CFA Society Chicago Book Club:

How to Measure Anything: Finding the Value of Intangibles in Business by Douglas W. Hubbard

how-to-measure-anythingPath dependence is the phenomenon often used to explain why people sometimes persist with practices that are no longer optimal or economically rational. Statistics is another area where path dependence has struck. The statistical techniques that students learn in school, the ones that practitioners apply in industry, and the ones researchers use in journal publications often aren’t the best or the most appropriate ones but rather the ones that continue to be used because they’ve always been used.  Douglas Hubbard’s How to Measure Anything (2010) attempts to update some of those techniques for the 21st century.  In addition, he offers some refreshing perspectives on behavioral finance and the biases that adversely affect decision makers, even the so-called professional decision makers at the executive level in industry and government. Finally, he offers a unifying framework for decomposing complex problems into individual variables, assessing the value of reducing the uncertainty for each of those variables, measuring those variables, and finally determining probabilities through Monte Carlo simulations and Bayesian statistics.

Starting with antiquated statistical techniques, every former stats 101 student probably remembers going through some type of hypothesis testing exercise such as testing if a coin is fair, a drug works, voters prefer a candidate, etc. Those tests take a null hypothesis, such as assuming that a coin is fair, flipping it multiple times, and then determining the probability of observing a series of outcomes if the coin were fair. If the probability of observing a series of outcomes on a supposedly fair coin is less than some arbitrary threshold, usually five percent, the experimenter rejects the null hypothesis and concludes that the coin is not fair.  For example, the probability of observing five heads out of five flips on a fair coin is 3.13%, which would cause an experimenter using the five percent threshold to reject the null hypothesis that the coin is fair. The five percent shibboleth comes from the statistician Sir Ronald Fisher’s 1925 paper “Statistical Methods for Research Workers.” He wrote a year later in “The Arrangement of Field Experiments” (1926) that the threshold was arbitrary and that other thresholds may be used; however, the damage had been done and the five percent threshold remains as a venerated relic.

The whole process is a convoluted way to approximate the more useful question: What’s the probability of getting a heads on a given coin? The Bayesian approach to statistics, in contrast to the frequentist approach previously described, seeks to do just that. Mr. Hubbard notes that the term “Bayesian” was first used by Fischer himself as a derogatory reference to adherents of the approach named after Rev. Thomas Bayes. Rev. Bayes is credited with developing the first formulation of how new evidence can be used to update prior beliefs.  In the case of Bayesian statistics, new evidence is used to update prior assumptions about probabilities.

Once the distribution of the relevant variables or drivers is better known, Mr. Hubbard postulates a relationship between the variables and generates a hypothetical distribution of the phenomenon that one is trying to predict using Monte Carlo simulations. First developed to solve intractable problems in nuclear physics, modern computing power has made the technique accessible to anyone with a personal computer and an Excel spreadsheet. Instead of trying to compute the probability of a phenomenon such as rolling a two with a pair of dice (“snake eyes”), Monte Carlo simulations flip the problem by simulating thousand or perhaps millions of rolls and then determining what percentage of the rolls were twos. With an Excel spreadsheet, Mr. Hubbard shows how to calculate distributions and expected values for complex phenomenon after estimating the distribution of the underlying variables and their relationships. Monte Carlo simulations are seldom taught in introductory statistics courses. The topic is usually reserved for advanced classes and special topics classes even though the basics of the technique are no more complicated than regression modeling and several other topics that are covered in introductory classes.

With new statistical tools in tow, Mr. Hubbard then sets forth on finding what to measure.  Here Mr. Hubbard again notes a pernicious tendency among decision makers to either measure what’s easy to measure or what they’re already familiar with. The solution, Mr. Hubbard argues, is to triage variable before trying to reduce uncertainty about them by introducing metrics to quantify the costs and benefits of acquiring additional information about each variable. He starts with the Expected Value of Perfect Information (EVPI): What would it be worth to know a presently unknown quantity with complete certainty? He then works backwards to determine the incremental Expected Cost of Information (ECI) and the incremental Expected Value of Information (EVI). Finally, he adds a time component, noting that for some decisions the value of information is perishable. Mr. Hubbard notes that adding the time component can prevent what pioneering decision theorist Howard Raiffa called, “Solving the right problem too late.”

