I don’t mean gambling, but real cards. You’re engaged with some seriousness. You’re watching how you bet and when, reading the players ahead and after you.

Then The House starts doling out stacks of chips. Would you play more or less cautiously if you had free chips?

Apply this thinking to equity markets, IR folks. In trading data, we saw European money sweeping into US equities Nov 28. Why did markets trembling Nov 25 decide by the following Monday to up the ante in risk-taking? Primary dealers implementing policy for global central banks also drive most program-trading strategies.

Thus, European money surmised that central banks would intervene, and their behavior reflected it. The rest caught on, and markets soared Nov 30 on free chips from central banks. It was short-lived. By Dec 2, we saw institutions market-wide assaying portfolio risk and locking in higher derivatives insurance. The chips were gone.

Money sat back expectantly. On Dec 8, The House delivered chips as the European Central Bank lowered interest rates. That’s devaluing the euro. At first, cheapening the euro increases the value of the dollar – which lowers US stocks (a la Dec 8). But if you’d hedged with derivatives as most of the globe did, you bluffed The House. Plus, the Fed will likely have to follow Europe’s bet up with a see-and-raise to devalue the dollar back into line with the euro (expect it next week, but before options expirations).

In poker, having “the nuts” is holding the best cards, and knowing it. Central banks have given arbitragers the nuts.

Arbitrage is a buy-low/sell-high strategy that depends on gaps. Say you’re in rush-hour traffic and all the cars are packed together and then a little gap forms and somebody shifts over from another lane. That driver has just arbitraged lanes of traffic. Now suppose suddenly a new empty lane materialized?

That lane is a stack of free chips in poker, or monetary intervention. A windfall. Global statistical arbitrage is money in planetary slosh after gaps. Remember, money can trade your equity, your options and Treasury futures in one fell swoop, in seconds or less. Or any random collection of electronically tradable securities from here to Stockholm.

Gritty rational money has bought growth issues, too. If inflation in equities is likely because The House may wander through with more free chips, that’s “growth,” not value (but is inflation growth? Hm.).

Generally, arbitrage makes life difficult for thoughtful investors. Investment certainty requires a fair and simple game. You buy in, you play your best, you win or lose. No free chips from The House.

So expect arbitrage. Expect volatility.

In fiction writing, authors will create portent by ending a chapter with something like: “She could never have imagined the consequences of her decision.” You can’t wait to turn the page to find out what she couldn’t imagine. The writer has subtly influenced your behavior.

The Fed is always trying to influence our behavior. Market performance October 4 (today) was mostly about Fed influence. Affirming commitment as lender of last resort – which sounds good but means “we will print endless piles of cash” – is the same as devaluing the dollar. So the dollar plunged in the last hour of trading, and stocks soared. (We all want stocks to rise but think about a teeter-totter. That’s stocks and dollars.)

In trading markets, exchanges continuously toy with behaviors by changing the spreads between fees for taking shares away and credits for bringing them to sell (this is the root cause of high-frequency trading). Exchanges are influencing behaviors.

Why does it matter? IR is about influencing behavior. In the past, we did it mostly with operating results, investment thesis and investor-targeting. Today, it must go further. Do you consider the impact of Fed policy and adapt your institutional outreach to match your investment thesis to impending changes in behavior? You should. If programs stall, don’t keep talking to growth money; shift to high-turn, deep-value money.

What about tracking your trading activity for action items? “Speculative behavior is up more than 30% in the past two weeks. That’s going to erode passive investment. We need to increase information flow and target money that can compete with speculators. Time to call on our best hedge-fund relationships.”

The IR program cannot live by story alone but by every evolving dynamic. Your equity marketplace – no matter your volume – is a particle accelerator slinging rational investment, speculation and risk-management. Trades are driven as much by other competing behaviors as by multiples of cash flow. You can’t reason with algorithms but you can alter their orbits.

