the free-ride opportunity in the financial markets. The same can be said for the handling of the savings and loan crisis when more than 700 banks were allowed to fail. America was made a great country by pioneers and visionaries willing to step out and put their money where their mouths were. No one should be “too big to fail,” and no one should be given a free ride, even if it is framed as “Keeping Americans in the loop.”

By Andy Waldock of Commodity and Derivative Advisors

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