In addition to the tendency to measure the wrong things and measure in the wrong amounts, Mr. Hubbard notes several other behavioral and cognitive biases, such as expectancy bias and overconfidence. Instead of just rehashing problems that already have been noted extensively in the behavioral finance literature, Mr. Hubbard goes further and offers solutions, especially to the problem of overconfidence and quantifying uncertainty. When asked to calculate a 90% confidence interval for an unknown quantity, such as the wingspan of a Boeing 747 aircraft, most people choose too narrow a range. Mr. Hubbard shows that with training the average person can estimate ranges for unknown quantities such that on average the true value falls within their estimated range 90% of the time. The training, called “calibration training,” is simple to conduct and has a tremendous success rate.  Organizations should probably spend more time training their executives to become better decision makers given how much time and money as they spend sending them to conferences, hiring executive coaches, and giving them physical and psychological assessments.

When the CFA Society Chicago’s Book Club met to discuss Mr. Hubbard’s book in April 2017, most of the participants welcomed his fresh approach to quantitative and empirical problem solving. If there were any misgivings about the book, they were that it didn’t fully live up to its title: “Finding the Value of Intangibles in Business.” The participants would have welcomed more examples of how the techniques described could be used to value business units or firms that make intensive use of intangibles such as brand identity, intellectual property, or perhaps others.

Hopefully, this won’t be the last time that Mr. Hubbard crosses paths with the Society and we’ll get to fulfill that promise.

 

CFA Society Chicago Book Club:

Blockchain Revolution: How the Technology Behind Bitcoin is Changing Money, Business, and the World by Don Tapscott and Alex Tapscott

BlockchainRevolution-674x1024Blockchains are simultaneously feared as a disruptive threat and lauded as a technological panacea, often with little understanding of how they actually work and often with little practical consideration of how they might be implemented. Don Tapscott and Alex Tapscott (father and son, respectively) assist the layperson in understanding how blockchains work and how they could be used in Blockchain Revolution (2016). The authors also, unfortunately, further delude the technological utopians by proposing seemly endless possible uses of blockchain technology while failing to address some of the practical considerations of implementation.

Starting with the positive, Blockchain Revolution is one of the first resources to both explain blockchain technology and to fully explore its potential uses beyond the now somewhat familiar bitcoin. Bitcoin is the digital currency created by “Satoshi Nakamoto” in 2009. Satoshi Nakamoto was the name that was used in internet chat rooms and the like by a person or group of persons who claimed credit for creating the cryptocurrency. Soon after creating bitcoin, Satoshi Nakamoto disappeared and the identity or identities behind the name never have been revealed. Replete with a dubious creation story, bitcoin maintains a religious, cult-like following despite scant uptake and usage. The history of bitcoin has been told elsewhere, including in Paul Vigna’s and Michael J. Casey’s The Age of Cryptocurrency (2016), which was the book of the month for the CFA Society of Chicago’s Book Club in February 2016.

What hasn’t been told widely until now are the other possible applications of the technology underlying bitcoin, the blockchain. A blockchain is nothing more than a ledger for recording transactions. The double-entry bookkeeping system that forms the foundation of modern accounting is widely attributed to Luca Pacioli, a Franciscan Monk and mathematician who lived in the 14th and 15th centuries. There are earlier claims to the discovery, which probably have some merit. There are probably undiscovered cave scribbles that merchant cavepeople used to record exchanges of spears and mastodon parts. As long as there’s been commerce, there’s been the need to record exchanges, and ledgers in some hasty form have probably served the part from time immemorial. The difference between blockchains and most previous ledgers is that previous ledgers resided with a trusted central party to the transaction, whereas blockchain ledgers are distributed, meaning that every member of a network retains a copy of the ledger. When there is a new transaction in the blockchain, members of the network that maintain the ledger verify the authenticity of the new transaction, append it to the chain of all previous transactions, and transmit the updated chain to the network.

That distributed feature is what poses the disruptive threat to numerous businesses that are based on intermediating markets. For example, the Uber business model is based on a central party that sits between drivers and passengers, links the two, and takes a slice of the profits in transaction fees. Similarly, Airbnb disrupted the hotel industry by intermediating the market for lodging by linking people who have spare capacity in their homes with travelers looking for a place to stay. Blockchains could further disrupt the disruptors by allowing those parties to transact directly and take out the middleman.  The Tapscotts mention several other less obvious areas where blockchains could be used to intermediate markets or keep records, such a land and property deeds, personal medical and financial information, stock and bond offerings, contracts, and wills. The authors even argue that intellectual property such as music and other artwork could benefit from blockchains by allowing artists to control access to their works and charge a royalty fee directly to end users when they access them.