It’s a chess game where you think three or four moves out. Say your stock has declined on big changes to strategy and financial returns. Your buy-and-hold folks are gone. How do you get back to GARP (growth and a reasonable price)? Execution is always a must, but you can’t simply target GARP money. You’re not a GARP investment. You’re a speculative high-turnover investment.

Fine. Don’t fight the tape. Target that money aggressively. Think about how that money behaves, and how it will change other behaviors in your market. If it buys, speculators will show up.

Who follows speculators? Right, momentum growth money. You’re thinking, “What do I say to high-growth money?” The facts. “We’re not a growth story now, but we know as we progress with our strategic plan that our stock will offer growth characteristics periodically. We want you to understand our story.”

Next, you’re moving on to the first wave of more conventional money: former value holders. At some point, the seeds you’ve planted will produce a pullback, and you want this wave ready to take up slack. Chess game.

Now some will say, “Nope, I do IR the old-fashioned way. I only target buy-and-hold money.” The old-fashioned way of fighting was to stand opposite each other in gentlemanly pose and fire volleys. Today we have satellite imagery and drones. Suit yourself.

But there’s no need to do IR the old-fashioned way in markets that don’t resemble yesterday’s any more than muskets and jets. For better or worse, this is the modern IR age. Make it your friend, IR pros (and join us Nov 3 at the IR Magazine Think Tank  in NYC to discuss crazy IR reality).

How many recognize this as a currency-devaluation? Markets jumped 4% here in the U.S. as the DXY, the dollar index, dropped.

Last Sunday, the European Central Bank pledged to monetize debts of Italy and Spain. Monday, markets plunged globally. That’s a currency-devaluation. The central bank is promising to increase the supply of currency without a corresponding increase in economic output.

Most blamed S&P’s downgrade of US debt. But the dollar strengthened, and Treasurys increased in value. Why would the diminished instruments be more valuable?

Because that’s not what caused markets to tank.

Last Wednesday the central banks of Japan and Switzerland devalued their currencies. Thursday, August 4, markets plunged. Many blamed debt talks. How, pray tell? That’s an assumption without buttressing facts.

By contrast, we have three profound examples inside one week of the global relationship between currencies. As we noted last week, currency trading volume is over $4 trillion daily. US equities are $100 billion or so, on average.

The tail is wagging the dog. Following the cash – the only commodity that is increasing by leaps and bounds upon the planet – leads us directly to the cause.

Why do stocks move inversely with the US dollar? The currency that is supposed to reflect the valuable exchange of goods and services is instead being used to compensate for the absence of valuable exchange. When things go up and down relative to denominating currencies rather than intrinsic worth, it’s difficult for anyone to assign proper values to securities.

Why should you care in the IR chair? It’s an object lesson. If you measure your success by the way rational money responds, you are on a bridge to nowhere. We’re seeing rational investment activity plunging yet again. How can investors buy your stock when its value is often controlled by the ying and yang of the yen? Or the dollar. In one major technology company today, the percentage of rational investment activity dipped to 8% of volume. So 92% of its trading is driven by something or somebody else? Yup.

We suggest setting ranges for the amount of program trading, speculation and rational investment in your volume – so you’re measuring overall trading health rather than investment activity. Because unless all of us call for fixed rates of currency exchange so stocks have value driven by business worth rather than European bailouts, it’s not going to change soon.

Assessing what we know about data, it’s logical to think that US equities will continue to appreciate now into options expirations next week. If currencies are leveling out again on all this intervention, money flows to relative value. But with expirations, the relative value might reside somewhere else.

I don’t know about you, but to me this seems…unhealthy.

What if riding in the sun means peddling across Death Valley in the summer, while the rain is a passing shower in the Italian Dolomites?

Context is essential. Let’s apply the same thinking to decisions about stock-repurchases and dividends. Conventional wisdom has long held that both actions appeal to the kinds of stock buyers who hold securities and count on fundamentals.

No argument there. But ponder the third dimension in the IR chair. The first dimension is your story – what defines and differentiates your investment thesis. The second is targeting the kind of money that likes your story. The third dimension is the state of your equity store.

