Cryptocurrency versus the Dollar

The first question to Fed Chairman Powell today in his meeting with congress was about a new cryptocurrency called “Libra” and its possible impact on monetary policy. Also, President Trump invited all but one leader of Silicon Valley tech companies to meet with him today.  That leader was Zuckerberg of Facebook. My response to these developments begins with a quote from Ahamed Liaquat’s, “Lords of Finance: The Bankers Who Broke the World”. Penguin Publishing Group. Kindle Edition.

“Before WW I Britain was the world’s banker. No other financial center—neither Berlin nor Paris, certainly not New York—came close to matching London’s standing as the hub of international finance.

The war had changed the balance of financial power, and the New York Times correspondent in Paris reported that “ninety out of a hundred regard Uncle Sam as selfish, as heartless, as grasping. The great majority of the British people have made up their minds that American policy is selfish, sordid and contemptible.”

The consequences were: the British pound was replaced as the exchange currency of the world by the dollar and London was replaced by New York as the hub of international finance. Now, America is engaged in a trade war to keep that position of world dominance and it is America calling China, selfish, sordid and contemptible as they threaten to replace us. The major factor cited by Ahamed in “Lords of Finance” for England’s decline was the decision to go on the Gold Standard. America had more gold than all the allies put together.

The major factor regarding the outcome of America’s Trade Wars may also involve money. Only this time, it may be a Cryptocurrency that changes the world order financially. I encourage everyone to read a white paper by Facebook at this link Libra Association website. Click on White Paper. The following is my interpretation of a few of the claims in this white paper:

  1. Libra is fully funded by multiple marketable assets denominated in multiple currencies. This should provide a relatively stable price.
  2. It operates on a blockchain system that could provide control over funds. being siphoned of to a hacker rather than the intended receiver.
  3. Libra uses a new programing language that also enhances security.
  4. It is governed by a group of expert IT firms, not just Facebook.
  5. It could provide more than a 2% return on assets to founding members and investors according to a Fortune magazine article.
  6. Allows for cross-border transfers of funds at much lower costs than currently available.
  7. All the user needs is a cell phone.
  8. It could dramatically reduce the ability of drug traffickers to move money.

The following is a well-reasoned opposing point of view by a respected source:

Hello Frank,

I think the position of the dollar as the reserve currency has only strengthened over time, particularly in recent years.  A currency functions as a medium of exchange and a store of value.  Over the years, the dollar has overtaken every government currency in the world and gold too in both functions.  It is the preferred reserve holding by central banks around the world.  It engenders confidence around the world through the two main institutions of the US Federal Reserve and the US Treasury (which issues default free debt-by definition).  We may criticize these two institutions domestically, and accuse them of political expediency and other things, but they remain the most solid institutions of their kind in the world – by far.  The ability of any cryptocurrency to dethrone the dollar, due to technological advances, is highly improbable in my opinion.

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AlgoDynamix Webinar

I had the pleasure of attending a webinar on June 13th by AlgoDynamix. The management team are physicists who met at Cambridge University. Instead of using historic return data, like I do, they look at behavioral characteristics of clusters they develop from a limit order book, as shown below:

I remember back when I was an allied member of the NYSE, it was believed if one could get a peek at the specialist’s books, one would be able to determine which way the market was going.  Perhaps AlgoDynamix is getting that peek with an insight into their behavior.

I believe this could be a major improvement over the methodology I developed. While my February 6th posting warned against having more than 40% in equities,  AlgoDynamix raised a red flag for a downturn in the market, which occurred in April, with a subsequent flag indicating an end to the downturn. In the past year that I have been observing their flags for ups, downs and endings, their methodology appears to have had predictive powers worth looking into.

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What Kind of Game Are We Playing?