The oldest and largest business based on intermediation is, of course, banks. The primary function of banks always has been to intermediate the market of lenders and borrowers. Without banks, potential borrowers could find themselves having to go door-to-door, pleading for loans and negotiating the amount and the terms of the loans with each potential borrower. Banks have always done that legwork primarily by taking deposits and issuing those deposited funds as loans. Add credit and debit cards, foreign exchange, settlement, custody, and clearing to the mix and banks make considerable profits just by sitting between market participants, recording transactions, and taking fees. The Tapscotts and other blockchain utopians contend that all such businesses based on market intermediation will become unnecessary and disappear due to blockchain technology.

The CFA Society Chicago Book Club members who met to discuss Blockchain Revolution during their March 2017 meeting agreed that the range of possible blockchain uses was enlightening but found the tone of the book overly optimistic and found the treatment of implementation challenges lax. Take contracts, for example. The Authors seem to presume that blockchains will obviate the need for traditional contracts and courts to enforce them. A hypothetical blockchain contract might look as follows: A stadium owner engages a vendor to fix the plumbing in his stadium. When a credible party who has access to verify that the work has been completed confirms successful completion of the work in the blockchain, payment is automatically distributed. But what if the stadium owner contests the quality of the work? Was the vendor merely to fix the plumbing so that it didn’t leak or was the vendor supposed to restore the plumbing to like-new status? What if the stadium owner was relying on the repairs being completed by a certain time so that he could host a concert? If the vendor doesn’t complete the repairs, is it liable for the foregone revenue due to the stadium owner’s inability to host the concert? These are not far-flung hypotheticals. Contract law deals with those issues constantly. It’s not clear how blockchain-based contracts will be any better than paper-and-pencil contracts in terms of interpretation and adjudication.

Safety and security of blockchains is given similarly little treatment. Assuming for the sake of argument that the double key encryption technology that blockchains use makes them impenetrable to hackers, they could always just access blockchains using stolen passwords. And unlike when someone fraudulently uses a credit card, there is no legal department at bitcoin to contest the fraudulent transaction or IT department to reset the password.

Blockchain usage will undoubtedly increase. Even without blockchains, market intermediation for a variety of products and services has become increasingly automated and that trend will continue whether by blockchains or by other means. The consequence of that for banks and financial institutions is that they won’t be able to rely as much on the simple act of intermdiation for revenue and will instead have to increasingly compete on knowledge and customer service. Even now customers no longer need banks to purchase a variety of financial products and services, but retail and commercial customers still come to banks and financial institutions for sound advice and financial planning—and to reset their passwords.

Despite its shortcomings, Blockchain Revolution is an important contribution to understanding rapidly evolving blockchain technology, and hopefully others will step up to fill in the missing parts of the puzzle concerning how blockchains will be implemented and administered.

CFA Society Chicago Book Club:

The Gray Rhino: How to Recognize and Act on the Obvious Dangers We Ignore by Michele Wucker

thegrayrhino-3D-coverOverlooking or underestimating obvious dangers is a timeless tradition. A man is terrified of planes but gets in his car every day and drives with no seat belt. A woman pays the fire insurance premium on her home religiously but doesn’t floss her teeth. People play the lotto but don’t take advantage of their employers’ 401(k) matching contributions. Organizations, including governments, are as bad or worse.  Passengers remove their shoes at airports to prevent a shoe bombing, which has been attempted once in human history—unsuccessfully—while infrastructure is allowed to crumble to the point of collapse, such as the I-35W Bridge in Minneapolis, Minnesota, that collapsed under the weight of normal traffic and killed 13 people. That catastrophe didn’t occur because it was rare, hard to predict or even unpredictable, a black swan in modern parlance from Nassim Nicholas Taleb’s 2007 classic of the same name.  Instead, those dangers are obvious and imminent; much like the danger of a charging gray rhino, from which Michele Wucker’s The Gray Rhino: How to Recognize and Act on the Obvious Dangers We Ignore (2016) derives its name.

