From Communism to Militaryism to Money Worship

A diplomat is a man who thinks twice before saying nothing” – WInston Churchill

“He would be there, he would be running his country, his country would be very rich.” – Donald Trump 17 May 2018 on his vision for Kim Dong-Un’s role in a future North Korea

Kim Il-Sung established the modern North Korea in 1948 as a Communist-Agrarian state modeled on Maoist China. When China’s reformists jettisoned Communist ideals, North Korea quietly removed all constitutional references to Communism under Kim Jong-Il in 2009 replacing them with a commitment to “Songun” or “Military first”, so adopting military rule as the supreme source of authority. Kim Dong-Un, the grandson of Kim Il-Sung and son of Kim Jong-Il, seems poised to re-orient the North Korean state once again, only this time toward Trump-ism which is a form of Money Worship…

If this astounding political transformation transpires, the history books will falsely portray Trump as a masterful diplomat and Kim Dong-Un as a courageous reformer. Why falsely?

Winston Churchill’s description of a diplomat does not apply to Trump. When confronted with the potential summit-stopper over Mr Kim’s post-cold war role in the World, Mr Trump could have side-stepped the issue with indecipherable blather. Instead he promised Mr Kim that the US would not undermine his power, instead creating the way for him and his Generals to become oligarchs. Summit-On!

Kim-the-Courageous will be another false historical narrative. The story will be that Kim Don-Un had always intended to bring North Korea in from the coldd but had to purge the Military first to assert his power. The purge was, indeed, brutal. But the trigger that pushed the youngest Kim of his dynasty towards Money Worship was the message he received from the greatest Money Worshippers of all – China. Lobbing missiles over Japan was unacceptable, so get with the program, get rich or get out!

Coase in CryptoLand : a convertible ecurrency is born

Facebook makes its money by selling its users’ data to advertisers without compensating users for that information. In micro-economics this is labelled a ‘free ride’ and ‘an externality’ and is an example of market breakdown. Markets have a habit of rectifying themselves and, indeed, Ronald Coase won the Nobel prize for discovering that markets will internalise these externalities so long as property rights are clearly allocated and enforceable. The Coase Theorem argues that Facebook’s ‘free data ride’ can be rectified by giving users ownership of their data. Users are then free to trade these rights with whomever they choose.

While Facebook’s free ride (and they are not alone!) is well established, rectifying the ongoing plunder has escaped the online community. This is as much due to the naivety of users who quite freely permission application developers to take all the data they can feast on, as well as the difficulty of coralling and controlling one’s data so that it remains safely guarded. Is it possible to construct a system where data remains the property of the individual?

Crypto, Smart contracts and Blockchain would seem to offer a solution to this problem. As Coase pointed out, the critical element for a market solution is the allocation of property rights. It is one thing to claim ownership of data, but is another thing to be able to exclude others from using it (unless they pay). If every individual were to maintain a secure Digital Data Wallet (DDW) then their data is theirs to deal with. Most of us keep our data in our head or written down or on a private network and stored out of the sight of others, so the DDW is an easy concept to implement. Tokening linked to a Smart-contract comes into its own now, since not only can it be used to buy or sell data, it also can be tagged to each data item that is permitted to be used by, say, Facebook. Together with a private blockchain, this tag will follow the use of the data item and only permit its use for the agreed purpose. The token/contract is like a licence which is paid for by Facebook (or others), tracked by blockchain and protects the data from third-party distribution without the permission of the owner.

The value of the data is open to negotiation and can change with behaviour and evolution of the internet itself. Standard currencies such as USD are acceptable numeraires to facilitate transactions but an online Crypto-currency seems better suited to price an online asset such as data. In fact, a currency that is backed by DATA would seem to have real value as opposed to just being the electronic rendition of regular fiat money. By this I mean you could think of a generic unit of ‘DataCoin’ representing ’10 email addresses of people who earn $100k per year’. The issuer of DataCoin has purchased 10 email addresses of people who earn $100k per year [or 20 email addresses of people who earn 50k per year] for every coin they dispense and any owner of a DataCoin is entitled to convert one DataCoin for 10 email addresses should they want to cash it in. The ownership of the data passes from one group to another upon conversion or an investor could just elect to accumulate a fortune in DataCoins representing all those email addresses that people have sold.

