Signs of an epic financial top in the making!
ICOs may well be the most popular investment craze since the dotcom boom of 1999-2000
HERE is the deal. You can buy an entry in a computer ledger issued by a startup company on the basis of an unregulated prospectus. It is called an “initial coin offering” or ICO. But though the ledger entry is called a coin, you cannot spend it in any shop. And whereas the use of the term ICO makes it sound like an IPO (initial public offering), the process whereby a firm lists on a stockmarket, coin ownership does not necessarily get you equity in the company concerned.
This sounds like the kind of bargain that would appeal only to people who reply to e-mails from Nigerian princes offering to transfer millions to their accounts. But ICOs may well be the most popular investment craze since the dotcom boom of 1999-2000; even Paris Hilton, a celebrity heiress, has jumped on the bandwagon. The list of active, upcoming and recent ICOs on the website “ICO alert” covers 31 pages of A4 paper and includes around 600 companies. More than $2bn has been raised in total.
There is a serious side to the craze, just as there was with the dotcom boom. The technology that underpins digital currencies—the blockchain—is an important development. This is a secure, decentralised ledger that everyone can inspect but that no single user controls. It seems likely to be adapted for use across the financial system—to record property transactions, for example.
Many ICOs are designed to finance applications that will make use of the blockchain—for trading currencies, lending money or searching for jobs. In some cases, the “coins” can be exchanged for services on the site. In a way, this is like selling air miles in a startup airline; investors can either use the miles for flights or hope they can trade them at a profit. For the business, it is also a way of creating demand for the product they are selling.
But in plenty of cases, an ICO is just a way of raising capital without all the hassle of meeting regulatory requirements, or the burden of paying interest to a bank. Businesses are able to achieve this feat because investors hope that the coins will rise rapidly in value, as has been the case with bitcoin or ethereum, the best-known digital currencies, which have seen stellar gains in the past year. Nothing makes individuals more willing to take risks than the sight of other people getting rich.
But bitcoin is also different from ICOs. Its appeal is as a digital currency that can be used in a broad range of transactions. And the supply of bitcoin is designed to be limited, meaning some people regard it as an electronic version of gold.
So there is a chance that bitcoin or ethereum will come into widespread use, although their function as a means of exchange is undermined by the volatility of their price. Currencies must be stores of value, at least in the short term. If you think a digital currency is going to rise 20% tomorrow, you won’t want to swap it for goods and services; if you think it is going to fall 20% you won’t want to accept it.
It is also worth remembering that governments set the rules regarding the nature of legal tender within their borders. They will always have the whip-hand when it comes to issuing currency. If they believe that a digital currency is being used for widespread tax evasion, or is distorting the financial system, they will crack down hard.
As far as business-related ICOs are concerned, a few may succeed. Investors may well be taking the “lottery ticket” approach, hoping that one big winner will offset a large number of losses. In a sense investors are acting like venture capitalists. But the sultans of Silicon Valley’s VC industry insist on a wide range of rights before they invest their capital, including protection against dilution of their stakes and (sometimes) the right to nominate board members. Investors in ICOs have nothing like that level of protection.
In the circumstances, it is hardly surprising that regulators are getting involved. In America, the Securities and Exchange Commission has ruled that these coins may, in some cases, be securities and thus subject to regulation. A British regulator, the Financial Conduct Authority, this week warned investors about the risks involved. The Chinese authorities have gone a lot further, declaring that ICOs are simply illegal.
It is not easy to draw a line between financial innovation and reckless speculation. Perhaps an ICO will finance some breakthrough that boosts economic efficiency. If you work in the tech sector, you may be able to spot the occasional grain of wheat among the pile of chaff. Everyone else should assume that ICO stands for “It’s Completely Off-limits”.
Here is a common factor linking 2008 and 2017. In the years before the GFC, reckless deregulation created dangerous debt excesses. Since then, recklessness has extended from regulation into monetary policy itself. Now, as then, irresponsible behaviour has been the common factor.
A big difference between then and now, though, lies in the scope for recovery. In 2008, the banks could be rescued, because trust in money remained. This meant that governments could rescue banks by pumping in money. There exist few, if any, conceivable responses that could counter a haemorrhage of faith in money.
Obviously, you can’t rescue a discredited currency by creating more of it.
If a single currency loses trust, another country or bloc might just bail it out. But even this is pretty unlikely, because of both sheer scale, and contagion risk.
So there is no possible escape route from a systemic loss of trust in fiat money. In that situation, the only response would be to introduce wholly new currencies which start out with a clean bill of health.
Below, James Cheo, investment strategist, Bank of Singapore, says risk events combined with a historically weak trading month in September mean overweight cash is the way to go.
Why overweight cash? Cash is trash. More importantly, this isn’t going to be a buy the big dip like in 2008, it will be a protracted bear market unlike anything we’ve ever seen before, drawn out over many, many years.
You should all be overweight US long bonds (TLT) before deflation strikes America and probably well after. You don’t have to be a nut like me and put all your money in US long bonds, but if you are a retail investor and are not at least 50, 60 or even 70% in US long bonds (TLT) right now, you are going to get slaughtered over the next year. I’m dead serious about this.
IF THERE is a consensus at the moment, it is that the global economy is finally managing a synchronised recovery. The purchasing managers’ index for global manufacturing is at its highest level for six years; copper, the metal often seen as the most sensitive to global conditions, is up by a quarter since May.
But Steen Jakobsen of Saxo Bank thinks this strength will not last. His leading indicator is a measure of the change in private sector credit growth. This peaked at the turn of the year and is now heading down sharply. Indeed the change in trend is the most negative since the financial crisis (see chart). Since this indicator leads the economy by 9-12 months, that suggests a significant economic slowdown either late this year or early in 2018. He says that
This call for a significant slowdown coincides with several facts: the ECB’s QE programme will conclude by end-2017 and will at best be scaled down by €10 billion per ECB meeting in 2018. The Fed, for its part, will engage in quantitative tightening with its announced balance sheet runoff. All in all, the market already predicts significant tightening by mid-2018.
Given the role played by central banks in propping up the economy and markets since 2009, it is certainly plausible that their role will be vital in ending the recovery. And while copper is a good leading indicator, so is the bond market. At the turn of the year, most people thought the ten-year government bond yield would rise as a Trump stimulus fulled the global recovery; the yield is now 2.06%, down from 2.44%.