Strategy Guide Note: There is no longer an interest rate in HSX so Dr Zeros has gone. The Twins are still around, but their influence is less. obvious. Also bear in mind that you have three potential deposits for you wealth, the movie market, the bond market and cash, each of which react differently to changes in the macroeconomic climate. If you’re serious about playing macroeconomics, you should consider your weighting in each of them (-Huy).

Given all of the hints and allegations about Interest rate hikes and their impacts, I thought it was time to write a column that I have mulling over some time now. Bear with me, this could get long, but will contain information that should be very useful to traders in making decisions in times of macroeconomic policy changes.

First, what is macroeconomics? Economists divide Economic theory into two broad categories: Microeconomics and Macroeconomics. Microeconomics is the economics of a specific market, explaining how supply and demand for widgets determines their prices. It looks at the behavior of businesses and consumers. It is also the area of economics that has the least disagreement among economists.

Macroeconomics, on the other hand, is the study of how all of the markets interact and how to make that interaction the most efficient and effective at achieving the macroeconomic goals of low inflation, low unemployment, and economic growth. It is the area of economics where there is the most disagreement – usually revolving around debates over whether the free market, for all its flaws, can better meet macroeconomic goals with or without government help, and if so, what kind of help.

In the real world, the macroeconomy is fueled by the money supply, which in the U.S. is under the control of the Federal Reserve Bank (usually called the Fed), and its chairman, Alan Greenspan. Their control is imperfect. Someone once compared managing the money supply to driving a car by looking through the rear view mirror. Mistakes get made, but overall the Fed has been doing an excellent job, by most economists standards, of money supply management for the last 20 years. We are currently living under the results of that good management, with the lowest levels of unemployment and inflation in 25 years. It is usually considered extremely difficult of getting both low at the same time.

The Fed has many ways it can control the money supply (monetizing or issuing national debt, changing the reserve rate, etc.), but the most common is through targeting interest rates. If the Fed fears inflation (which is too much money in the economy chasing after too few goods), and wants to tighten the money supply, it raise the discount rate at which it lends money to private banks. These banks then in turn raise the rates at which they lend money to their customers. If the Fed fears deflation (too little money), or think unemployment is too high, they lower the discount rate.

Keep in mind that entire books have been written about the Fed manages the money supply, and that the above is a thumbnail description that catches the main points, but misses a lot of nuances and exceptions.

This decision of whether to raise or lower interest rates has a profound impact on the economy as a whole. If interest rates go up, the cost of borrowing money has gone up. Since businesses borrow to make a lot of investments, this raises the costs of those investments and reduces the profitability of stocks in those businesses. If interest rates go down, the effect is reversed. Also, if interest rates go up, it raises the profitability of bond investments (buying a bond is really the same as loaning someone some money) as an alternative to stocks, so the stock market goes down and the bond market goes up.

Since the effects of interest rate changes are severe, investors watch for changes in interest rates very carefully. Wall Street watches Alan Greenspan religiously and analyzes everything he says for an indication of the future direction of interest rates. Greenspan knows this, and also knows that gradual changes are better for the economy than sudden shocks, so he usually telegraphs his intentions well in advance, so that when the change is actually announced, the effect on the market is less pronounced. Wall Street also watches the same indicators that Greenspan watches to determine if the economy is overheating or needs some fuel added to the fire such as the unemployment rate, productivity rate, and consumer and producer price indexes (which are all tabulated by the Bureau of Labor Statistics). This why good economic news often causes the Dow to take a downward dip. High inflation figures might be an indication that the Fed thinks the economy is getting out of control and might raise interest rates, which spooks the stock market and spurs the bond market in anticipation of these changes.

Now, what does all this have to do with HSX? HSX has its own macroeconomy, money supply, and stock and bond markets, and they have their own macroeconomic policy decisions, which I am sure they have always made, but have only recently began talking about publicly. HSX implements macroeconomic policy for two reason, I believe.

1) Since HSX is a market simulation, they try to simulate some of the same things that happen in the real world. Dr. Zeros new monthly pronouncements on interest rates are intended to be a direct parallel with the Fed’s Open Market Committee meeting where interest rate decisions are made an announced. Max’s hints of interest rate changes have a parallel in Greenspan’s cryptic cautionary advice to the market. I had a brief e-mail communication with Max where he implied that Dr. Zeros’ monthly pronouncements about the HSX economy will become a regular event. Get used to it.