In his book, The Seventh Sense: Power, Fortune, and Survival in the Age of Networks, Joshua Ramo asks: “Do you believe the spread of democracy is inevitable? Or do you think we live in an age of global chaos and American decline?”  He goes on to say, “The world is not one big, flat equally connected topology. It is filled with closed and gated worlds. By “gates,” I mean not only in-and-out passages but also protocols, languages, block chains. Whatever binds and shapes a topology is a gate.” Ramo concludes: “The critical question is: Who will be the gatekeepers of finance, biology, trade, and pretty much every other source of power?”

Among those who believe this is the critical question of our times there seems to be general agreement the winner will either be America or China. Perhaps the following articles provide a clue.

  1. Bloomberg (Huawei Reprieve: U.K., Italy and Germany Reject US Boycott)

Last year Huawei surpassed Ericsson to become the world’s largest telecoms equipment manufacturer and trailed only Samsung for smartphone sales. CEO Guo Ping said: “We are working with our partners to serve global customers with 37 availability zones across 22 regions.” Built on the success of networking equipment and now devices, Huawei has grown its revenues fivefold in less than a decade: around $20 billion in 2009 to around $110 billion last year.

  1. Victor Hanson in his book: The Case for Trump had this to say about Trump’s role in this ongoing collapse of established ideas and institutions: “Trump’s sometimes scary message was that what could not be fixed could be dismantled.” Hanson then quotes Kissinger as saying: “I think Trump may be one of those figures in history who appears from time to time to mark the end of an era to force it to give up its old pretense.”
  2. Fareed Zakaria on May 25th said Trump’s actions may usher in a “Sputnik moment” for China where it surges ahead of America just like America did to Russia.

The stock market is viewed by many as an unbiased, objective indicator in that money has no philosophy and knows no borders.  If that is true, what does the following chart have to say about who is winning and who is losing?

Looks to me like the world has been the biggest loser and US high-tech, the big winner. China high-tech is down about 50% from its high but up from its lowest point. So, I accept this as evidence that America has fared better than China and the world X America.  However,  I also agree with the weak form test of the Efficient Markets Hypothesis that a time series of past prices does not predict future prices.

Checkmate or Surrounded With Nowhere to GO?

While the Trump administration is focusing on trade wars as a solution to stimulating our economy, China is focusing on inviting our former allies into their Gateland via their 21st century opening of the silk road called the “Belt and Road” Initiative. Xi Jinping claims China has signed up $64 billion in contracts during the current conference in Beijing.

Peter Frankopan in his book: “The Silk Road, A New History of the World,” says China’s One Belt One Road initiative, which is both a land and maritime Silk Road seeking to connect East Asia, Central Asia, the Middle East, Africa, and Europe, is,  the driving force of 21st century geopolitics. If, as some observers say, Xi is playing a game of GO, where the winner surrounds his opponent leaving nowhere to GO, while Trump is playing chess.  Trump may claim stock market results as, check, but not checkmate; while Xi closes the gate and puts a 5G lock on it.

It seems that Trump and his supporters believe in the stock market while Xi and his people believe in China. If Trump succeeds in telling the rest of the world who they can do business with and weakens China’s lead in the 5G race, is that checkmate? No

If China succeeds in forming a Gateland with SE Asia, central Asia, Europe, Russia and South America, where would that leave America and the rest of the world? Probably worse off.

One point that I have left out is the future role of the dollar in the global economy.  This past year China has been the world’s largest purchaser of gold and has been steadily decreasing its holdings in U.S. Treasuries.  China has been testing an electronic currency and is one of those countries calling for a replacement of the dollar as the exchange rate currency.  That would be….Goodbye Camelot, I’m glad I knew you.

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Market Truths

A Truth that’s told with bad intent

Beats all the Lies you can invent

William Blake

 

We’re told trade wars are good

And debt of nations, states and you.

Even better if it’s B or  below

But Prized above all are concept woes.

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Sage Advice

You expect things to go badly

And they don’t

That you call good luck

You expect things to go well

And they don’t

That you call bad luck

Because you lack an understanding of uncertainty

You put your trust in luck

Rather than reason

Mulla Nasrudin

The article below is what I have learned about managing uncertainty.  Begin by attempting to describe it.  You cannot manage what you cannot describe.

