Changing the Rules in the middle of the Game - shame on you.

It is a sad time for me as a trader in what I always believed to be a free market system. Yes I am a libertarian and strongly believe that government intervention in the market is not only wrong, it makes matters worse. But my exposure to government intervention was more from an economic point of view, whereby fiscal stimulus package either by tax cuts or government spending had a direct impact on the economy which would feed its way into the market place in an indirect way. Also the Fed which has the powers of monetary policy could also play a role in the markets but once again they are limited to the creation or cancellation of liquidity. So why is it such a sad day for me this Monday morning?

I tell you why, although I strongly disagree with the policies of intervention discussed above; at least I knew the rules of the game when signing up. With the recent banning of short selling on financial stocks in the US and Europe and now the banning of all shorting in Australia, the authorities have effectively entered the ring well into the fight and tied our hands behind our back. This is just not fair play.

One can argue that I am squealing because I am going to lose or lost money, in my case I am fortunately not going to lose too much money, although I will lose. I am more troubled by the fact that the authorities have decided to lay the blame of the current malaise at the foot of an industry that to a large part ensures efficient market pricing. To believe that the reason for the dramatic sell off in financial stocks is because of the hedge fund industry is naïve in the extreme. I don't have all the facts and figures but I believe that around 4 or 5% of the total equity market is out on loan which means that the hedge fund industry and its respective shorts are just tiny and hardly the cause of the damage being laid at them.

There is an overwhelming loss of confidence in a sector that has cooked up a brew of artificial wealth, and this potion has finally proved lethal to its manufacturers and consumers. This realization is at the foot of the problem, and there is no where to hide. The bankruptcies and bad loans need to flush themselves through the system, and the "entrepreneurs" who incorrectly forecasted profits from these institutions need to accept the consequences.

Clearly this is not going to happen, as government authorities do not have the luxury if you can call it that of sitting back and letting the business cycle correct its mistakes. Instead they will try and do "something". On the surface these aggressive steps will provide the system with a degree of comfort that the whole pack of cards will not come tumbling down. However, as soon as the "relief" passes, and the players in the system realize that the rescue is not a real rescue but a system of bringing people who were safe from the devastation into the game, we will encounter a force of revulsion and fear that may blow up in the architects of this systems face.

What they are hoping for is to avoid the death spiral of deflation and reliquify the system to inflate away the debt the government is taking on. This will ultimately destroy the value of the dollar, which already is a currency that is suffering from an identity crisis. Just because a weaker dollar makes sense now do not think a dollar short is a guaranteed trade, as we may still see a flight to safety in Treasuries and Bonds which will keep the dollar alive and probably lose the fight against inflation right now.

Dr Bernanke is a great student of the 2 depression era's in the 20th century, and he is determined to learn from the mistakes made then with his highly aggressive stimulus type package, remember he is the man who said they will drop money from helicopters if they need to. The powers that be long understood where this economy was heading and were sure to employ a man who they believe was/is best placed to fight the deflation monster.

Now I don't know Ben but I wonder how much he understands about crowd psychology, and if my instincts are correct, he is grossly under estimating the risk aversion forces that are spreading across the globe. So yes government holding your hand and saying we will help you get out of this mess can provide some relief, but when you realize the "thing" holding your hand is the actual monster that got you into this mess, you will be reluctant to obey the orders they give. In fact you may actually turn against them.

So yes I am reluctantly holding onto my deflationary views, but I do believe the deflation we are currently experiencing and will experience will be relatively short lived as the seeds for massive inflation have been planted and will sprout. However, given all the action over the last couple of weeks and months, I am forced to take a less bold approach into my trading as I realize I am fighting a battle with my hands tied behind my back, and more importantly against opponents who don't hold by the original rules of the game. I also need to factor in the fact that the relief rally may last longer than what is rational.

At times like these it would be more sensible to lower my exposure to the markets as I fundamentally and technically still believe we should see prices much lower, but I need to factor in the quantum of the "relief" that is likely to continue to manifest from the latest set of stimulation.