So I just want to bring up one of a hundred gorillas in the markets these days because I’ve waited and waited for someone to discuss it and am dumbfounded by the silence surrounding the matter. So at least on Sunday we are all very aware market manipulation is both morally and ethically wrong in that manipulation is taking gains unfairly from those who are playing by the rules – remember one man’s gain is another man’s loss in the zero sum world of trading. But market manipulation is also illegal, which means those who are doing it should be prosecuted by the relevant authorities. This is all very simple. Where the grey comes into the equation is what constitutes manipulation?
Well according to the CFTC there is a four-part test that has been established through case law.
The Commission will look to “the traditional four-part test for manipulation that has developed in case law arising under [CEA Sections] 6(c) and 9(a)(2)”5 in its interpretation of Rule 180.2. Under this test, (1) a person must have had the ability to influence market prices; (2) he or she must have specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand (recklessness will not be sufficient); (3) artificial prices must have existed; and (4) the person must have caused the artificial prices. Attempted manipulation under Rule 180.2 may be found if a person has the requisite intent and commits an overt act in furtherance of that intent.
Well that’s pretty clear and pretty easily understood. So now let’s take a look at a few examples to see if they pass the four-part test. There are the obvious ones that we’ve all heard about recently being FX, Libor, silver and gold. And while FX and Libor have been ‘exposed’ and responsible parties have had their wrists stroked, silver and gold are yet to be exposed beyond some poor low level chump over at Barclays. But the one I really want to take a look at, and this is the one I just cannot believe that no one is calling out, are the damn central banks.
Now I don’t know if the Fed is purchasing equities (cash or futures) but I do know I read an article where Bernanke many years ago indicated that the Fed actually does have the authority to purchase equities if ‘deemed necessary’. I cannot for the life of me find that article but if anyone can please send it to me. And perhaps he was referring to the ‘doomsday black book’ the Fed won’t allow the nation to see. And while I’m not ready to give the Fed a pass, let’s focus on a recent example as we know central banks are a coordinated ring of criminals around the world who readily admit to purchasing equities on global markets (I’ve got to imagine US markets are not free from this as many foreign companies trade on US markets).
Last week BOJ came out the day after the Fed formally ended its purchasing program and shouted to the world that it would be reallocating billions of dollars from debt to equities (and please don’t give me the “hey we don’t have the right to go after BOJ” we sue foreign banks on a daily basis). Now before we get into the nitty gritty of the four-part test let’s just remind ourselves generally what the market does. We’ve all been around the markets for some time and most of us have had some training and/or education about markets. We learned that markets are efficient because they provide a forum for sophisticated investors to allocate a finite resource (i.e. cash) to a marketplace of companies. The investors will do so in a way that maximizes their return on that cash. As such, investors will work to allocate funds to the best values meaning the firms whose price relative to their expected future free cash flows is the lowest. What provides the efficiency is the fact that it is a finite resource being allocated. That is the basis of market efficiency. You lose the finite aspect of the resource being allocated and you lose the entire integrity of the market. To make this clear think about two men selected randomly and told they must live out their lives on what they are about to receive. The first man is handed one dollar while the second man is handed an unlimited amount of dollars. Who will spend their next dollar more wisely?
Now bring in the central bank. This is an entity that has the power and authority to create money from nothing, which makes it an infinite resource to them. This is clear in America where unlimited deficits have been covered by unlimited money printing since the early 1970’s. So the BOJ releases a wire indicating their intention to boost equity purchases and what is the result? The Nikkei moves up almost 10% in the next two days. Was this price increase based on an increase in expected future free cash flows by the overall market? No. Both BOJ and investors realize there is a limited amount of shares and when demand for those shares spikes suddenly microeconomic laws tell us the price of those shares will move up given supply remains the same. The BOJ had no other motive than to influence market price.
Now let’s move on to our four-part test. 1. Does the BOJ have the ability to influence markets? Yes of course. 2. Did the party intend to influence prices outside of normal market forces? Yes of course. BOJ wasn’t buying equities for any other reason than to prop up the market, even they are open about that. And actually we can stop there. Notice at the end of the four-part test it indicates that attempted manipulation can be prosecuted if the party had intent to influence markets and acted overtly to further that intent, so effectively numbers 1 & 2 above. I’m sorry to say this is a slam dunk. Absolutely 100% fosho BOJ was (admittedly) intending to influence markets and acted overtly to influence markets.
So why is this not being prosecuted? Well the same reason Presidents, bankers and legislators aren’t prosecuted for the multitude of crimes they commit. We have a two party system in the US. The elites and the rest of us. That’s it. It is no more complicated than that I’m afraid. But what confuses me is why aren’t guys like Peter Schiff (don’t get me wrong I fking love this guy) talking about the ridiculousness of central banks participating in equities? Or even your run of the mill econ professors? Now that bothers me. I’ve come to accept the two class system but I am still hanging onto hope that there are others out there who have yet to drink the kool aid.