Hi Investors! After the Disaster with the Japanese Yen at the end of last week - what other potential market disasters are waiting in the wings? And Central Bank Digital Currencies are coming, is that good?

Welcome back to another week of Market Movers, where I summarise the top headlines that attracted my attention this week to keep you up to speed with the markets and give you some light reading for the weekend - this weeks issue is being released a day early as I'm at a wedding tomorrow

As usual, lets start with a look at the general markets, followed by the digital asset space.

Don't forget to check out the Risk On Investor resources page for access to the growing selection of calculators, tools and video guides to help you become a better investor. There is also more content posted frequently on the YouTube channel to keep you informed and entertained - you can also read back on previous newsletters if you're a new joiner to the investor club

Have a great weekend

Chaz (RiskOnInvestor.com)

Disclaimer - The opinions of the author in this newsletter should not be taken as financial advice. Any mention of investment products is not a recommendation to buy.

If you are looking for financial advice, please seek the services of an industry professional and do your own research.

Capital is at risk when investing

£1m Portfolio Update

Well - turned out that last week was a bad week to go on holiday to an area with patchy phone signal and not monitor the markets!

Before I went on holiday I noted down my investment holdings and found that my total holdings had reached an all time high, that was on the 29th.

If you've been reading the news you will be well aware that suddenly the markets decided the US isn't looking as strong as before with a weak jobs report - I shared extracts from earnings calls which suggested this might be the case last month. Combine that with the Bank of Japan increasing interest rates which is making the Yen carry trade (borrow yen at ridiculously low rates and use that debt to speculate on assets) and we had the perfect scenario for a sudden unwinding.

JP Morgan and some others have suggested that the unwind is only partially done, and I can believe that. But I would imagine that we won't see the rest of the unwinding happen as suddenly as market participants have time to reinforce their capital base now and ensure they are properly hedged for the currency risk.

All of that meant a sudden 25% haircut for the portfolio in the space of a few days which sets me back a few months.

Far from the end of the world, but certainly a frustrating time to have been away and not monitoring my positions.

Major Market Indices

You would be forgiven for thinking that this quote came from a recent news article after the market turbulence we've seen recently.

You would be wrong.

​This is an extract from an article published on the 16th August 2007​

History doesn't repeat but it often rhymes, so are we in for another wild ride with the Yen carry trade unwinding? It turns out that this was a trade that even legendary investor Warren Buffet might have been involved in according to the late Charlie Munger.

I don't want to spread alarm but this arrow shows when that article was published, right before a 50% sell off as the house of cards came tumbling down as the subprime mortgage scandal unfolded in the financial markets.

Do I think a scenario like this will repeat?

I'm on the optimistic side here. I'm struggling to see the same fundamental level of contagion in the markets.

My short term risk areas:

The consumer is weak

I have shared information before from payment providers which are my economic barometer.

Consumer spending in the US has been grinding to a halt. This is positive in that it will keep inflation lower which is the reason for the tight credit conditions being created but it will start bleeding into the equity markets when spending begins to hit the bottom line of revenues in 6-12 months time.

Not all equities would be hit the same here. Many of the AI companies have huge cash reserves which are being deployed for capital expenditure. In other words, those selling the shovels are unlikely to be hit hard but consumer staple and luxury brands might struggle.

The longer consumer spending stays weak the more likely it is that the US enters a recession, and when the US sneezes, the rest of the world catches a cold.

Commercial real estate has been battered

Since the pandemic the rise of online work has hit the commercial real estate sector very hard.

Over the last 6 months we've seen asset managers who hold large positions in commercial real estate slashing the valuations of their holdings.

Declarations such as this; where Manulife write down their holdings by 40% have not been uncommon

But why is that a problem? It links to my next point about bank weakness, we could end up with a similar situation (as a worst case scenario) that followed the path of 2008 whereby lenders have to devalue the real estate, this could push them to reposes if valuations drop too much, which introduces new selling supply onto the market, which further suppresses prices and the cycle continues.