Your equity is a product, competing with other products, with unique supply and demand constraints. If you suppose that your story is correct for a particular buyer without considering whether the buyer can act on interest in your story, you’re leaving money on the table. So to speak.

For instance, if I want four Keith Urban tickets at Pepsi Center in October for no more than $50 each, I’m already sold on the investment thesis – “Keith Urban puts on a good show.” What if there are only two tickets available at $50? Well, I’m not the right buyer for the investment thesis, then.

Back to buybacks and dividends. Our data show that roughly 12.5% of volume on a given day is “rational,” or focused on fundamentals. The rest of the volume – nearly 90% — is either managing risk by tweaking with balances, or speculating on divergences. So if buybacks are designed to benefit money that buys and holds things of value, but that segment constitutes only 12.5% of the audience, are you matching message to audience? Context matters.

What’s more, much of the passive participation in your market depends on liquidity. Asset managers need it to control risk. Speculators – a bona fide constituency in any healthy market – game the changes in your liquidity.

Take high-frequency trading, which is both speculation and a form of risk-transfer or risk-management. It starts the day at zero, trades intraday, and ends at zero whenever possible. If you’re engaged in a buyback, often all you’ve created are magnified opportunities for short-term traders, who sell to your buyback manager’s algorithms to end the day and head home with profits, fleecing your company’s treasury. Without helping your target buyback audience.

Plus, the Federal Reserve is continuously depreciating the US dollar that denominates your earnings, which you hope to enhance by reducing outstanding shares. At best, it’s a wash. So why not cut out the middle man – all that noise in the market – and pay dividends straight to holders?

We’re not saying it’s the panacea for ages. But in the current market structure, the best thing you can do for fundamental investors is bestow cash on them. The market has sound and fury but limited rational substance.

June launched by kicking markets right in the rump. We blamed economic data. It’s true but not that simple. Behind the data at the behavioral level, institutions decided against equities roughly May 13. We don’t make this up, we just observe it in the way trades execute. When methodologies, purposes or time horizons change, it manifests in trade executions.

Money didn’t hedge with options expirations May 18-20 either. If you decide not to insure your house against loss, what might that mean? That you expect to sell it shortly, that risk is nonexistent, or that insurance is too darned expensive. As an analogy, two of those three are negatives and the middle one doesn’t exist on Wall Street.

Here’s another example of behavioral signs. Russell indexes benchmarked against market caps on May 31. MSCI indexes for global quantitative diversification recalibrated the same day. What matters isn’t how they rejigger but what demand is reflected in algorithmic and speculative trading. Demand was terrible. Brokers overestimated demand and so shed excess shares June 1, crushing broad measures.

While bad economic data are a root cause for institutional wariness, it’s not that money woke up Wednesday June 1 and said: “Holy gray underwear, Batman, the economy is lousy!”

Every day, the collective We in the USA and the globe round take various economic temperatures. We watch retail sales reports, oil inventories, speeches by Fed rulers. We check jobs numbers. In our businesses we’re measuring cash flows, sales channels, balance sheets, income statements. We monitor our health with physicals and checkups (We just battered ourselves Sunday riding Elephant Rock).

Why would it be odd to do that with our traded shares? We in IR sometimes pay lots of lip service to market-structure stuff, but we still BEHAVE as though fundamentals are the only price-setting force. The best of the best in terms of rational investment behavior across our client base registers investment at about 16% of daily volume. If you don’t measure data and behavior, you won’t know what’s setting your price.

That’s what we do. We’re sort of the Redbook of stocks, the Fed survey of trading behaviors. We’re assessing different purposes and time horizons behind trading activity to provide a realistic, three-dimensional view of the health of your trading environment, and the role of investment versus noise or risk-management in setting price and driving volume.

By the way, we saw a marked increase in Speculative “over-valued” signals in trading last week for clients. It’s observable mathematically.

We’ll leave you with a scintillating market-structure tidbit. We saw a particular Asian bank program-trading a great number of securities the past three days. It could be that easing done around the Japanese earthquake in which yen were deployed to purchase securities and stabilize markets might now be reversing out.

