Wall Street Financial Truth

Chapter 11 Who Emptied Your Wallet (2)
In layman's terms, inflation is like a person having a high fever, and if it happens occasionally, it may increase resistance.But once you have a high fever for a long time, the brain will burn out; and deflation is the fever reduction, which is a necessary process for restoring health.Of course, a normal body temperature (no inflation or deflation) should be the best normal state. Only by maintaining a normal body temperature can the economy develop in a truly healthy way.

No matter how artificially adjusted, inflation will definitely be followed by deflation, just as natural as the moon's full moon.Japan has grown rapidly for 30 years, followed by 20 years of deflation, characterized by the fact that 100 yuan this year is equivalent to 103 yuan next year, which is equivalent to a deflation rate of 3% per year.Japan has been in deflation for 20 years, and the "panacea" to loosen the currency is no longer effective. Adopting zero interest rates or even negative interest rates does not work.Why is the panacea (spamming currency) not working?Because the previous hole was too big, and the issuance of new currency will only fill the old hole. The money that everyone spent before is money that will not exist tomorrow.

This financial crisis is said to be once in a century, but it is actually the outbreak of drug addiction that has been encouraged by loose money and credit in the past few decades, and the punishment is only just beginning.At present, continuing to loosen credit can only aggravate drug addiction, which is of no help; Detoxification means moderate deflation, deleveraging, and gradually filling up the holes.Although the process is slow and painful and may last for a decade or so, it is a necessary path to recovery.If we continue to take poison, we will be completely collapsed!

3. Anti-inflation and anti-deflation
The current financial crisis is far from calming down, and the central banks of various countries cannot raise interest rates yet, so everyone feels that severe inflation is imminent.The stock market is already riding high, the housing market remains volatile, and other assets are almost in bubbles.China's economy is cooling down, the demand for bulk commodities is decreasing, and prices are also falling. It seems that gold is the last bastion left.

Will severe inflation really come?I beg to differ.In my opinion, there is no danger of inflation at all, and deflation should be more worrying now!

Before the financial turmoil, the inflation that lasted for many years was "created" by the banks' expanding lending business.During that period, both borrowers and lenders were buoyed with confidence, which drove up the amount of borrowing, which is the so-called excess liquidity, forming inflation.After the financial crisis, the willingness of banks to lend has undergone fundamental changes, so the money supply has also changed accordingly.Now that companies are laying off employees continuously, the public has lost confidence in the future, and people are tightening their wallets. How can there be inflation?

In fact, since 2009, Americans' living expenses have dropped by 0.5%, clothing prices have dropped by 0.4%, entertainment consumption prices have dropped by 1.1%, and travel prices have dropped the most, reaching 3%.Most notably, food prices fell by 0.7%, reflecting the severe deflationary pressures now on the market.

Over the years, Wall Street has "created" huge amounts of "wealth" by using derivative securities, such as MBS, CDO, CDS, etc.According to the data disclosed by the Bank for International Settlements, in 2007, the market value of various financial derivatives in the world alone was as high as 480 trillion US dollars, equivalent to 2006 times the total global GDP in 10, and the average person on earth was 8 US dollars.If there is really so much money in the world, wouldn't it be possible for the world to be unified and enter communism?
At present, the reason why people are worried about inflation is that governments around the world are bailing out the market, thinking that it will start the money printing machine and greatly increase the money supply.According to the forecast of economists, in the next five years, the virtual wealth accumulated on the books over the years will shrink by half, that is, more than 240 trillion US dollars will "disappear".The currency issued for the bailout is less than 4 trillion US dollars. These seemingly large amounts of currency are actually used to fill the holes caused by excessive lending in previous years, and the effective money supply of society has not increased.In fact, when the financial crisis broke out, deflation had already arrived, which is reflected in the general decline in prices, including oil, automobiles, real estate and various consumer goods.

Over the past few years, countries around the world have paid a heavy price for this financial crisis.We should realize that economic development cannot be achieved quickly.The prosperity of the real estate market and the stock market caused by artificial excessive loosening of credit to stimulate the economy is like a mirage, and the economic crisis will come sooner or later.Once the economic crisis comes, it is even more futile to expect to artificially shorten the process of the crisis, that is, to stimulate the economy at the expense of huge deficits, or even to skip the necessary period of deflation, and it will even lead to a more serious economic crisis.

