Friday, May 14, 2010

Token Economy System

I remember being fascinated about a "Token Economy System" designed and implemented in a mental hospital setting. For me, a psych major with a bent for economics this was an easy concept to grasp as it was based on the model for a “real economic system”. This novel approach to reinforcing positive healthy behaviors amongst the hospital residents was a resounding success. However, if in duplicating this system and you skipped some steps or took shortcuts you could end up with something less than desirable, like for instance inadvertently reinforcing less desirable behaviors, while at the same time squashing good behavior. Or if there was cheating or widespread counterfeiting of Tokens it would quickly lose its value and usefulness as a carrot to the residents and not have any effect on behavior whatsoever. In fact, if the price of the Token was valued high and too difficult to attain, or too low in value to even expend the effort towards garnering, you would have a breakdown in its desired effectiveness in modifying behavior. These of course are the risks to a real economy system as well.

The last time I checked, the world was no sane place, and it is now apparent to me that it has a varying number of well developed "Token Economy Systems" that reward its “captive residents” with Token's, be it Credits, Euro's, Dollars, Rymimbi... for certain "desired" behaviors i.e. wanton consumption and production at any cost. These “Token Systems” started out it quite well, but it is plain to recognize that some of the “residents” are developing some really bad habits that are causing many “other residents” to be denied their basic needs.

Here is the definition you are likely to find in a psychology journal or text book:

"Token Economy System"

A token economy is a form of behavior modification designed to increase desirable behavior and decrease undesirable behavior with the use of tokens. Individuals receive tokens immediately after displaying desirable behavior. The tokens are collected and later exchanged for a meaningful object or privilege. Source:

Not too hard to understand. Relatively simple idea, good behavior = tokens vs. bad behavior = no tokens.

It is easy to see how pervasive the Token Economy Systems are, you don’t have to look very hard. For instance, if you look at the US One Dollar Bill, it says "THIS NOTE IS LEGAL TENDER FOR ALL DEBTS PUBLIC AND PRIVATE" Did you know that the One Dollar Bill as does every US dollar denominationed bill is a "FEDERAL RESERVE NOTE"? Not too long ago you could take this note and exchange it for precious metal, ACTUAL Silver/Gold. That is not the case anymore. By calling it a note connotes that it can be turned into something of value, but what is that something?

Currently the US has 8,133.5 Metric Tonnes of Gold which at $1,000 per oz. Is somewhere in the $5 Trillion Dollar range of value. As a point of reference, there is currently $24 Trillion dollars in the US Retirement System/Structure (IRA's, Kehoe's, Pension, Mutual Fund and 401k Plans), $3 Trillion or 16% of which are in 401k plans or at least were as of 2006. As of April 26th, 2010 there was close to $8.47 Trillion Dollars in M2 Money Supply, see graph below.

Of course as long as Gold goes up so does theoretically the Dollar, unless the US, IMF, Germany or China decides to sell their Gold which could have an immediate impact on the price. As far as the EURO goes, Germany, France, Italy and the EU bank have Gold Reserves that together outweigh US reserves. This lends implicit credibility to the status of the Euro, however which of these countries in their right mind would spread their Gold around. This is at the root of federalization of the Euro zone. Funny when post becomes prologue, in regard to the US and the individual states.

If anyone of these three countries decides they have had enough of the Euro AND GO IT ALONE its splitsville. Bye, bye Euro. In fact, I would anticipate more of an alliance of the Euro countries into the haves and the have not’s. Curiously Portugal (383 Tonnes), has greater Gold Reserves than the U.K. (310 Tonnes) what does this say about the credit risk of a Portugal vs. the U.K. Spain has (282 Tonnes) and with Greece (112 tonnes) it is easy to see how Greece is the odd country out. Even Turkey (116 Tonnes) has more gold.
The components of the US money supply, expressed in terms of M0, M1, M2, and M3, measured monthly from January 1959. Most recent data is February 2006 for M3, and July 2009 for M0, M1 and M2. (Note: The Federal Reserve previously published data on three monetary aggregates, but on 10 November 2005 announced that as of 23 March 2006, it would cease publication of M3)

• M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.