Behaviors are the best measure of purpose. Life and trading do not happen in vacuums, and the IR pro who knows has a valuable advantage. It’s good to be cool in the IR chair. See you at NIRI!

Traders have not to my knowledge named them “Charlie Sheen.” But alert reader Walt Schuplak at the Market Intelligence Group in New York sent an item about rogue algorithms. Our friend Joe Saluzzi at Themis Trading wrote on it yesterday.

Joe explains that certain trading practices create arbitrage opportunity. Profiting from divergence isn’t bad of itself, Joe notes. But if the chance to profit is fostered where divergence could not or would not occur on its own, it raises fundamental questions.

Bloomberg writer Nina Mehta wrote today about the Australian government’s initial rejection of the Singapore Exchange’s effort to buy the Oz stock market. Singapore is a shareholder-owned exchange. The Deutsche Bourse is public. Same with the InterContinental Exchange, throwing in with the Nasdaq on a bid for the NYSE, both of which are public too. The London and Toronto markets are run by public companies. BATS may IPO.

The shares of all these firms in theory compete for investment with your shares. For exchanges, the profit and growth drivers are data and transactions. In US markets, revenue from tape data is divided up according to “quote share,” or how often an exchange is quoting at or near the best bid or offer for a security. Revenues also come from market-access fees, data products, and trades. Growth comes from propagating these drivers through more asset classes. Listing is a small piece.

Stay with me here. This is a crucial concept to grasp in the IR chair. These are your marketplaces. How much money do exchanges make if your stock trades 500 shares daily? Exchanges don’t earn commissions; they generate fractions of pennies per share.

Exchanges need companies with billions of shares outstanding. They need options and swaptions, fixed income and wholesale counterparty clearing, commodities, carbon credits, contracts for difference, futures, swaps and complex derivatives – trading at high speed ideally, with vast webs of manufactured arbitrage, all producing data and transactions.

And there’s more. The exchanges write the rules filed with the SEC that determine what transactions will take place, in what fashion, and at what cost. Do you get to script the terms for how your customers buy or sell your products and have those rules turned into regulatory mandates? Do pharmaceutical companies pen the regs governing generic drugs or the approval process?

I am not criticizing the exchanges. They are dealing with the reality handed to them.

But I hope you grasp the monument to cognitive dissonance that has been erected in the securities-exchange business today. Exchanges are counting on machines to create arbitrage opportunities that shouldn’t exist, because that’s the core growth driver. And the fees for adding and removing shares at the exchanges – the very driver behind arbitrage – are approved by regulators.

In essence, the exchanges can only thrive if everything that you hate and which scares you increases. Clearly, companies need better trading data at minimum. And an alternative exchange model.

If every public company decided that the Berkshire Hathaway model was best – a million shares outstanding, priced at $100,000 – the entire global exchange system, and all that HFT and a great portion of the webbing of derivatives totaling $500 trillion or more would be superfluous.

And…wait for it…which model typifies the Federal Reserve? Is the dollar in finite supply of great value or in a vast and churning sea of HFT?

Speaking of fires, we’re marching through them with the Issuer Data Initiative. The Number One Need is more names behind it. If you haven’t committed support for better trading data, do so today. Your peers will thank you someday, and you can remind them then that they owe you.

Before we get to what happened Mar 16-21 in trading markets, a word on BATS Exchange. The Kansas City operator of the third-largest American trading venue has made no secret of its interest in listing companies for public trading. BATS made it official today, announcing plans to offer IPOs another path to global liquidity.

Provided BATS offers competitive listing prices and good data, it can compete. We hope exchange executives will consider the key data points in the Issuer Data Initiative. BATS has a reputation for data excellence already, providing a great deal of free data to its trading clients.

We see too that BATS filed a proposed rule change with the SEC last month that will require customers to mark trades as principal (for their own accounts), agency (on behalf of others) or riskless principal (buying from or selling to a customer). See, issuers? Exchanges file rules to change how things are done. Issuers are participants in markets too. If they want something changed, they too can ask.