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Sortino & Forsey Give Away

This is the last vestige of the software we have developed over the last half-century. To download the Sortino-Metrics Software click on the link below:

https://drive.google.com/open?id=1j-lL2Y33dqHFBLdXfvNuKHZXtPvV7RxM

Right click on the Sortino-Matrix folder. A window will open. Click on Download.  The Readme word file will explain how to set it up.

The motivation for providing the executable software, Sortino-Metrics.jar, is to provide an easy way for practitioners to use these metrics to help their clients. The reason for including the source code is to encourage academics to improve on the work that Professor Hal Forsey and I have worked on for the last 50 years. We believe the metrics found in this software are an improvement on the standard metrics, particularly those in the A-B-C form shown below:

(A – B) / C

A is the average return on some portfolio of securities, B is the return on a benchmark and C is a measure of risk.  If B is the return on the 90-day T-bill, a common surrogate for the risk-free rate of return, then the numerator is that of the Sharpe ratio.  Many people also use the 90-day T-bill rate when calculating the Sortino Ratio, implying that only the risk measure, C, separates the Sortino ratio from the Sharpe ratio. Since downside risk would then be measured as deviations below the T-bill rate, the denominator of the Sortino ratio would have to be much smaller than the denominator of the Sharpe ratio.  The result is:  The Sortino ratio would always make the performance of the portfolio look better than does the Sharpe ratio.  Small wonder that many portfolio managers prefer the Sortino ratio to the Sharpe ratio when showing their performance.

Sortino first published his version of this ratio in the Journal of Risk Management in 1981.  That was a long time ago and the Sortino ratio should be replaced by a much-improved ratio, called, The Upside Potential Ratio, developed with my colleagues at Groningen University, Robert van der Meer and Auke Plantinga.  This ratio was first published in Pensions and Investments Magazine and then The Journal of Portfolio Management, both in 1999.  Hmmm, this is a long time ago also. So why is some ratio that doesn’t work as well, live on, while this superior ratio is ignored? Possibly because the Upside Potential ratio is based on a much different theory than any other.

The focus for all other asset management theory is on A, the average return on the asset.  Our theory*, focuses on B, the return on some Benchmark return required in order to achieve an investment objective that will accomplish a financial goal.  For a pension fund, B is the return required in order to meet or exceed all the promised payouts in a defined benefit plan or, meet or exceed all the payouts that would maintain the standard of living for a 401k beneficiary.  B separates good outcomes from bad outcomes.  C is the downside risk below B, a measure of the risk of not achieving the investment objective that will accomplish the goal. Mathematically it looks like this:

Visually it looks something like this to me

 

*Brian Rohm named it, Post Modern Portfolio Theory, in an effort to market the optimizer developed at PRI

Thus, it requires a different mindset just as MPT required a different mindset from the financial accounting approach of Graham and Dodd.

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It Has Gotten Worse

In the previous posting we called attention to the call for 40% fixed, 60% equity in July.  What does a 60/40 allocation look like as of Jan 1?

It now projects 20% more downside risk than upside potential if only passive indexes are used.  Even selecting a combination of active ETF’s has 10% more downside risk than upside potential.

What if we go to 50% fixed?

Now the UP Ratio is 14 times more upside potential than downside risk with a 15% allocation to Vanguard Growth Technology, 8.9% allocation to the Hong Kong ETF, 7.8% to the MidCap Growth iShare ETF and 4.7% allocation to the iShares Asia X Japan ETF.  This is not a well diversified portfolio, but it is close to mine.  I overweight China Technology and the Spyder, which over weights Technology.  I use the model as a guide and my brain as the decision maker.  I am currently at 50% Equity and I plan to move to 40% fixed in the very near future.

This is how I recommend professionals use this model.  Amateurs should not use it.

 

 

 

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