Monday, November 8, 2010

It's Like Musical Chairs, But There's No Chairs

In his latest post "Dependency, the Fed and the Market," Charles Hugh Smith argues that the "the U.S. stock market is increasingly dependent on the the Federal Reserve's constant interventions to maintain the illusion of an organic demand for equities," and this "growing dependence on the Federal Reserve will end like all dependencies--badly."

Actually, the U.S. stock market is dependent entirely on high frequency trading (HFT) to maintain the illusion of an organic demand for equities.  Unfortunately, as my investment advisor tells me, withouth HFT right now, there would be no liquidity, and the market would crash.  Or, as my wife summarized in plain English, the stock market "is like musical chairs, but there's no chairs," and HFT is the music, not the Fed. 

To be clear, the Fed is playing a very important role: it is distracting usually insightful people like Smith from fully understanding the deeper game.  Smith routinely shows that he sees the outlines of the deeper game, which must play out over a longer timescale, yet he also routinely allows his vision to be obscured by daily events that, when put in their proper context, are not worthy of attention.  For example, see his post of November 1 (which I critiqued here), and then compare it to CHS's post of November 2.  In the first post, he argues that the Fed is foolishly blowing an asset bubble that must collapse.  In the second post, he argues that the size of QE2 is nowhere near enough to blow an asset bubble.  He got it wrong in the first place, but upon further reflection, he got it right.

I'm still trying to figure out what I can learn from this phenomenon because everybody is susceptible to falling victim to it.  If I were to summarize my current thinking it would be that each of us has blindspots created by biases, and the key to eliminating the blindspots is detecting the biases.