• M1: The total of all physical currency part of bank reserves + the amount in demand accounts ("checking" or "current" accounts).

• M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).

• M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of Eurodollars and repurchase agreements.

Every country in the world now has a "Token Economy System" but how long before the Token ceases to be perceived as real value? The U.S. as an example of too many Tokens circulating is not acknowledging that this is a worldwide affliction. Quite simply there are just too many "Token" notes sloshing around the world. Add the dynamic that this Token money is able to move 24/7 chasing the Sun, so to speak, creating huge risks in any one currency and or asset. Bubbles literally can be inflated and burst in very quick and destructive ways, literally overnight.

I found it curious that the US Government would stop collecting and publishing information on the M3 money, particularly institutional money market mutual fund balances, deposits of Eurodollars and repo agreements. I doubt of course that they stopped gathering the data, more likely they just stopped reporting because it would fill in too much detail. Likely that the M3 money is enormous and static and is inherently problematic, because it can move incredible fast.

If you are brave enough you can check out this Wikipedia entry on Money Supply and quickly ascertain that many industrialized and emerging markets i.e. countries in the world have increased over the last 20 years their money supply. At least doubling or trebling it. Except Japan which likely accomplished this feat in the 1980's.

I urge you to look up the definitions of “Token”, “Economy” and “System”; actually if you just refer to the “system” I encourage you to follow the jump below. This definition in itself is a system.

If you took the jump it's not so hard to understand the complexity involved once you put a framework of simple ideas and declare it a system. How it quickly becomes alive, amorphous, unwieldy and wild. Like Frankenstein a patchwork of pieces, alive but no Soul.

So I bet you are asking how the heck did we end up here, with an out of control “Token Economy System” and how can we make it better. Well the answer believe it or not lies within our learning about successful and unsuccessful implementations of “Token Economy Systems” in mental institutions. Let’s explore this a bit more.

The Purpose of a Token Economy System

The primary goal of a token economy is to increase desirable behavior and decrease undesirable behavior. Often token economies are used in institutional settings (such as psychiatric hospitals or correctional facilities) to manage the behavior of individuals who may be aggressive or unpredictable. However, the larger goal of token economies is to teach appropriate behavior and social skills that can be used in one's natural environment. Special education (for children with developmental or learning disabilities, hyperactivity, attention deficit, or behavioral disorders), regular education, colleges, various types of group homes , military divisions, nursing homes, addiction treatment programs, occupational settings, family homes (for marital or parenting difficulties), and hospitals may also use token economies. Token economies can be used individually or in groups.

Missing from that description are countries, companies, organizations and yes even not-for-profits. When the "Token Economy System" for use in mental institutions was envisioned we were still on the Gold standard. It was easy to describe a "Token Economy System" juxtaposed with a "Real Economy System". Looking back we can now see how we have supplanted the "Real Economy System" with a "new and improved" "Token Economy System", which in and of itself is not a bad thing, in theory. It's just like in the mental institution you have to be aware of the risks of a bad implementation.

In using a “Token Economy System” as a euphemism for a "Real Economy System" it is important to recognize the basic tenets for a successful Token Economy System. For instance:

"Token Systems should never deprive individuals of their basic needs, such as sufficient food, comfortable bedding, or reasonable opportunities for leisure. If staff members are inadequately trained or there is a shortage of staff, desirable behaviors may not be rewarded or undesirable behaviors may be inadvertently rewarded, resulting in an increase of negative behavior. Controversy exists regarding placing individuals in treatment against their will (such as in a psychiatric hospital), and deciding which behaviors should be considered desirable and which should be considered undesirable."