What drove trading markets roughly March 16-21 also speaks to the importance of good data. Somebody always must execute the trade and report it. That’s the way we all know the volume for any stock. On March 16, the G-7 countries announced a concerted effort to devalue the Japanese yen by flooding markets with currency. March 16-18 also included the monthly options-expirations cycle, and S&P quarterly index rebalances.

During the same period, we observed uniformity in trading activity for a set of “primary dealers” that work with central banks in the United States, Europe and Japan. Across the market-cap and sector spectrum, the same behavior occurred for this set of primary dealers.

We surmise that central banks armed these large brokerages with cash, which is how central banks engage in “quantitative easing.” The brokerages, also all commercial banks today, deployed it by buying securities from selling institutions. It had the desired effect, stabilizing equity markets and reducing upward pressure on the yen.

We’ve seen that many stocks have returned to their pre-March-10 “rational price” levels. But the behaviors producing those prices aren’t rational. If these were riskless principal transactions, do governments now own a bunch of equities with taxpayer dollars? Or were these all principal trades and so the brokers now have high levels of inventory?

Let’s suppose it’s the latter. Fine, so long as markets rise. Brokers can sell inventory as more buyers return to equities. It’s bad, however, if, say, Portugal defaults, causing the Euro to weaken and the dollar to rise. US equities would slide, and brokers would dump inventory to protect themselves as markets fell.

So everybody get out there and buy something made in Portugal.

I’m not sure that’s funny. But it segues to the stock market. So let me tell you a story about a severed foot in a sock.

Nets have been cast wide to discover what went wrong in the markets last week. There were hearings today before the House Subcommittee on Capital Markets. There have been wringing regulatory hands. Scott Patterson postulated in the Wall Street Journal that a Black Swan waddled through, courtesy of a tail-risk-timed futures bet by a Santa Monica hedge fund.

Looking at client data, the reason why the mystery cannot be solved is because there is no mystery. Our conclusion about trading on May 6-7 after studying prodigious data: In the absence of value and real buyers and sellers, machine-driven markets may collapse. This indeed is tail risk or a Black Swan – severe divergence. But markets functioned as machine markets will, and it was nobody’s fault.

Here’s why. High-frequency systems generally furnish shares and hold no positions. When they trade with each other, the trend of the crowd – general market sentiment – is magnified, be that fear or greed. High-speed trading systems don’t represent a thoughtful search for value; they’re the other side of the trade. Period. And if high-speed systems are BOTH sides of most trades, market reactions can be extreme.

This is how Accenture can briefly trade for a cent. Registered market makers put in wide bids and offers so they can transact between. If you intend to trade inside the best bid or offer, you might, for a $50 stock, set your offer at $100 and your bid at $0.01. If your bid suddenly becomes the only one and some panicked body enters a market order to sell, the trade will execute at one cent. Blaming traders for getting out of the market is like excoriating the signal man on the track for stepping away from in front of the train.

Most days, there is no trend. There is continuous reaction by speculative systems to actions from risk managers and investors. Passive, high-frequency market-making is speculative no matter what anyone says. It’s trading for trading’s sake. Period. When speculators encounter markets devoid of actual buyers, sellers, or risk managers, extreme bids and offers set prices. And the Dow drops 1,000 points in minutes.

We’ve been saying since 2008 that the market is a synthetic construct susceptible to a giant tear in the continuum. Regulators and even the exchanges are looking in the wrong place for answers. Rather than asking who screwed up, we should be saying, “Holy cow. The foot in the sock is severed.”

For a brief, terrifying period on May 6, we stared cold truth in the face: Nobody saw widespread value, even as the market dropped 1,000 points. That should wake us up.

Our markets don’t have any clear value. There is something radically wrong when liquidity is the only thing propping them up. Here’s an analogy: picture four people at a card table. One has a large stack of dollar bills. The other three are poised. Each time the one lays a dollar on the table, the other three slap to grab it and the fastest keeps it. When the dollars stop coming, the game dies.