2) HSX also adjusts the macroeconomy because it has to. The real stock market doesn’t create money, it just helps exchange it. For every stock bought low, their is a stock sold low – for every stock sold high, there is a stock bought high. It keeps going up because new money, from wealthier citizens and foreign countries keeps coming in. There is no such parity of exchange on HSX. Money is created from scratch every time a new account signs on. It is also created when a stock is adjusted upward after a good opening weekend, when a stock is delisted above its selling price, when a bond pays out interest or adjusts upward, when Max hands out 10k HBucks for getting a trivia question correct on WBS, and when the Twins go on a buying spree.

If HSX did nothing to control their macroeconomy, we would be in inflationary hell. All stocks and bonds would be grossly overpriced and we would have no fun, since all we would be doing is betting where the money would go next, instead of betting on the performance of films. The game would collapse and all of us would have to find another addiction.

So, since HSX has good reasons to have some macroeconomic fun with the market, how do they do it? I have observed two primary tools:

1) Volatility adjustment: HSX can control the amount the price of a stock changes when a unit is bought. They usually don’t announce these changes, but they have announced them enough to know that they do it. Theoretically, I suppose they could have different volatility settings for buys than they do for sells, but I don’t know if this is the case. Adjusting the volatility is a powerful tool to use when a major “event” is causing a money supply problem, such as when HSX is publicized in a major news publication (I myself logged on when Entertainment Weekly gave them a write up), or when a major delist threatens to flood the market. During times like this, HSX can lower the volatility to curb the inflationary effects. When TITAN, TMRND, and MSHNT all offered serious arbitrage opportunities, HSX changed volatility across the board to eliminate the price gaps. This became evident by the huge price swings and chucks which occurred. The price gap did close, but every other stock plummeted in price.

2)Action by the Twins: This has only been acknowledged to have happened twice, but I suspect it takes place more often, based on the behavior of certain stocks (ROBOT, for instance). It looks like that when HSX wishes to undertake a major Twins buying or selling operation, they will make a change in the money market interest rate first. HSX implies that the interest rate change causes the Twins action, but I strongly suspect they are two separate decisions, since writing the code for an automatic change would be a major pain, and we know that the twins can act independently of any interest rate change. So, when Dr. Zeros changes interest rates, this is symbolic that the twins are going to start something. This has only happened once so far, and the Twins action was astounding, and probably excessive. But be very careful on drawing conclusions based on one data point. It is quite possible that any future interest rate change would signal a much smaller impact, and perhaps be limited to the bond market, or even a few overpriced stocks.

So, how do you use this knowledge to your advantage? If Dr. Zeros announces and interest rate change, I would strongly suggest running over to his Board on Ticker Talk and see what Twins buying action is announced. The last time, they bought 50 billion shares (I believe), seemingly indiscriminately within the stock market (I think the Bond market was ignored, but I could be wrong.) The greatest percentage changes were in the lower priced stocks, and the spree continued for several days. I would look at the amount of the buying spree and look where it is concentrated. If it seems significant, make your move as early as possible. If the twins say they are selling bonds, get the hell out of the bond market and into the stock market, ASAP, for instance.

Also, keep an eye on the learning curve of traders. In the real world, if Greenspan sneezes the market drops 50 points. But Greenspan has a track record and real money is at stake. It is very much unclear how traders will respond to hints from Max and Dr. Zeros. I would suspect that people won’t change their behavior much for now, but if hints are followed by severe enough actions, people will start to pay attention.

What are my thoughts on HSX’s monetary policies? I am cautious. I know that the Fed has a long track record, expert staff, and a history of making good decisions. I have this nagging fear that Dr. Zeros might send the market into a tailspin just for s***s and giggles, or because he thinks having the HSX follow a Wall Street tailspin would make a nice media angle for a new story in the WSJ. I am probably paranoid, but it would help if I knew what criteria HSX was using to decide if the market was over or under priced. What is an overpriced bond if the Oscar winner is guaranteed to offer a 100% return the next day? Theoretically, if KWINS were guaranteed to win, she would be a good buy if she were priced at $1 billion per bond (this is why I agree with The Trades’ The Analyst and think their Oscar bond scheme is goofy.) For all of traders’ talk a few weeks ago that stocks were overpriced, WDDNG was a windfall and SPHER and BORRW were priced only slightly above their actually box office.

My advice to HSX is to tread cautiously and when it comes to making macroeconomic decisions, “when in doubt, don’t”.

Laissez faireishly yours,

Tom Miller