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Reggie Middleton

Reggie Middleton

Who am I? Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I…

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Scarily Prescient Analysis of @Grexit and the Most Advanced Application of Blockchain Tech Ever Seen As Strategy To Hedge Against It

The Wall Street Journal has a well done analysis of Greek debt coming due in about a week. It's a lot considering the size of the country's shrinking economy! Here's a snapshot:

What Greece Owes When

I have explained the Greek situation in full detail for my blog subscribers back in 2010, 2011 and 2012.

For background and perspective, read Lies, Damn Lies and the EU Confiscation Of Greek Sovereignty Masked As The Bailout That Never Happened. Pay close attention to these parts...

So, as I was saying...

It just won't work because it doesn't solve the problem. Instead, it attempts to conceal the problem in fashion that pretends it never existed. Let's walk through this so a 5 year old can understand it.

Interestingly enough, Reinhart and Rogoff, of This Time Is Different: Eight Centuries of Financial Folly fame contend "that historically, significant waves of increased capital mobility are often followed by a string of domestic banking crises". If that is actually the case, then the very goal of the Euro project was bound to bring about a sting of banking crises and all of this was actually inevitable. As excerpted:

The forgotten history of domestic debt has important lessons for the present. As we have already noted, most investment banks, not to mention official bodies such as the International Monetary Fund and the World Bank, have argued that even though total public debt remains quite high today (early 2008) in many emerging markets, the risk of default on external debt has dropped dramatically, especially as the share of external debt has fallen. This conclusion seems to be built on the faulty premise that countries will treat domestic debt as junior, bullying domestics into accepting lower repayments or simply 12 defaulting via inflation. The historical record, however, suggests that a high ratio of domestic to external debt in overall public debt is cold comfort to external debt holders.

Default probabilities probably depend much more on the overall level of debt. Reinhart and Rogoff (2008b) discuss the interesting example of India, who in 1958 rescheduled its foreign debts when it stood at only1/4 percent of revenues. The sums were so minor that the event did not draw great attention in the Western press. The explanation, as it turns out, is that India at this time had a significant claim on revenue from the service of domestic debt (in effect the total debt-to revenue ratio was 4.4. To summarize, many investors appear to be justifying still relatively low external debt credit spreads because "This time is different" and emerging market governments are now relying more on domestic public debt. If so, they are deeply mistaken.

... and this part from Saturday, 23 July 2011 The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!: I detail how I see modern bank runs unfolding

Now, with a full background on how we got to where we are now we move over to Goldman's recommended defensive plays to a Grexit, as reported by ZeroHedge. Before we go on, remember my admonitions about blindly following Goldman's retail and institutional analyst recommenations:

  • If tensions turn systemic, EM assets likely to see pressure

Even as Greek concerns have escalated, risk markets have so far traded in a resilient fashion, treating those concerns as effectively isolated to Greek assets. But in previous episodes of acute Euro area stress in 2010 and 2012, a wide range of EM assets came under pressure, especially CEE FX and CDS. Hungary was the hardest hit across all asset classes.

  • To hedge Greek risk, long $/CEE

Among EM, $/CEE has seen the largest moves in times of Euro area stress. This has reflected a weakening EUR and EUR/CEE moving higher. Specifically, the HUF and PLN are likely to depreciate against the USD in the medium term as policymakers welcome weaker currencies in the fight against "lowflation", and would move even more rapidly if Greek risks do become systemic. Locally, the entry levels are also attractive given the rally in EUR/CEE in recent weeks.



Hedging Greek risks in EM assets

Euro area sovereign and financial risks rising again
The nearly constant barrage of headlines reporting comments from Greek and Euro area policymakers is indicative of the renewed deterioration in sovereign risk. Greece and its Euro area counterparties continue to work within a tight schedule to avert a disorderly outcome. Our base case remains that some new accommodation will eventually be found between Greece and the European authorities. But risks of an accident remain as commercial bank deposit outflow and a shortfall in tax collections can precipitate a critical situation in the interim. Even if an agreement to extend the programme is reached this week, the gap between the demands of the Greek side and the actual programme requirements is very large.

The situation is fluid, and if an agreement is reached quickly to extend the Greek bailout, then broader asset markets (including in EM) should stay largely unaffected. But we continue to receive questions on how EM investors can consider hedging the risks of a more messy outcome - that either leads to a "no man"s land" where Greece is without the funding that comes along with a programme or, in the worst case, an outright exit from the common currency. In these latter outcomes, with systemic risk likely to increase, EM assets would come under pressure.

