Wednesday, February 22, 2006

Summation of Forces

After re-reading my deflation scare post I see I've left out an important part of my thinking, which is an occupational hazard of losing one's mind. In Physics, summation (addition) of forces is used to, you guessed it, add up all the forces acting on an object along a vector, or direction, such as one of the x,y,z, coordinates of 3 dimensional space. I find it a useful heuristic, or thought model, in contemplating the financial markets as there are always multiple forces, if you will, acting on the minds of market participants.

I my earlier post I alluded to one force, the Federal Government's deficit in an environment of Central Bank accommodation, by which I mean, the government spends money it does not have by diluting the stock of money already in existence. Friedman, I believe, refers to this force when he argues that inflation is always and everywhere a monetary phenomenon.

There are, however, other forces acting on the minds of market participants. These can be grouped into expectations, which can flow from both fundamental and technical analysis. For instance, in our example, if market participants expect that the current pause in money dilution is just that, they might just keep piling into gold, oil, equities, etc. Alternatively, if a price level is broken, say $535 support in Gold, expectations for further declines by the black box crowd might come into play.

The spice of playing the markets in the short term is never knowing which of the forces you deem to be causal is in play at the moment.