In replacing the "Real Economy System" with the new and improved “Token Economy System” we needed to make sure that we manage the risks carefully as though it were a real economy system. Instead, we have ignored the risks and we have an unsuitable situation and potentially a volatile one. These risks are not in the Token itself, for the last time I checked we don't have an issue with the token... paper, bits and bytes, copper etc. etc. Although very subjective the Tokens in use easily meet the basic tenets of proof in a "Token Economy System:

"Anything that is visible and countable can be used as a token. Tokens should preferably be attractive, easy to carry and dispense, and difficult to counterfeit."

Here in my view is where we fell short in our implementation. We need "A clearly defined target behavior". Perhaps we need to look at each "transaction" a reach for the common good? Are we doing enough in society to specify what acceptable behavior is? I know that we have delineated good behavior in comparison with bad behavior in broad terms, e.g. murder, stealing and terrorism, but are we not evolved enough to tackle the lofty aspects of what make us uniquely human. As many are oft to describe as created in the widely held notion of and in the "image" of an infinite being? Can we not prize more of humanity? Does this need to be regulated? In a successful "Token Economy System" it has to be in the manual, i.e. regulatory framework.

"Individuals participating in a token economy need to know exactly what they must do in order to receive tokens. Desirable and undesirable behavior is explained ahead of time in simple, specific terms. The number of tokens awarded or lost for each particular behavior is also specified."

Another need is for appropriate "Back-up reinforcers" does a 15-17 room starter castle count as an appropriate Backup reinforcer. Could we not use the amount of kids fed or clothed or educated as a meaningful status of accomplishment, wealth and celebrity? Or how about the number of elderly we idolize and respect.

"Back-up reinforcers are the meaningful objects, privileges, or activities that individuals receive in exchange for their tokens."

We could make adjustments to meet a new and growing demand for a "System for Exchanging Tokens"; quite frankly the current system apparently doesn't work too well, and now is too unwieldy. Of course while some of the “residents” are benefiting from the way it is currently, too many don't and for the time being they are ok with shuffling about staring blankly, but when this changes and the collectively start channeling Chief Bramden – in One Flew Over the Cuckoos’ Nest-- and throw the Hydrotherapy Console out the proverbial window it will be too late.

Perhaps a new system of accounting that records the Goodwill of a transaction is needed. In order for a good "Token Economy System" to flourish it needs a good "System For Exchanging Tokens" might I suggest a requirement to measure "Therapeutic" value in addition to Demand and Monetary value, just ask Goldman Sachs. A new system to value and provide a mechanism to exchange Tokens and place value on meaningful back-up reinforcers and recognition of good behavior would go a long way towards fostering a fairer more equitable “Token Economy System .

"A time and place for purchasing back-up reinforcers is necessary. The token value of each back-up reinforcer is pre-determined based on monetary value, demand, or therapeutic value."

Of course a successful ‘Token Economy System”, requires transparency. "A System For Recording Data" a baseline from which to measure how far someone, something or entity has come or gone is essential. Yes I know this sounds awfully Orwellian, but if we want a successful "Token Economy System" this is essential. If we don't like it let's go back to the "Real Economy System".

"Before treatment begins, information (baseline data) is gathered about each individual's current behavior. Changes in behavior are then recorded on daily data sheets. This information is used to measure individual progress, as well as the effectiveness of the token economy. Information regarding the exchange of tokens also needs to be recorded."

Last but not least we need to ensure "Consistent Implementation Of The Token Economy By Staff", i.e. government(s) and business structure. The lack of fairness, inconsistency of enforcement and counterfeiting of tokens and unfulfilling and gaudy back-up reinforcers is undermining the foundation of our floundering ”Token Economy System".

"In order for a token economy to succeed, all involved staff members must reward the same behaviors, use the appropriate amount of tokens, avoid dispensing back-up reinforcers for free, and prevent tokens from being counterfeited, stolen, or otherwise unjustly obtained. Staff responsibilities and the rules of the token economy should be described in a written manual. Staff members should also be evaluated periodically and given the opportunity to raise questions or concerns."