In February of 2017, the CFA Society Chicago’s Book Club had the privilege of hosting Ms. Wucker in person to discuss her Book. The conversation was wide ranging and included water shortages, global warming, the Challenger Shuttle disaster, and many other topics. Why do we spend resources worrying about and preventing rare events but ignore or do nothing about obvious, preventable dangers? Ms. Wucker has several explanations from the social sciences: taboos about raising alarms, groupthink, anchoring and confirmation biases. She notes the origins of the sobriquet Cassandra, an unflattering term used to describe people who warn others about potential dangers. The original Cassandra was given the power of prophecy from the god Apollo. When she didn’t reciprocate Apollo’s affections, he threw a curse on her that prevented others from believing her prophecies, including her prophecy that the Greeks would attack Troy, which is what ultimately happened. The negative connotations that are associated with the name of someone who correctly warned others about impending danger speaks to deep seated cultural aversions to raising alarms. That negativity combined with the fact that Cassandra was a woman who was punished for shunning the advances of a male superior is a similarly depressing statement about society.

With the manifold existence of Gray Rhinos and their causes firmly established, the question turns to their taxonomy and life-cycle. Ms. Wucker identifies eight types and five stages of a Gray Rhino.  The eight types include the “Inconvenient Truth” Gray Rhinos that are widely recognized but not acted upon due to denial, including manufactured denial, and high costs to fix.  Global warming is the classic example of an Inconvenient Truth Gray Rhino. There are also the “Creative Destruction” Gray Rhinos such as Kodachrome, where acceptance and orderly unwinding are the only tenable solutions. It was not mama but the inevitable march of time that took our Kodachrome away. For each of the eight types in the taxonomy, all follow a life cycle of five stages. The first stage is denial, the second is muddling or kicking the can down the road, followed by haphazard diagnostic exercises, the third, panic, the fourth, and finally action.

Ms. Wucker’s Taxonomy and Stages are invaluable contributions to the ongoing policy discussion. The Taxonomy and Stages also need to be viewed in the context of organizational motivations and individual incentives, though. A good example is the Challenger disaster that Ms. Wucker opens her book with.  When making go/no-go decisions, it’s helpful to look at data from previous failures as well as data from previous successes. Space shuttles relied on re-usable solid rocket boosters for their initial launch. The boosters were built in segments and each segment had o-rings that were supposed to keep hot gas from escaping. When o-rings get too cold, they become brittle and fail allowing hot gasses to escape, which is what caused the Challenger disaster. On the morning of the launch, one engineer spoke up against the launch. The coldest successful launch took place when the temperature was 53 degrees. In that launch, gas escaped passed the first ring and caused corrosion on the backup ring, but the backup ring contained the gases. Below 53 degrees, there were no data. On the morning of the Challenger launch, the temperature was 35 degrees.

On January 28, 1986, NASA got an additional data point. The backup ring failed and seven astronauts died.  The Challenger disaster didn’t happen because the world’s smartest people didn’t understand the threat of cold weather to the proper function of o-rings. It happened because of the tremendous pressures on NASA to proceed with the launch. The space shuttle was originally conceived as a way to easily and cheaply launch people into space and return them in a re-usable ship.  The term “space bus” was even used. In practice, the program proved to be more costly and inefficient than the shuttle’s predecessors. NASA was under tremendous pressure to demonstrate the viability of the program.  In addition, the Challenger was going to launch the first teacher, Christa McAuliffe, into space. Millions of people were tuned to their television sets to see a launch that had already been delayed several times.  The organizational and public relations pressure to proceed with the launch overwhelmed good judgement.

Organizational pressures and incentive structures are that root of several Gray Rhinos. Scarce public funds either can be used to pay teachers or fix bridges that seem to work fine (until they don’t). Publicly traded companies struggle to look past obstacles beyond meeting quarterly numbers. Politicians aren’t incentivized to deal with any problem such as global warming whose most detrimental effects are likely to occur after a two, four, or six year term.