Fortunately many lenders are far better capitalised than they were in 2008 so this is a tail risk in my opinion but certainly a nasty one should it play out with global real estate estimate to be almost $40T in assets, about twice the size of the entire Chinese economy with lending levels at about £2.7T it puts the subprime mortgage crisis ($1.5T) into perspective.

US regional banks are in poor health

This is a risk that seems to be simmering under the covers, and if banks can hold on for another 12-24 months then I think the crisis will be averted entirely.

Many banks hold US treasuries and other bonds as part of their books.

Sounds sensible, and I would generally agree, but there is one issue.

As interest rates rose, the value of those treasuries and bonds took a hammering. This means that many of the banks are sitting on $billions of unrealised losses in their books.

If the bank has adequate cashflow then they can simply hold those bonds to maturity and everything is fine because they will recoup the face value despite the lower trading amounts now. However, if we see any large liquidity draining black-swan type events, the banks could be on the chopping block.

In that instance we would see the central bank asset purchase programme get the dust shaken off and brought back out, but not after market chaos.

Conflict in the Middle East is looking more and more likely

The US has been deploying soldiers into the middle east and recently this has stepped up further.

As an outsider to the situation it feels somewhat distant, and don't get the next statement wrong, war is awful and costs human lives but this is an investing newsletter and war creates uncertainty, and uncertainty is bad for risk and therefore financial markets.

The conflict could also see trading vessels being blocked from the Red Sea, and as such put inflationary pressure on the western world as container prices increase due to the longer trip times to go around the south of Africa. This in turn could see interest rates be tightened and lead to further losses in equities.

China invades Taiwan

This is similar to the above, but potentially on a larger scale.

If China invades Taiwan then the fate of the world will likely rest on the shoulders of whoever is US president at the time.

The US is in a tricky situation, largely of its own making and can be summarised at a high level of:

The US has significant economic ties with Taiwan, notably TSMC which is a major computing chip manufacturer. The US has a lead in the AI arms race and needs TSMC to remain fairly independent from mainland China for that to continue.

On the other hand, the US doesn't recognise Taiwan as a sovereign state.

This creates issues because why would the US then step in to defend Taiwan if China 'invaded' a country it already claims ownership of?

That would be akin to a rebellion breaking out in Texas, Texas declaring it wants to be independent and then China stepping in to defend Texas even if Texas is part of the US.

As I'm sure you can imagine, this would get messy fast, especially if the US decides it will defend Taiwan to defend its economic interests. This could be why we've seem the US government offering incentives to US chip makers to try and catch them up to TSMC, because it gives the US an option to abandon Taiwan.

So where does that leave us?

The over-riding emotion currently appears to be uncertainty.

Until some of that uncertainty subdues, financial markets are going to be jittery. I don't know how long that could last.

One thing does appear realistic, the current turmoil is temporary and markets have shown strength since last weekend.

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Digital Assets

Just a note on the above table - Microstrategy has undergone a 10:1 stock split this week, hence the wildly inaccurate numbers being pulled.

Central Bank Digital Currencies (CBDC) Are Coming

As a quick run-down, a CBDC is simply a digital form of money, that usually settles instantly and the payment network is maintained by the central bank.

Don't we already have digital money, is there a gap in the market for CBDCs?

Yes and no.

Depending on what country you live in you will have different experiences in this area. I live in the UK and we have a network called 'faster payments'

If I make a bank transfer in the UK through faster payments then the money will be shown as leaving my account instantly, and for the most part, the recipient will have the money shown in their account instantly.

I think we often forget that this system isn't universal and the UK has world leading fintech companies.

Under the hood, the payment didn't actually settle instantly, the faster payment network settles at 7am, 1pm and 5pm, but that process is abstracted away from us as the consumer.

A CBDC has the power to settle instantly and potentially cheaper than most private networks such as Visa or Mastercard currently.

The reason CBDCs could potentially be cheaper is that if run by the central bank, the network doesn't have to be 'for profit' in the traditional sense.

That's because there would be something far more valuable up for grabs - control.

Lets take the example of Thailand, which is perhaps the most interesting CBDC example because it is almost a reality.