There is no doubt we are utilizing a collection of "Token Economy Systems" the world over. The problem inherent in this framework is that of perception. If the system is perceived as broken, unfair, the benefits and rewards mis-placed. The rules re-written the baseline's smeared or erased and the residents restless, the "Token Economy System" for which it stands for will breakdown completely, and the residents will be looking to run the asylum. If we can't make these changes to make it a better system, we will revert back to a "Real Economy System" whether we intended to or not.

Tuesday, May 11, 2010

The Case for DOW 4500 WATCH IT Unfold! - Week 2

So far this week is kind of fun... Remember this is a twenty year head and shoulders it just didn't develop overnight, and it's not going to fail overnight either... although it'll happen faster than the previous downsides, much faster.

I'd like to comment on the "Flash Crash", as it has already been nearly a week and there doesn't appear to be any real tangible answers yet.  Looking at the following S&P 10 Year Weekly, it appears as though last week rated pretty high on the WTF scale (the study utilized is the Up/Down Ratio, it's not so meaningful, interesting though).  As you can see the S&P is bouncing off of a significant Fibonacci confluence of 1030-66 range which it had enough force to "PUNCH" through last week.  One could easily read this as a double bottom or retest of 1050, and if you are Bullish that is an appropriate way to read it.  However, in the context of the larger scale technical pattern of a 20 year head and shoulders, it's better to be pessimistic than optimistic.

Just think how close we were to October 2008 last Thursday, not only in the velocity and ferocity of the sell off, but also in the price action.  Looking at the channel (in red) I added to the chart down below you can see we are in a very significant and dangerous area.  Note also the cursor line and the OHLC for that week. 

To think that in just the span of one day or even 2hr's time the market nearly wiped out all the gains from October 2009.  This was a big signal.  The way you have to read it... was that this is a sign to get the heck out of the water.  When there is no circuit breaker (after 2:30pm), and the NYSE has to go and manually hit the "Bug's Bunny Air Brakes" for 60-90 seconds to break the selling cycle -- alas giving new meaning to the term China Syndrome -- this is not good.  At best this is likely the first beginning of a flag which will likely torture both Bull's and Bear's alike until one capitulates in the direction of the data and on how the news gets.  In which case you can still sell now and get back in when it makes up it's mind.  If we break the February 11th low I guess we'll see each other in ShangHai, if we don't I guess we could get ready for a period of higher lows and lower highs, or the slow boat to ShangHai.

As an aside this event reminds me so much of a trading tactic I see often in a stock that is well traded and is widely held by big institutions holding a significant amount of shares.  The tactic works as follows, when a big holder wants to get in or out of a stock they sacrifice a good number of shares (Market Order) in either direction to "Trip the Stops" or "Trip the Buys".  For instance, in selling (not shorting) a large position "Tripping the Stops" ensures that you can unwind your hefty position without danger of the stock prices collapsing too quickly, because of the preponderance of stops beneath you.  By releasing 10,000 to 50,000 shares in a market order it quickly runs through all the Standing Sell orders blowing them out and down to a ridiculous level, and at the point where you trip all the standing Buy orders, creating a nice swell of buying to sell your big position into.  Note, this effect works on multiple time frames.  The SEC should also be looking at who or what caused the Buy orders to come in so quickly, it seemed like in a minute and a half after the rinse ended it was right back to where it started.  

In the case of, the "Flash Crash"  50-100MM shares getting dumped on one to ten strategic stocks at the same time (Out of the 2.5Billion traded that day), could have the same effect as tripping the stops, and creating a false positive and swell of buying inertia (over several days) to make sure large institutions could exit their positions more gracefully.  Often you can see the resulting candlestick on a chart, technically it's out of place, but generally it leaves a counter signal.  In this case, it's a huge hammer, bullish of course, but if you knew how it was made you'd best go the other way, or get out.  This is a Jesse Livermore tactic of market manipulation, and I thought he was dead.