Three weeks ago, we described how in previous episodes of Euro area turmoil, on average EM bond yields tracked the move lower in G3 yields as demand for safe assets spiked, whereas EM credit spreads widened, EM FX weakened versus the USD and EM equities came under broad pressure (see "Taking one step back", EM Weekly: 15/03, January 29, 2015). That said, both EM and G3 bond yields are now at much lower levels - which makes the argument for being long EM fixed income more debatable in the current context. In this EM Weekly, we drill further down within EM FX, CDS and equities to evaluate the relative performance across countries over those previous episodes to help identify how best to protect portfolios against an escalation in Greek risks.

The EM asset experience in the 2010 and 2012 episodes of Euro area stress
Even as concerns around the extension of the Greek programme have escalated, risk markets have so far traded in a resilient fashion, treating those concerns as effectively isolated to Greek assets. But in previous episodes of acute Euro area stress, a wide range of EM assets came under pressure as risk traded poorly. Below we study the two previous episodes of Euro area stress in 2010 and 2012 to assess how different EM assets were affected on average. Euro area stresses were also elevated in 2011, but in that episode it is harder to distinguish between the impact of the Euro area worries and the US debt-ceiling crisis, which played a major role in roiling markets.

Starting with EM FX, Exhibits 3 and 4 show the average moves versus the USD and the EUR over the two periods when Euro area stresses were at their most acute: mid-April to early June 2010 and mid-March to early June 2012. Exhibit 3 shows that in these "risk-off" periods, almost all EM currencies depreciated versus the USD. In relative terms, the largest average depreciations were recorded in the Central and Eastern European region (PLN, HUF, CZK), followed by a couple of the high-yielders (RUB, ZAR) in the European time-zone. The MXN and BRL were most affected in the LatAm region, whereas NJA currencies outperformed.

Most EM currencies appreciated versus the EUR (Exhibit 4), which is unsurprising given that the Euro area was the epicentre of the shocks at these times. But, notably, the CEE-4 currencies saw meaningful depreciations versus the EUR, even as the EUR itself was depreciating. The geographical proximity and the strong trade and financial linkages of the CEE region to the Euro area meant that currencies there have tended to bear the brunt of Euro area crisis episodes.

Goldman believes Hungary is the most susceptible to Grexit risks. Since I've only excerpted the analysis, you can get the full story from the ZeroHedge article direcly...

$/HUF and $/PLN weakening our preferred ways to hedge Greek risks
At the current juncture the market appears to be making a couple of assumptions: first, that the ongoing disagreements between the Greek government and the Eurogroup represents the typical political posturing that has tended to take place in advance of eventual eleventh hour agreements; and, second, that in the event that agreement cannot be reached by the end of February, the upgraded EU toolkit, including the OMT and the soon-to-be-initiated sovereign QE, will keep market pressures from spilling over into the rest of the EU periphery, and by extension into the broader market.

Our read of the situation is less sanguine on both counts. An eventual agreement between the Greek government and the Eurogroup is still our base case, but we worry that the gap between the current programme on offer and what would be acceptable to a majority of the Greek parliament is very large. In addition, market pressure has often been the forcing variable in the past in helping to close this gap, so paradoxically the absence of broader market pressure is likely to make an eventual agreement that much less likely. In the event that an agreement cannot be found, and "Grexit" becomes a serious possibility, we would expect systemic concerns to affect markets more broadly than currently. As Francesco Garzarelli discussed (in Global Markets Views: "Systemic risks posed by Greece set to peak at month-end", February 17, 2015), even if peripheral bonds are shielded from the fallout by the ECB"s purchases, we would expect the EUR and stocks to come under downward pressure, and credit spreads to widen, reflecting the downside risks to a fragile economic recovery in the Euro area.

Given the results documented in the previous section, our preferred way to hedge these risks would be through long $/CEE positions. In previous episodes of Euro area stress, the combination of the EUR moving lower versus the USD and EUR/CEE moving higher has meant that $/CEE has tended to see the largest moves across the EM FX complex. Even setting aside Greece-related risks, our forecasts call for EUR/USD to move to 1.11, EUR/PLN to weaken to 4.22 and EUR/HUF to weaken to 320 in 6 months, as policymakers in these economies welcome or actively seek weaker currencies in their fight against "lowflation". This implies that the HUF and PLN are likely to weaken against the USD in the medium term based on macro and policy considerations, and if Greece-related risks turn systemic, the weakening is likely to be even more rapid. Finally, given the rally in EUR/HUF and EUR/PLN over the past three weeks, locally the entry levels are also much more attractive.