What does this all add up to in the end? First, the likes of Facebook are forced to pay their users for their data. Second, a ‘convertible Crypto’ is born.

Out damn Spotify!

“Without underwriters, Spotify shares won’t debut with a price based on investor feedback, with buyers lined up.” Bloomberg January 4, 2018.

Spotify, the digital music platform, intends to list publicly this quarter. Instead of an Initial Public Offering, where the company simultaneously lists its shares and raises capital at the same time, Spotify intends to just start trading on the NYSE one day. IPO’s are major events involving Investment Banks (IBs) whose job is to place the new issue with investors, sometimes underwrite the deal and generally to make a lot of noise. For their troubles, the Investment Bank will typically charge a 7% fee on the capital raised during the IPO. Spotify has been valued in the private market at $13billion and therefore intends to cut out the Investment Banking fees associated with their listing.

Needless to say the IB community are aghast at the potential challenge that Spotify’s listing route poses to their franchise. The average IPO is underpriced by about 15%, which means that those IB clients who are fortunate enough to receive an allocation profit by about 15% at listing. Spotify see this as a gift from their existing owners to the IB’s clients which, for each $1billion raised in an IPO, amounts to a gift of $150million. Advising on an IPO is not actually risking your own money, so Spotify think that the money is probably better spent rewarding their existing shareholders for their loyalty.

The IB community have mounted a campaign to question and derail Spotify’s disruptive approach and the Bloomberg quotation is an example of the fear being whipped up. The statement that “…Spotify shares won’t debut with a price based on investor feedback…” however, is pure air. It implies that the IB monopolises the ability to value a company and that the final investors on the buy-side are just dumb animals who are incapable of understanding valuation. Corporate advisors who think they are indispensible need only look at the software developers who now occupy the desks where their sales and trading buddies used to sit to realise what is coming. The buy-side are not dumb animals, they are risk-takers and Spotify have decided to cut out the sell-side ipo-sideshow in favour of a listing method which shifts the pricing responsibility directly to the final investors. Just as the final buy-side investor has benefited from tighter bid/asks as computers replaced traders, the buy-side will benefit from the disintermediation of new listings.

How would Spotify’s approach to listing work? Rather than opening up 15% over the placement price, the market will open with an electronic auction. Buyers and sellers willing to express a bid or offer are matched off until the market clears and settle at the average average price. After that, the market is left to trade according to order flow. My prediction is that it will only take a few minutes before a price is discovered and a few days for it to be reinforced with two-way volume flow. If I am right and an orderly market is established without the IB, then the expensive razz-matazz surrounding the IPO process will have been exposed as a fiasco. This will prompt every prospective public listing candidate to consider the same approach. We may never witness a traditional IPO ever again!

In Shakespeares play Macbeth, Lady Macbeth famously uttered “out damn spot” while haunted by the apparition of blood stains on her hands over the murder of the King. A lot of Bankers are similarly haunted by the prospect of their IPO gig being disrupted… “Out damn Spotify”!

Did Crypto’s crash or did they just have a bad hair day?

October 18 1987 goes down as the worst day in the US Stock Market when the S&P500 lost 22.6%. This was nearly twice the decline experienced in 1929’s ‘Great Crash’. The panic that followed occupied the financial pages for months.

On January 16, 2018, the CryptoCurrency CCI30 index of the 30 most traded currencies fell 22.9%. But as the following list of Reuter’s top news stories, the CryptoCrash did not even rate a mention.

So when is a crash not a crash? To put it in perspective, Crypto’s are volatile critters for reasons not worth mentioning here. For instance, in 1987 the daily standard deviation of return for the S&P500 was 1.1% whereas the daily standard deviation of the CryptoIndex is 4.5%. [Standard deviation is one way of quantifying the volatility of a risky security].

