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Another Flash Crash!

There was a US flash crash yesterday, not yet in the stock markets, but in T-bills and gold. Once again the algorithms of high-frequency computerized trading ran amok. First over 100,000 Treasury futures were sold, boosting yields on T-bills to 1.99% from 1.93 in a few seconds.

Then in one minute, starting at 10:48 a.m., $1.8 bn in gold contracts changed hands. The yellow metal wound up the day off $77.10/oz, or 4.3%. Silver plummeted in sympathy, winding up down even more, off 6.9%, despite trading halts. Oil fell over 38% for a few moments. There was heavy selling in metals and currencies.

Stocks however were not affected.. yet.

The alleged cause was the ho-hum testimony by Fed Chairman Ben Bernanke, who did not announced another quantitative easing round. To have expected him to would have been silly, and it does not account for the dump. Nor does the Chinese decision to allow banks in Shenzhen, just north of Hong Kong, to offer to move yuan abroad in Chinese currency rather than requiring that they buy foreign exchange. Nor does the rumor that the Chinese shorted a million oz of gold because they need to raise money.

Some experts believe the sell-off in Treasuries and gold was again triggered by ''fat fingers'', someone inputting numbers wrongly. That is what allegedly happened on May 6, 2010 at 2:45 p.m. when something slashed the Dow-Jones average briefly by 1010 points in few moments, before it closed the day down 600 points.

This event led to a massive exodus by retail investors from stocks, because they lost confidence in the fairness of markets. The sequel is still harming stock-trading volumes nearly 2 years later. Estimates are that as much as $850 bn in shareholder equity was wiped out in a matter of minutes and nobody can explain how it happened.

Given the recurrent urban myth that banks manipulate the price of gold, I do not think the ''fat fingers'' explanation will hold this time. And it is interesting that in yesterday's stock price reversal there were huge volume increases on the Big Board, perhaps indicating a trend change.

While the current issue of The Economist argues that high-frequency trading like this creates liquidity in the markets and reduces the cost of trading, there are enough examples of subsequent mini-crashes in particular commodity markets to worry experts.

What is needed is a slowdown in trading, regulations against blasts of market-testing spoof bid and asked price offers, an audit capacity for regulators, greater international cooperation. Or perhaps even a hurdle before algorithms are given a free hand in buying and selling financial instruments.

The Financial Times' Gillian Tett, favors a ''socio-technical risk analysis'' as proposed in a paper by a former British trader and IT expert, Dave Cliff, and a military IT analyst from Carnegie Mellon University in the USA, Linda Northrup. The paper, published in Britain in Dec., proposes using engineering to anticipate the dangers from complex technology before it is allowed to proliferate robotically, without human oversight. This proliferation creates ''systems of systems'' no human being can understand or control. (Dave Cliff and Linda Northop, The Global Financial Markets: an Ultra-Large-Scale Systems Perspective.)
My Financial Times was not delivered today so I decided to research the issue on my own. Today Ben Bernanke reports to his other overseers at the Senate. More for paid subscribers follows from Ireland, Scotland, Norway, Denmark, Thailand, Belgium, Canada, Brazil, and Britain. Tomorrow's blog will be late.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.