I've excluded the portions relating to CDS, but the EM FX is more than what's needed. I'm fully aware that CDS trades and exotic forext pairs may be beyond the ken of most retail investors and likely many institutional investors as well (which is why banks get them into such precarious situations, that cost them so much to get out of, ie. How Veritaseum's UltraCoin Could Have Saved Harvard Over $1 Billion!). Alas, I digress. Those who follow me know that I clearly aim to disintermediate rent seeking in the financial space and to return said rents back to the community at large in order to let true talent, intellect, and most importantly drive (the prime determinent of success absent institutional barriers to entry, participation and geo/socioeconomic discrimination). These tweets make a good segway into how and why consumers - big and small (like Harvard who was taken advantage of by the Bank Morgans and stay at home day traders) - can now compete with Wall Street and stand toe to toe.

Now, I will work the magic of technology and show everyone who can make it to the bottom of this article (unfortunately, that is truly only a select few) how to encapsulae the Goldman researh (which I haven't personally vetted, but does make sense on its face) in one single trade. This trade, a digital swap, is something that Goldman itself, nor any of its competitors (save Veritasuem, which is a software concern and not a financial institution) can offer you. Goldman suggests "$/HUF and $/PLN weakening our preferred ways to hedge Greek risks." A cursory look at these two pairs through both the 2012 scare and now lends credence to the Goldman assumption.

So, let's take a position on both pairs with a single UltraCoin swap. This can be be modeled with Veritaseum's UltraCoin Trade Modelling Spreadsheet before actually being entered through the actual ultracoin client. Keep in mind that, as a digital derivative transaction:

  1. You can take as small or as large a position as you please. This example uses a $4000 at risk amount, you can use as little as 12 cents or as much as $300 million.
  2. The use of leverage can give you extreme buying power (up to 10,000x), but along with it is extreme risk and larger fees. At the end of the day, its still beats ANYTHING Goldman can, or would offer you. Here we have the equivalent of two forex pair swaps for $100,000 for $121. Read How Veritaseum's UltraCoin Could Have Saved Harvard Over $1 Billion! to see how much JP Morgan and Morgan Stanley charged Harvard. Here's a spoiler, it was more than the 10 basis points they would have been charged with UltraCoin!
  3. This is a very custom swap. I'm not saying Goldman can't do it, but it's not just sitting around in their inventory, and they will charge you accordingly - with no more liquidity than is offered here, but with a LOT less transparency and safety. As a matter of fact, you always either no where your money is (in the blockchain) or have it in your possession (via your wallet), that is unless you lose it. Here's a graphic of the order placed, and to find the location of your funds at any time, just hit that "Track Transactions" button at the bottom.

Rest assured, Goldman, et. al. can never tell you where your funds are at any specific time. The ex-president of Goldman, Mssr. Corzine can attest that Man Financial probably couldn't either, as per Wikipedia:

In 2011, MF Global faced major pressures to its liquidity over several months. Some analysts and financial commentators indicate that MF Global probably experienced a number of trading days in 2011 during which the firm's bets on sovereign debt would have required the use of customer funds to meet capital requirements, thereby maintaining operating funds and possibly overall solvency. A large part of these pressures on MF Global were a result of the firm's involvement in a significant number ofrepurchase agreements. Many of these repo agreements were conducted off their balance sheet. Also, MF Global made a $6.3 billion investment on its own behalf in bonds of some of Europe"s most indebted nations. Failure of those, and other, repo positions contributed to the massive liquidity crisis at the firm.

  1. UltraCoin is P2P software, not a brokerage firm or a bank hence there is absolutely no exposure to our balance sheet or the risks of such that my ensue. It never, at any time, even takes possession nor has control of any of your funds, thus it can never abscond with them or use them in an inappropriate manner.

  2. The only other possible (okay, credible) sales objection the Goldman team could raise to prevent their clients from defecting to a software solution as compared to their 45% of gross revenues paid as their compensation solution is that the Veritaseum solution rides on the Bitcoin blockchain, exposing users to BTC volatility. Outside of the fact Goldman would likely charge you more for the swap than the volatiity may cost you, I have modeled in a 10% drop in BTC prices, along with all the fees charged to show you what happens when the swap is constructed properly. Just follow the series of graphics below carefully and read everything.




Ultra Coin

I love to talk! I'm willing to discuss anything in this article, from Grexit to Wall Street banks to the technology that challenges their hegemony, with anyone. Just reach out to me here.

 

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