Put simply, Crypto’s are 4 times more volatile than stocks by this metric. This means that the 22% decline in Cryptos that occured last Monday only feels like a 5% fall in the US stock market – a bad hair day certainly but not worth jumping off a building over. A better way of thinking about it is that Cryptos would need to fall by 88% in one day for it to feel like Black Monday in October 1987 – a near total wipeout.

So punters, don’t expect to hear much about CryptoCrash in the newspapers until that market effectively disappears!

Throwing the FinTech baby out with the Crypto-bathwater

I remember walking back from a conference at the European Central Bank in late 2008 accompanied by the then Head of Risk Management for the ECB. We discussed what the long-term impact of the Global Financial Crisis that we were experiencing was likely to be. My comment was that regulation would take centre stage post-crisis, particularly since the major private financial institutions had both sought and been granted support from their regulators. My prediction proved correct as, in fact, the banking business has been beaten up and dumbed down by the regulators post-GFC. The banking community has been fined and restructured almost out of existence, forced to ‘pay the piper’ or lose its future…

As the phenomenon that is Crypto rages around us, I cannot help but reflect on that conversation. It’s only a matter of time before the gravity-defying Crypto bubble collapses back to the fair-value price of the electrons that these assets are actually worth. In the meantime, great quantities of wealth will have been redistributed from one socio-economic group to another. The winners, those who substituted their electrons for worldly riches, will live large but remain largely silent through fear of retribution. The losers, those who traded their families’ means of existence for a handful of electrons (at least Jack traded his for a handful of magic beans!), will shout loudly and for a long time…and they will naturally turn to the Government for compensation.

Irrespective of what one’s view is of the value of a crypto-currency, the innovation shares features with the FinTech world which have brought benefits to the financial sector. Crypto related FinTech benefits include (i) the Blockchain which has potential to cut transaction costs for every investor, (ii) the fact that regulators have been forced to review their securities laws and (iii) the electronic issuance of new crypto related securities such as ‘Asset-backed tokens’ and ‘Stapled-tokens’ may well lead to efficiencies in the IPO markets generally. But if Governments are convinced to step in to avert a ‘systemic crisis’ during a Crypto-crash then the easiest reaction is to shut the whole thing down. Regulators already have their fingers on the trigger and it would be a shame if the whole FinTech sector was punished for the excesses of a few.

Throwing the FinTech baby out with the Crypto bathwater is a real risk if regulators are forced to write cheques to those who suffer losses in the impending Crypto-bust. Moreover, if the regulators shut the whole thing down, Cryptoland will never be able to regenerate itself in the way that the more intelligent use of the internet grew out of the dotcom bust.

The lesson from the GFC for Crypto-land is don’t put your hand out for support when the fuse blows. Shut up and die like a motherboard.

Who is driving the Singapore property market up?

After over 4 years of successive quarterly declines in residential property prices, the Singapore market has finally seen a reversal. From its peak in September 2013, the property market fell nearly 14% before registering its first increase of 0.7% in September 2017. Reports suggest that the December 2017 quarter will add to this gain.

Property prices are rising despite the continued existence of ‘cooling measures’ such as high rates of stamp duty and credit rationing. The stamp duty tax on property transactions ranges from 3% for Singapore Citizens who purchase a single property to live in, up to 18% for foreigners on any property purchase. Singapore Citizens are charged 10% on their second property and 13% on third or subsequent purchases. SIngapore Permanent Residents are charged 8% on their first property and 13% on subsequent purchases.

The point is that Singapore Citizens pay the lowest rates of stamp duty by a large margin.

In neo-classical asset pricing theory, the ‘marginal investor’ determines the price. A marginal investor is the trader who is active in the market. They typically have the lowest marginal tax rates and/or the strongest demand for the asset. On this characterisation, the Singapore Citizen would be tagged as the marginal investor since they face the lowest tax rate and they also form the majority of the market.