Investment expert Ian Gordon once put forward a famous Kondratieff theory. He believes that investment has a long cycle, about 60 years. This cycle can be roughly divided into four seasons: spring, summer, autumn and winter. Each season lasts from 13 to 17 years and repeats itself. ground cycle. Stocks do especially well in the "spring," when the general economy is growing.Then entered the "summer", driven by inflation, investment inflated, such as art, gold and silver and raw materials have good returns.Then came the "autumn", and the performance of the housing market in the past 15 years was particularly outstanding. The stock market and the housing market reached the extremely high levels accumulated in the previous three quarters, and then suddenly turned around and entered a long bear market.If this theory is accurate, the current global economy has entered a "winter", and this bear market is likely to last until 2020, and the severe winter has just begun.

In fact, economic inflation and deflation are as natural as the moon's waxing and waning and the ebb and flow of the tide.Man-made regulation can only relieve for a while, and excessive tides will cause tsunami and floods. Only letting nature take its course is the way of heaven. Japan's 20 years of stagnation is a lesson from the past. 20 years ago, Japan's bubble burst after rapid development. Although interest rates have been zero since then, it has remained deflationary for 20 years, just offsetting past inflation.According to the analysis of many economists, China's development in recent years, and the current economic situation, have many similarities with Japan back then.Due to the huge excess of liquidity, all kinds of assets are in the bubble.Once credit is tightened and liquidity is recovered, the economy will cool down.It will inevitably lead to a decline in the price of raw materials, and the prices of various commodities will fall accordingly, that is deflation.

Spain has experienced deflation for the first time in history!This sends a very strong signal that deflation is spreading across the globe.As the global economy enters the severe winter of full-scale deflation, holding on to cash is the kingly way, and the cash held on will appreciate in value, which is a good investment.

4. Is it all because of the computer?
Over the past few years, in order to find the culprit of the financial crisis, the American media has exploded, and everyone has different opinions and opinions.The most interesting is Alan Greenspan, who pointed his finger at advanced computer technology, saying that the current results are all caused by computers.

I entered Wall Street as a financial software engineer. After thinking about it, computers are indeed "indispensible" for the development of Wall Street to today.

On Wall Street, the primary function of computers was to store transaction information and transfer paper transaction records into the computer system, making transactions easier. As a result, the transaction volume increased sharply and the cost dropped sharply, prompting the rapid flow of capital on Wall Street.With the further development of computer technology, transactions are gradually developing towards automatic processing and automatic delivery.The rise of Nasdaq was driven by computer systems, and its over-the-counter (OTC) method stole the limelight from the original Wall Street star, the floor trader.The development of Electronic Communication Networks (ECN) has enabled buyers and sellers of securities to "meet" directly and become a huge virtual network exchange, without the need for traders to execute orders.Archipelago, one of the top five ECNs, entered the New York Stock Exchange, causing more than 600 traders who had enjoyed exclusive privileges on the floor for many years to "retire and return home".

My old colleague Peter is my predecessor, and I have been his assistant for many years.Peter has been doing stock arbitrage (Arbitrage) transactions on Wall Street for more than ten years, that is, the arbitrage behavior of the same stock in different markets.For example, if Microsoft's stock is listed in New York and Toronto at the same time, the same shares have the same rights.However, their prices often vary, such as selling for $30 in New York, but selling for $30.5 in Toronto.Pete could buy in New York and sell in Toronto at the same time, making $100 on every 50 shares between the changes.It's easy to say, but in fact such opportunities are often fleeting.At that time, Peter was watching about 10 stocks every day, constantly catching such opportunities.I can't even leave for lunch, so I often ask my colleagues to buy a lunch box for me, and grab a few bites on the desk in a hurry.Even going to the bathroom has to buy time, and it is resolved in an instant. I am afraid that I will miss a big deal if I go to the bathroom.Over time, he suffered from stomach problems and neurasthenia, and his eyes were even more near-sighted.

Later, the company began to develop a program trading system.For arbitrage trading, first, computers are used to monitor the stock prices in various markets. Once a difference is found, a message will pop up on the computer screen, and the sound of the alarm will remind you that it is up to Peter to decide whether to trade.After the first two months of trial, Peter felt much more relaxed. He didn't have to stare at the computer all day long, he only needed to pay attention to the alarm reminder, and he could also browse the Internet and pick up girls on the phone.Unfortunately, the good times don't last long!

