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Where is the U.S. Budget Deficit Headed?
Those who trade forex are in budget mode these days. Barack Obama’s blueprint for this year’s federal spending includes $100 billion in additional stimulus for the economy, and a massive $800 billion, according to Bloomberg, in taxes on high income earners, banks that benefited from the bailout, and the oil and gas industries, in order to trim the deficit in the future. The balance of the budget is expected to reach $3.8 trillion.
In order to finance this huge gap between federal income and spending, the Obama administration will for the most part follow the path of the previous administrations, and it is expected that outstanding public debt will reach some $18.5 trillion by 2020, essentially doubling in a decade, which equates to more than 100% of GDP by the numbers of today. This approaches the astronomical values registered in Japan since the aftermath of the 1989 stock market crash.
Can such a high ratio of debt to GDP, such a large and ballooning fiscal deficit be sustained in the long term? Online and offline commentary would have us believe that the U.S. is running a grave danger by becoming so heavily indebted to the rest of the world, that, as in the case of the trade deficit, it is only a matter of time before the spending habits of the government make the healthy development of the American economy an impossible task for future generations. Funding wars, extending social security, bailing out and taking over private companies, enabling space programs are just some of the jobs that the federal government is tasks to undertake, all the while presenting the façade of financial soundness and reliability to the rest of the world in order to uphold the value of the USD. Many argue that this is an unrealistic and irrational mission.
Yet these prognostications have been made during the major part of this decade. In fact, complaints about fiscal irresponsibility are nothing new. Ever since the days of President Reagan, American people and the government have been subscribing to the notion that it is possible to spend other people’s money, with barely perceptible negative effects. We should recall that the U.S. is still the dominant economy of the world, the vanguard of capitalism, and that the dollar is still the trade and reserve unit of central banks around the world.
It seems unlikely that the bad numbers that the government keeps printing will lead to a collapse of trust in the American economy any time soon, as long as the global framework of economic cooperation and international alliances built by successive American governments remains in existence. The real danger is not that investors will suddenly grow tired of bailing out the American economy; indeed, the crisis of 2007-2009 has shown that they are even more willing to do so when the American economy is doing terribly. The real peril is that at some point some kind of geostrategic problem, such as that observed in Taiwan, in the Middle East, or some kind of issue between Japan and China, or some matter that we cannot predict today will disrupt economic confidence so much that the financial system will cease to function in a normal manner, resulting in collapse in emerging economies first, before leading to a severe crisis for American investors and the government. Otherwise, there is no sign that investors will abandon the U.S. simply because the government is printing numbers that are too big for adequate comprehension.
Perhaps the forex trader is the only being that is well-placed to derive significant advantages from the chaotic state of the world economy. This may well be the time when the best lessons are learned and the most valuable experiences obtained in forex trading, and elsewhere, for the beginning trader.
Using the z-score
Analyzing a forex strategy and deciding on its effectiveness is one of the most important tasks faced by a forex trader, regardless of the knowledge and experience level. Unless we are able to determine the profit potential of a trading system, we’re fumbling in the dark when it comes to making decisions and planning about the future. And we all know that planning and discipline are crucial to a successful forex trading career. Consequently, it’s clear that we must have a credible and reliable way of testing our strategies in order that we can have a reasonable degree of foresight in our trading choices.
In this context, the z-score is an extremely useful tool employed by analysts for determining if a strategy can generate strings of wins or losses. Of course, any strategy will create strings of wins and losses at times, just as any random list of wins and losses will contain strings. We use the z-score to decide if a trading strategy is generating the strings in a way that is non-random. What use is this knowledge for the trader? Obviously, if we can ensure that our wins and losses follow each other, we will be more confident while building up a position, because a profitable trade is more likely to be followed by another one that is also profitable. Conversely, it will be easier to stop or reverse a trade after one or two losses, because we know that our strategy generates losses in strings, and a losing trade is likelier to be followed by one that is also a loss.
In order to analyze the results generated by our strategy we must compare the z-score of our strategy to its confidence interval on the normal distribution. The normal distribution is a very useful concept used by scientists and statisticians for, for example, analyzing the frequencies of traits in a population. It is a curious fact of nature that the IQ levels of individual in population are distributed in a manner that is dependent on normal distribution.
If the results generated by our trading strategy are non-random, we would expect them to be clustered at the tails of the normal distribution pattern, as defined by its relevant confidence interval. It may sound complicated, but with just a little practice, it’s in fact a very straightforward, useful, and simple method which requires only high school mathematics.
The z-score is of course just one of the numerous mathematical methods available to traders for establishing the usefulness of a strategy. The crucial point when using any of these methods is to ensure that we gather our data sample from actual trading results, and not from historical, hypothetical what-if scenarios that have little relevance and credibility in the actual market environment. Let’s remember that even the top forex brokers in the market are unlikely to help us much if we don’t apply sensible and logical methods while trading the markets.
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