Now consider what happened yesterday. Markets popped back when Europe devalued its currency. That’s what pumping $1 trillion worth of Euros into the system is. When markets respond favorably to devaluation, prices reflect inflation, not value.  Our global market and economic construct is predicated on liquidity in place of value. Sooner or later you run out of liquidity and the whole thing crashes down. No amount of printing and dumping more into the system is ever going to fix it.

That’s the bad news. There’s good news too. We saw vast disparity in client data. There was no discernible pattern, because it was, to quote funny man Jeff Foxworthy, “pandelerium.” But here’s the interesting thing: we saw strength in the market structure of clients with firmer commitment from informed money. Value matters. Resilience stems from value in the eye of a beholder, not from automated quotations.

We’re at what Barack Obama would call a teachable moment: The sustainable basis for healthy, vibrant markets is the infinite variety and intelligence of the opinions of buyers and sellers transacting with currencies of constant value.

If we want our IR jobs to count for more again, our governments must stop this insane, insatiable stream of liquidity from central banks. Yes, it would hurt for a bit, but imagine the grand and verdant vistas of value beyond the shadowy valley. We’re all in this muddy liquidity puddle together, be it with Yen, Euro, Dollar, Sterling, Loony or whatever.

Let’s put our foot down about this. Or we’ll be left with a severed one in our stocking. Again.

Speaking of power outages, starting April 22 equity markets developed voltage problems. IR professionals, we’ve got two words for when you meet the CFO in the hallway and she asks, “What’s up with the stock market?”

Risk Management. What two words did you think we were going to offer? “Risk Management” is why the same stocks that were up yesterday can be down today. We saw surging European and Asian inflows April 22, and a reversal of the same inflows on April 27.

From the IR chair, it’s flummoxing. Your nearest peer, in the same industry, about the same market cap, doing similar things, reports results on April 22 and beats expectations and soars 10% in a day. You then report the same good results almost pound-for-pound, a handy beat. And your stock declines three percent.

What gives?

Time for those two words: “Risk Management.” Large portfolio trading schemes such as pension and investment funds may hold an array of securities. Let’s say euro-zone bonds, currency futures, US Treasuries and US growth stocks. Suppose these investments are protected with risk metrics software from SAS, and trading-desk level systems from prime brokers JP Morgan and Deutsche Bank. These systems are designed to monitor and maintain portfolio risk and return within certain parameters.

Greece’s bailout is approved. The systems determine that this will strengthen the US dollar, thus weakening inflows to US equities from European and Asian sources. The systems themselves execute automated trades, complete with offsetting derivatives, to control risk.

This behavior causes a domino effect. The same securities the system said to buy last week are now the ones it sells. That triggers other limit orders and stop-losses, changes the nature and size of passive market-making trades, and attracts statistical arbitragers finding fleeting imbalances. And because ONE variable in the overall risk-management schematic is different – maybe a risk metric is the ratio of dollars on reserve at the European Central Bank, which has just returned a bundle of them to the US Federal Reserve – it over-corrects.

The next day, the system tries to rebalance the overcorrection, producing a spike in US securities again. Commentators bray about renewed enthusiasm for US economic growth, which in fact plays almost no role. Leveraged ETFs had just today adapted to yesterday’s big risk-management change. Now those are out of balance.

Suddenly, inefficiencies abound. Passive market-making systems aren’t getting liquidity to the right spots fast enough. Stat arbs are executing simultaneous offsetting trades in ten different market centers, creating the illusion of movement where none exists.

And the next day, the risk-management system tries to rebalance again.

This is how you get great volatility in markets designed to function smoothly and efficiently.

You don’t need to explain it in detail to your CFO. But you should be able to say, “We have integrated global markets. Our results, which were great for our active investors, now are secondary to global risk management. That’s the reason we’re under pressure. It’s a portfolio problem.”

But portfolio problems are our problems too. What’s the answer? We invite your suggestions. Meantime, be sure management doesn’t take it personally. It’s not always about you.