The Singapore authorities have expressed their ‘concerns’ that property prices are rising again. Foreigners and PR’s were blamed for the previous run up in prices from 2010 to 2013, hence the disproportionate impact of the cooling measures on this group. But clearly, with stamp duty still considerably above that of the Singaporean citizens category, the current increase in property prices cannot be blamed on foreigners this time.

Since Singaporean Citizens (and single property owners most likely) are at the margin of current property transactions, it must be this group that are driving up prices. This fact is extremely difficult for the government to deal with. If the government wants to fight the market and control property prices then it must focus its tax increases on the Singaporean. This would be electoral suicide for the reigning PAP. A second difficult fact to swallow is that there is room to lower rates of stamp duty on the highly taxed categories, like Foreigners and PRs, since they are not responsible for the price pressure. Foreigners and PRs’ are now incentivized to rent, rather than own, which is a reason that rents have not fallen as much as property prices.

Arresting a ‘property bubble’ was the stated reason for the cooling measures from 2009-2013. In hindsight, there was no bubble. Market forces are strong animals and the current upward pressure on prices, despite the cooling measures, is entirely rational. The government must accept this or risk its very existence.

The Nobel Prize for nothing

Q: Why did the monkey sit in the tree?
A: That’s what he does. Its behavioural.

Today is a sad day for the field of Economics in particular and for Science in general. Richard Thaler, the populist champion of the embarassing branch of economics labeled ‘behavioural’, was named 2017 Nobel Laureate for Economics. It seems that the current passion for populist political personalities has spilled over into academia. The Noble awards committee should be ashamed of itself.

Behavioural economics is an ‘explain-all’ theory. Why do people leave their jobs? Its behavioural. Why do firms issue bonds rather than equity? It’s behavioural. Why do Europeans work shorter hours than Asians? Its behavioural. Why does the monkey sit in the tree…

The problem with explain-all theories is that by explaining everything, they actually explain nothing. Our monkey in the tree may well be there to escape predators on the ground or since the fruit he eats happens to be high up. A theory which delivers a testable hypothesis is able to discriminate between two or more possible explanations and successfully eliminating one possibility is a contribution. Behavioural economics has no such luck.

Behaviouralists often criticise mainstream economics for assuming that people are rational. Behaviouralists point out in their experiments that people are prone to make mistakes. Rational agents have expectations that are unbiased but there is no requirement that they do not make mistakes. In fact error is part of economic reality. Systematic error is where the rationalists and behaviouralists part ways.

Thaler is genuinely entertaining and his seminars are reminiscent of a stand-up comedy club in the West Village. He has had a ball with Finance. He started out on the correct foot graduating from Rochester, then it all went wrong. Making fun of scientists is age old but, dudes, it’s not Nobel prize-worthy.

Pink Elephants, Bank Runs and Bond ETFs

Pink Elephant statements are of the form “I see a Pink Elephant. Prove to me that I don’t see a Pink Elephant”. Pink Elephants are subjectively held false premises that somehow become accepted fact.

I chaired 2 sessions on Bond ETF’s last week at the WBR Fixed Income Leaders APAC seminar in Singapore. The sessions were brimming full of attendees and, to my astonishment, less than 20% of the audience had actually used an ETF. One of the ‘Pink Elephants’ about Bond ETF’s is they are illiquid during times of stress. I think this is rubbish and, on the contrary, they are more liquid than their predecessors.

Consider life before and with Bond ETFs….

Life before Bond ETFs
Unlike equities, bonds have generally been off-limits to the average man in the street. Market conventions have maintained minimum sized bond purchases at USD100,000 or more thereby excluding small investors from directly investing in the bond market. To get around this restriction the small investor focused on Bank Deposits as their fixed income vehicle of choice. Investors made a deposit and the Bank then made direct loans or bought bonds themselves to ensure that they could pay the interest and make a profit.