Soon, the company further developed this program trading system, which was programmed with various pre-designed trading modes and different algorithmic trading (algorithmic trading) computer software, making it an automatic trading program system.I was responsible for the first development of Peter's stock arbitrage trading method.I programmed Peter's trading style into the system.In this way, the transactions made by Peter can be executed automatically by the system, and can be monitored 24 hours a day, and traded in the global market, even if Peter is dozing off at work, he can trade with accuracy.When I showed it to Peter, he was so excited, he kept high-fiving me, 'cool, cool...' he kept saying, very proud!
The system was developed very successfully.Peter became more comfortable going to work every day, and every day was like a vacation.He was still ignorant in the first few months, and the next step can be imagined.Soon, Peter received a layoff notice.On the day I went home, I felt very sorry, as if I had caused him to lose his job, and kept saying to him: 'I am sorry, ver sorry! ’ Pete was a sensible man, and he said, “It’s not your fault, you just did what you had to do. I’ve had enough of Wall Street, and I just came home for a big vacation.”

If computers are only used to this extent on Wall Street, the effect should be positive.It not only increases transaction volume, but also reduces transaction costs, maximizing investors' returns.But "needles do not benefit from both ends".With the further improvement of computer technology, disadvantages have also begun to appear, which is like a beast to the market.There used to be a model in algorithmic trading: if the stock price rises by 5%, or the number of buy orders increases, you can buy a lot; once the price falls by 5%, or the number of sell orders increases, you can sell.

This looks good, but the problem is that if multiple companies’ systems use this trading mode at the same time and conduct transactions, once the stock price rises to a certain point, the system will enter an endless loop when the system buys at the same time: the more the buying price The higher you go, the more you buy the system.As mentioned above, at that time, the stock market suddenly soared by 10% within 20 minutes, and the result was chaos.In the end, these systems can only be stopped and all transactions within these 10 minutes will be invalidated.After similar problems appeared many times, the US Securities Regulatory Commission established strict regulations and set more and stricter conditions in the computer system before the game continued.

Due to the enormous computing power of computers, the financial derivative products that used to be only talk about on paper have been turned into reality one by one by the financial geniuses on Wall Street. This is what Greenspan is really referring to.

In the 20s, Long-Term Capital Management's hedge fund (Long-Term Capital Management) used Monte Carlo Simulation (Monte Carlo simulation) to generate so-called "random data" with computers, which will win the Nobel Prize in Economics The Black-Scholes model generates the price of derivative securities through real-time calculation of the computer system, and develops the so-called "organic combination of historical transaction data of the financial market, existing market theories, academic research reports and market information." an impenetrable computer system held together".At that time, the geniuses of LTCM didn't have to go to the company to manage business at all. They played golf every day, went to the beach for vacation, and let the computer do the work for them.Things went wrong, and it ended in a whopping $90 billion loss.

The collapse of LTCM is just a preview.This financial crisis is a wonderful drama of derivative securitization on Wall Street.Ironically, modern risk management, while increasingly fashionable and comprehensive, is not doing anything.The behemoth of derivatives was finally crushed by its own weight.

Without the rapid development of computer technology, this financial crisis may not be so serious.But no matter how powerful the computer system is, it is also developed by the human brain, and it is controlled and executed by humans.After all, it's not yet the era of the movie "The Matrix", isn't it too ridiculous to blame the computer?

5. A stock market thriller

In the past year or so, I have been fortunate to participate in the development and management of a large project, which is a brand-new securities transaction monitoring system that costs a lot of money to "build".From hundreds of millions of transactions around the world every day, this system automatically generates thousands of alerts for suspicious transactions such as money laundering transactions and internal transactions, which are sent to the regulatory authorities for review and to the Canadian Securities Regulatory Commission. For the record, it monitors Canada-related securities transactions in hundreds of large and small trading systems around the world.

On May 2010th, 5 at 6:2pm, I was on the phone with my friend Kieron in New York.Keelung was my old colleague at Credit Suisse. He is currently in charge of the support of a stock trading system at Bloomberg, and this system is also under the monitoring of "I".So we often talk on the phone, in addition to "business contacts", we also exchange views on the stock market by the way.

In the past few months, the U.S. stock market has been rising all the way. The Dow once broke through 11700 points. It has risen by 16 to [-] percentage points from the lowest point during the crisis, and it is only [-]% away from the historical high point.Could this be the end of the financial crisis?The U.S. real economy has not really improved, the unemployment rate is still high, and the housing market is still "falling and falling".Especially recently, with Europe's 'Piigs' (short for Portugal, Ireland, Iceland, Greece, and Spain) being exposed, all of them close to bankruptcy due to high levels of debt, everyone is worried about whether it will trigger a larger sovereign in the Eurozone Debt defaults, which in turn hit the euro, plunged Europe and the world into financial crisis again.As we all know, the stock market should always be a barometer of the economy. Is the current US stock index extremely high?
It's really 'Speak of the Devil' (say Cao Cao Cao Cao arrives), the more worried things are, the more things happen.

(End of this chapter)