Digital wallets are big in Thailand, this has meant that the Thai government was able to send ~$280 (about half a months average wage) to 50 million Thai residents who didn't meet a pre-defined income or savings threshold.

So that sounds like a form of Universal Basic Income so far, right?

But dig a little deeper and we can see the control benefits CBDCs offer to the issuer.

The funds have to be spent within 6 months - that is easy to police because the money can be 'programmed' to disappear if not used. This also stops money simply being hoarded.

If you have a criminal record then you did not receive the money, again because this is issued electronically through digital wallets it makes 'screening' people easy to do.

Proponents of this system will have argue that if you are doing nothing wrong then there is nothing to fear.

I personally don't agree with that sentiment because it concentrates power and removes your rights over your own money, and in my opinion, at some point, even if it was set up with good intentions, it will get abused at some point, likely for political reasons.

So let's run the Thai example to it's potential conclusion.

What could you program this money to do?

1. Impose negative rates on savings. If you are the government in control of a country that's going through a tough time, you could set a negative interest rate on the savings of, say, the top 20% of households to encourage them to spend more and stimulate the economy, otherwise their money will lose value.
2. Confiscate or freeze money instantly. If you are suspected of a criminal activity you could have your money frozen until the conclusion of a trial.
3. Geographical spending restrictions. If power was partially devolved to local leaders then it would be possible to limit the amount of money you could spend outside a certain geographical area if the leader wanted to help stimulate the local economy.
4. Taxed at the point of use. Currently you can compile a tax return at the end of the year and look for deductions etc, then pay your tax. But what if it worked the other way around? All income was taxed immediately and then at the end of the year you needed to compile your deductions and reclaim the money.
5. 'Good' citizens could be rewarded. If a citizen does something for the benefit of the community they could be awarded money retrospectively, similar to retrospective public goods funding in the Ethereum network today.
6. Socialise losses. This is more of an American saying, but if there was a disaster you could enforce say a 2% blanket tax across all citizens to cover the cost of a sudden cost issue by immediately confiscating 2% (or whatever level) of savings from all residents of the country.
7. Sin tax - If you had a bad habit, say excessive drinking or smoking then the CBDC could cap your intake of these substances by rejecting transaction with them in. This could be used to reduce healthcare costs
8. I'm sure many more I can't even imagine!

As you may have noticed, some of these could be considered 'good' and some could be considered 'bad' - which ones is likely to depend on your outlook and I'm not saying there is a right or wrong reaction.

But CBDCs do concentrate power at a central bank.

Most central banks are supposed to be impartial to politics and only there for stabilisation, so in theory many of the benefits of a programmable CDBC shouldn't be realised because of impartiality rules, so at some point I envisage a financial power struggle here between governments and central banks which governments would likely win.

It also becomes difficult to see the role that general banks may have for retail customers if everyone ends up banking directly with the central bank.

I can very easily imagine a world where banking becomes more niche. For example, a bank might specialise in small business loans where it really needs a person to review a bespoke proposal because most direct to retail offers are from the central bank only, and since the central bank can't go bust, why would you put your money anywhere else?

The downside of this future would be a fragile banking system. If banks become niched down in say, commercial real estate lending, then a collapse in real estate values would sink the banks due to a lack of diversification.

Does crypto solve this?

Not yet. The benefit crypto has is that is is mostly an anarchist style form of capitalism where stablecoins, lenders etc are all free to compete with very little regulation.

This has meant we have everything from purely 'on chain' stablecoins such as DAI, and the more closely aligned with future CBDCs such as USDC all fighting it out for dominance.

My most likely route is that we do see a form of CBDC in the future, the extent of it's applications will depend on how its built, will it be built on a closed database or an open public blockchain such as Ethereum?

If you think it's going to be built on an open blockchain, then buying into tokens such as MKR or AAVE might be a good option as they will natively be able to integrate with an on-chain token so will likely either be bought out by banks or become direct competitors.

[DISCLOSURE - Chaz holds $MSTR, $RIOT in an ISA and $wStETH and $GALA in unsheltered positions]

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Have a great weekend!

Chaz

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