Sunday, May 09, 2010

The Case for DOW 4500 Watch It Unfold

Given the recent events unhinging the capital markets, public and shadow... I will shift my focus to cover the likely decline of the equities market to DOW 4500.  Privately I have been anticipating this decline since October of 2009.  It was only when the market's reaction on 4/29/2010 -- in response to the Goldman allegation's -- that I believed that a top had been put in.  Given now there is heightened awareness due to the "Flash Crash" and the rapid rate that the market is unraveling there is no time to waste.  Knowing this will help protect yourself and protect your assets.

Ok so I've been watching this right shoulder (this is a market technical term Head and Sholders pattern which usually signals a significant decline is in process or is about to occur) form since October of 2009, and I have been patiently waiting for it to develop. Being that it was an election year I thought that it would take on the aspect of a rounded top and that it would likely move into a trading range until after the election. I also considered that the decline would happen much quicker than the left shoulder top in 2000 and the head top in 2007.  However, based on the action since the Goldman civil suit was announced I have concluded that it is failing harder and faster than envisioned.  In fact we are seeing the first throes of the downside now.  Given the recent spate of the recent geo-political, geo-financial and geo-environmental issues it is adding lubricant to the already slippery slope of a mega downtrend.

From a techinical aspect this never looked very good, from a fundemental aspect it is starting to reinforce the dire technical aspect.

Check out NBC Anchor Brian Williams on Letterman... He's certainly right regarding the fact the world has no money... but this isn't a joke.  As you can see from the chart above we've been working on a twenty year head and shoulders. Technically the right shoulder will drop somewhere below 6500.  Utilizing Fibinacci analysis using tick data -- Thanks to Prophet Charts and Think or Swim -- the absolute support level for the DOW is 4500.  Even I was surprised by the velocity and ferocity of the sell off, which seemed to appear out of no where, but in point of fact this was inevitable as this is restoring balance to a market mechanisms that have been out of balance for some time.  The fact that the selling continued very strongly into the weekend is decidely ominous. What's more.  This is not even a market to stay short for too long either as the snap backs will be breakneck events. Wait till everyone starts pulling their money out of 401k plans -- mutual and hedgefunds -- after this weekend. Europe's attempt to prop up the Euro will likely prove futile, as this ball has started to roll and has too much momentum. In addition, with so much mis-trust of the capital markets both Shadow and Public we are likely to see credit and the bond markets freeze precipitously once again. In other words here we go again. The Greece populace is decidely fed up and since they invented democracy they have the right to uninvent it.

Here is a more expansive view of the $DJI using tick data from the 1900's utilizing Fibonacci retracement lines I was able to identify specific levels of support and resistance for the DOW, notice that the in the Thursday "Flash Crash" it broke through a Fib line at 10,210 and bounced right back up, remember prior support (11,086) is now resistance. Another item that I would like to point out to you is the period from 1978 to currently, what would I attribute to this rise? Two things, the "Rise of the Machines" and "Rise of the 401k" Plans. I will be writing more expansively on these topics in the next few weeks, but both play a big role in the the market proclivities of the last 10 years.

Here is another view from another perspective the S&P 500 During the same 20 year period this also shows a head and shoulder, but it also shows an enormous double top two decidely bearish patterns the weight of which will be too heavy to hold back.  Notice the FIB Confluence "two Fib retracement lines at different time frames laying on top of each other" at 1050, this represents a sticky support level if we wipe this out this week which would be a break of the February low this will result in a drop to 900 in short order.

People are going to be crushed by this, because stocks on the snap backs will appear to be cheap, but they will fall once again only to crush them again. 