Thus, life before Bond ETFs was a bank intermediated world where the bond risk was borne by the bank’s balance sheet in return for a sizeable spread.
Bank portfolios are heterogeneous animals. Centuries ago, they consisted of localised lending but their risk managers learned that diversification is good and securitisation enabled concentrated risks to be diluted. But the banking community has never adopted a collective benchmark to which they gravitate, so no two banks are the same from a depositor’s standpoint and the only way of finding out about the differences is when rumours of trouble start circulating. Bank Runs are the result of this uncertainty, where depositors pull their money irrespective of the truth and the bank is forced to liquidate its holdings or seek assistance from the Central Bank.

The point is that life before Bond ETF’s was not all circuses and candy-floss…

Life with Bond ETFs
The innovation here is that now bonds trade like equities, so the little man can now buy them and the bank’s role is disintermediated. Further, the ETF’s portfolio is publicly announced and the investor bears the risk directly, which is priced in real time. There is no uncertainty surrounding a bank’s soundness since there is no bank, thereby eliminating one of the classic risks in the financial system – no more Bank Runs. Hooray!

Further still, the transparency in the ETF enables the big end of town to analyse the characteristics of the ETF (yield, duration, curve, currency, credit) directly and add this instrument to their investment universe. These institutions are motivated to buy cheap characteristics and sell expensive ones thereby becoming an active liquidity provider to the ETF world. In the pre-ETF world, these institutions would have ignored the banks completely during periods of stress, instead sitting back and watching a Bank Run unfold content that it was not their problem.

This view of the world runs contrary to the Pink Elephant.

The data seems to support a liquidity backstop for Bond ETFs

It is interesting to compare the amount of trading in the primary and secondary markets for Bond ETFs. The primary market is where the ETF manager deals directly with their Authorised Participants (APs) to create or redeem units in the ETF. The secondary market is where ETF units are exchanged between investors without affecting the ETF’s asset base. The featured image uses data from Blackrock (the operator of the Ishares ETF family) which shows that during normal market conditions only about 17% of turnover makes its way to the primary market. This number falls to less than 5% during stressed market conditions (eg Oct 2015 during the oil collapse or November 2016 when Trump was elected) which means that much more trading takes place in the secondary market when stressed. Market stress is characterised by wider discounts or premiums of the ETF’s market price relative to NAV. Wider discounts or premiums trigger pools of capital to buy or sell units cheaply to those investors seeking liquidity.

Contrary to the Pink Elephant that has somehow achieved acceptance by the broader investment community, the data suggests that Bond ETFs liquidity increases during periods of stress. This is achieved by motivating institutional pools of capital to profit from wider discounts or premia during stress.


Cyber-currencies are hot. The Initial Currency Offering (ICO) craze is bigger than the finger-spinner. Should you ‘invest’ and what are cyber-currencies really worth?

The basic logic behind a cyber-currency is that it serves as a medium of exchange to ease the physical difficulties associated with barter. You may have some coconuts that I want, but I don’t have the ball-bearings that you want. We cannot do business. But wait, instead I have a cyber-currency called ‘Fish-Coin’ which happens to be accepted by the ball-bearing manufacturer. I give you Fish-Coin for the coconuts and then you exchange the Fish-Coin for the ball-bearings. Deal done – I have coconuts, you have ball-bearings and the manufacturer has precious Fish-Coin!

How precious is Fish-Coin? Well, I guarantee that there is only 100million Fish-Coin on issue while there are 1.2trillion US Dollars on issue. Therefore, 1 Fish-Coin is worth $12,000. So if you can buy a Fish-Coin for less than $12,000 you have an arbitrage opportunity. IF you value the US dollar then the Fish-Coin equivalent must be $12,000 and, what’s more, if you think the supply of US dollars is increasing then Fish-Coin is going to appreciate in USD terms in line with this monetary expansion, therefore protecting you against inflation…

This all sounds dodgy but the logic is internally consistent and quite SOLID. If you value US dollars then the exchange rate with my newly imagined Fish-Coin must be FC1 = USD12,000. What’s more, my FC is much better than USD since it carries the protection of a triple-Artificial Intelligence enhanced Blockchain technology with both private and public encryption keys, and unlike BitCoin, there is no endogenous debasement mechanism (no mining for FC!). Fish-Coin is clearly the BEST MONEY EVER IMAGINED, and therefore, by Gresham’s Law (“The Good money drives out the Bad”), my Fish-Coin is the dominant medium of exchange which means that it replaces the USD entirely, not only as a medium of exchange, but also as the Reserve Currency of choice for the world’s Central Banks…I could go on…