Meanwhile in Europe, Morgan Stanley launched a lending book for European Exchange Traded Funds (ETFs) today. Here is the key to understanding financial reform currently mucking up Congress. It encapsulates everything that’s wrong with today’s capital markets.

You may think we’re overstating it. Nope. This is the Grand Unified Theory tying all manner and form of derivatives together, and illustrating how high-frequency trading fits in this puzzle.

It’s not Morgan Stanley’s fault. The bank didn’t create the rules. The story today at UK financial publisher IFA Online about the ETF launch concludes: “Morgan Stanley says by providing a constant supply of manufactured inventory, ETF borrowers can benefit from lower borrow fees than current market rates, and greater availability of ETF supply.”

Broker-dealers under existing rules use a create-to-lend process with ETFs. They borrow shares of the underlying components of an ETF, then use that inventory to create new shares of ETFs for trading. Then those new ETF shares may be lent out for shorting, because the broker-dealer can pass through liquidity from the borrow market for the underlying securities – stocks comprising the ETF – to those shorting the ETFs. Voila, instant arbitrage opportunity.

This process increases liquidity, which is good, except that a market thirsting for liquidity has a value problem, not a supply problem. Supply-growth also spawns derivatives that have no underlying assets. That’s like a single batch of residential mortgage-backed securities carved into multiple tranches of collateralized debt obligations that don’t represent the full underlying value.

It’s also what happens with our money. Member banks of the Federal Reserve may use Tier 1 and Tier 2 capital to create money on their books in what is called fractional lending. That’s derivative capital – something for nothing. Similarly, dollars issued by the Federal Reserve in support of US-government backed obligations are derivatives disconnected from either the assets of the country or its productive capability to meet and service those obligations. Just like the CDO market that collapsed in 2008.

Now add in high-frequency trading. As TheStreet.com writer Don Dion observed in August last year, “Both bona fide market makers and proprietary traders are seeking out the fastest way to hedge trades, create units and maximize ETF trading capabilities.”

ETFs are assigned a lead market maker like Morgan Stanley, which fashions the first units and delivers the underlying mix of stocks to the sponsor in exchange for them. After that, it can sell shares of the ETF to buyers and hedge with equivalent mixes of underlying shares. By balancing out these two and fashioning more ETF units, then doing these same things at high speed, trading trumps investing and arbitrage becomes the goal, rather than capital formation.

Making money on the spreads between residential mortgages and their collateralized derivatives is a form of arbitrage. Do it a bunch and make a ton of money.

When the Federal Reserve issues debt obligations for the government and then increases the supply of cash, it is arbitraging the value spread between the earlier debt-denominated dollar and the later, cheaper version. When ETF creators and investors buy and sell the ETFs and the underlying securities, it’s arbitrage.

And when all these things are happening simultaneously, nobody knows the real value of anything anymore. No ratings agency can accurately assess risk because no single instrument represents the full picture.

The Federal Reserve, according to statistics at its web site, was counterparty to primary dealers for transactions totaling $12 trillion of US Treasuries and mortgage-backed securities in 2009 alone. It also says that trading in government obligations averaged $570 billion DAILY in 2007. The Fed provides no current statistics, but by comparison, daily dollar volume in NYSE and Nasdaq stocks combined is less than $100 billion.

If we want this something-for-nothing, derivative problem to stop in the private sector, the government needs to get out of the derivatives business itself, first. The very body wanting to regulate this activity is the one fathering it all.

That’s the Grand Unified Theory of derivatives. It’s the notion of creating something from nothing. Something for nothing subsumes our society, our markets, our financial instruments, and our currency. The chief propagator of this policy is the government itself.

This should get our attention across the spectrum of interests, from Left to Right. We can’t treat symptoms like Goldman Sachs and expect the disease to disappear. We need to rip out the root, which is, frankly, the Federal Reserve Bank, the limitless source of manufactured ETF-like paper from government. That’s the cancer killing our markets and pointlessly enriching banks.