This is where my theory of the "Rise of the Machines" and "Rise of the 401k Plans" comes into the mix.  Both in my view have contributed since 1980 to pushing the markets to an un-realistic level of value.  The evolution of accounting methodology has contributed by enabling these assets to be accounted for differently so that it captures and adjusts to the artificial environment created, 1. By the ability to move, manage and track large quantities of assets via electronic means and 2. Create an artificial floor and steady demand for assets via the advent and widespread adoption of the 401k plan.  The levels of which we are at right now are so lofty that we will see the floor drop out like a ride at Coney Island with many people stuck to the wall as the ride keeps spinning.  As the ride slows we will start to see institutions start dropping to the floor as the force of macro economic gravity takes over.

In 1978, Congress amended the Internal Revenue Code by adding section 401(k), whereby employees are not taxed on income they choose to receive as deferred compensation rather than direct compensation.[4] The law went into effect on January 1, 1980,[4] and by 1983 almost half of large firms were either offering a 401(k) plan or considering doing so.[4] By 1984 there were 17,303 companies offering 401(k) plans.[4] Also in 1984, Congress passed legislation requiring nondiscrimination testing, to make sure that the plans did not discriminate in favor of highly paid employees more than a certain allowable amount.[4] In 1998, Congress passed legislation that allowed employers to have all employees contribute a certain amount into a 401(k) plan unless the employee expressly elects not to contribute.[4]

In the mid-1980s, there were fewer than 8 million participants with less than $100 billion of assets in 401(k) plans.[5] By 2006, there were seventy-million participants with more than $3 trillion of assets in 401(k) plans.[5] There were 438,000 companies sponsoring 401(k) plans in 2003.[4]
Originally intended for executives, the section 401(k) plan proved popular with workers at all levels because it had higher yearly contribution limits than the Individual Retirement Account (IRA); it usually came with a company match, and in some ways provided greater flexibility than the IRA, often providing loans and, if applicable, offered the employer's stock as an investment choice. Several major corporations amended existing defined contribution plans immediately following the publication of IRS proposed regulations in 1981.
A primary reason for the explosion of 401(k) plans is that such plans are cheaper for employers to maintain than a defined benefit pension for every retired worker. With a 401(k) plan, instead of required pension contributions, the employer only has to pay plan administration and support costs if they elect not to match employee contributions or make profit sharing contributions. In addition, some or all of the plan administration costs can be passed on to plan participants. In years with strong profits employers can make matching or profit-sharing contributions, and reduce or eliminate them in poor years. Thus 401(k) plans create a predictable cost for employers, while the cost of defined benefit plans can vary unpredictably from year to year.
One danger of the 401(k) plan is if the contributions are not diversified, particularly if the company had strongly encouraged its workers to invest their plans in their employer itself. This practice violates primary investment guidelines about diversification. In the case of Enron, where the accounting scandal and bankruptcy caused the share price to collapse, there was no PBGC insurance and employees lost the money they invested in Enron stock. Congress inserted trust law fiduciary liability upon employers who did not prudently diversify plan assets to avoid the chance of large losses inside Section 404 of ERISA, but it is unclear whether such fiduciary liability applies to trustees of plans in which participants direct the investment of their own accounts. (Wikipedia)
The inception and adoption of the 401k plan has been the single best asset enhancer known to man.  In a way the proposal to change the social security system to private accounts could have kept the monster abated, by continuing to feed and lift the floor of all mainstream asset classes.  So with it's demise it was only a matter of short time before the pace of ascent in assets started to slow and trend down.

And what better tool to keep track of all these millions, ahem er... billions upon billions of steadily rising assets...  the computer.

And here is where the current downtrend started...  4/29/2010 the singular event that set this reaction in motion.  I now dub this the "Gold Shoulder" precipitating the "Flash Crash" that set the hook.  Just be fair to GS it could have been anything as the primer it just turned out to be Goldman instead of Greece, although one could argue that the Goldman allegations created a suspicious enough atmoshphere amongst investors that resulted in a hair trigger instead of a squeeze trigger.



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