How can something like Fish-Coin be so logically elegant yet equally the biggest load of clap-trap since Bernie Madoff’s “double lookback” option strategy? The fault lies not with the creator of Fish-Coin (ie me), but with the creator of the US Dollar (ie the US Treasury) and those who use it (ie you). Just like Fish-Coin, the US Dollar is worth ABSOLUTELY NOTHING and those who happen to hold real-money-balances at the end of the day when the sun goes down, must have the confidence that they can buy their ball-bearings or pina colada’s (a coconut derivative) or whatever with it as soon as the sun comes up the next day. It is this confidence that tricks people into carrying US Dollars in their wallets rather than spending them completely.

So should you participate in the cyber-currency craze? No. Is there any cyber-currency worth buying? The only one that I can think of is Sushi-Coin which is fully backed by a standard piece of sushi available from New-Tskiji market in Tokyo. If you can’t trade your Sushi-Coin for ball-bearings or a pina-colada, at least you can eat it!

The 3-point field goal and UBER’s IPO conundrum

The National Basketball Association introduced the 3-point field goal for the ’79-80 season. An extra point could be earned for shots that originated from outside the ‘D’ therefore encouraging shooters to take more spectacular long shots. While initially criticised as a gimmick, the 3-pointer has become a key weapon for a team’s offense with an average of 30.3 attempts per team per game in the NBA last year. The simple arithmetic is that a 3-point shot has less chance of success than, say, a slam-dunk, but it carries a higher return of 3 points compared with 2 when shooting inside the D. 3-pointers are optimal when the expected return exceeds that of shots closer to the hoop.

It took a few seasons for the NBA to wake up to the fact that shooting early from outside the D has a generally higher payoff than approaching the goal.

This is a lesson that the Tech IPO market might benefit from.

It’s currently in vogue for tech startups to remain private for as long as possible rather than to go public. Pre-IPOs are being advised to approach the public markets cautiously and only shoot when success is a slam-dunk. In the meantime, without a market referent for valuing the company, there is a tendency to systematically underprice each funding round so that the next round is an ‘up-round’ rather than ‘down’. No doubt this behaviour is encouraged by VC firms in order to keep their ongoing investment cheap! This practice is detrimental to the founders and early investors since they experience real-value dilution when late stage investors buy equity cheaply. Surely, then, there must be an incentive to do something to limit this wealth transfer?

An early IPO is similar to a 3-point shot. There are two main benefits of an IPO: (i) access to liquidity and (ii) market pricing. While markets are almost always wrong, they do tend to deliver an unbiased assessment of the value of a company. So, whereas a private firm will price capital raisings low to position for future ‘up-rounds’, basing a cap-raise off a public market price would seem to increase the valuation for the firm. Put simply, shooting early for an IPO may well be a 3-pointer for existing shareholders.

UBER is the poster-child for the stay-private-longer strategy, with its last cap-raise valuation stretching to the $60-70billion region. Its recent governance travails are worthy of a soap-opera, and while no-one doubts its success, the valuation will have definitely suffered. One wonders if an early IPO would have averted some of their struggles?

As a corollary to the above, I am continuously shocked at how complicated the capital structure is that private companies find themselves with before reaching IPO. Preference shares, convertible bonds, pre-ipo discount securities, make-good provisions and so on and so forth. Surely, one of the motivations for remaining private is to simplify the capital structure with, say, common equity? A benefit of going public is that any investor seeking protection is free to contract with counterparties in the secondary markets rather than negotiate directly with the company’s founders.

It is impossible to test the hypothesis that tech startups would be better off with an earlier IPO rather than later. A few disruptive entrepreneurs need to attempt the IPO equivalent of the 3 point field goal to make the case.