The assembled Book Club members and Ms. Wucker did offer several solutions to the Gray Rhino problem.  First, align incentives. Executive compensation should vest fully over a period of years or even decades.  Investors should similarly hold companies to account for long term performance and be more forgiving of short term volatility. Allowing US banks to hold stocks as banks do in Japan and Germany might allow more steady capital into capital markets and reward longer term performance, too. Second, break the problem into small pieces. There’s an old expression: “How do you eat an elephant? One bite at a time.” The same logic applies to Rhinos. Instead of trying to fix all the nations crumbling infrastructure, prioritize. Fix one bridge at a time, starting with the most dilapidated. Third, to combat groupthink and denial, include diverse perspectives in one’s circle and allow multiple channels of access to leaders and decision makers.  Related to that third point, the group discussed the competing leadership styles of Presidents Reagan and Kennedy. President Kennedy’s administration followed a spokes-on-a-wheel format where multiple influencers had direct access to the President, which could explain his successful resolution of the Cuban Missile Crisis. President Reagan, on the other hand, had a more linear chain of command with multiple bottlenecks and chokepoints, which could explain how in the Iran-Contra Affair a few rogue elements of his administration where able to conduct arms sales and a covert war without knowledge or involvement from either the State or Defense Departments.

The Gray Rhino is a welcome addition to current policy debates and compliments established organizational behavior and social science literature well. At 304 pages, it’s also a manageable and enjoyable read. The Society is very grateful to Ms. Wucker for her book and for her attendance at our meeting.

CFA Society Chicago Book Club:

The Accidental Superpower: The Next Generation of American Preeminence and the Coming Global Disorder by Peter Zeihan

superpowerGeography is destiny.  Demography is second.  Everything else is a distant third.  That’s the takeaway from Peter Zeihan’s The Accidental Superpower: The Next Generation of American Preeminence and the Coming Global Disorder, which was the book of the month for the CFA Society Chicago’s Book Club in January 2017.  From settling the Nile Valley to deep water navigation and the shale oil revolution, Mr. Zeihan explains how geography influences almost every aspect of civilization from formation to eventual demise.  Landlocked countries tend not to have navies of any consequence.  Countries with neighboring threats tend not to have excess resources to project military power beyond their borders.  Countries lacking internal resources are more likely to engage in trade.  The fact that the US is facing two oceans and has no neighboring threats coupled with its need to secure energy and goods explains how she can—and has—projected her power abroad for decades in part to secure global trade.  The shale revolution and ample food supplies coupled with the rising costs of extra-continental labor and domestic supply chain alternatives such as 3D printing explain why she might no longer need or care to.  The conclusion is that a newly self-sufficient and relatively young US will withdraw from participating in global trade and security while the rest of the world collapses under the weight of its aging populations and competition for scarce food and energy.  How’d we get here?

To answer that question, rewind to the beginning of the book, which starts at the end of World War II, the most destructive war in human history, and the agreement that helped in part to ensure that it never happened again, the Bretton Woods Agreement, signed by 44 countries at the Mount Washington Hotel in Bretton Woods, New Hampshire.  In addition to the consequences of that momentous agreement, we learn that its namesake town and the Hotel at which it was signed were so overwhelmed the 730 delegates that descended upon it that the Hotel’s manager locked himself in his office with a case of whiskey at one point during the gathering and refused to come out.  Those anecdotes along with Mr. Zeihan’s wry sense of humor alone made the book well worth reading.  The Agreement’s consequences were threefold: (1) all the signatories’ currencies were to be freely convertible into US dollars at a fixed rate, and the US dollar was likewise to be exchangeable for gold at a fixed rate, (2) the US would protect maritime shipping, and (3) the signatories would be part of a “strategic umbrella” of protection against the common Soviet threat.

Just as geography had ordained that the WWII belligerents compete militarily to secure markets, resources, and shipping, the Bretton Woods Agreement with the stroke of a pen ensured that they would no longer need to.  Being freshly ravaged by war and facing a common Soviet threat further ensured their assentation to the agreement.  In addition to Bretton Woods, there was one more ingredient in the elixir that spawned the post-war boom: demography.  The signatories boasted youthful populations.  Few variables in economics are known with near certainty for any extended period of time.  Demographic variables are an exception.  At any given time in any given country, one can tell with reasonable certainty how many skilled young workers will be entering the workforce.  Skilled workers don’t magically fall from the sky ready to leave home and acquire gainful employment, as much as their parents may wish it. There is a pipeline from birth to school to adulthood.  Once in the workforce, laborers again follow a predictable life cycle. As they begin working, they begin paying taxes and saving.  As their savings grow, they deploy their savings into capital markets until they finally retire, spend down their savings, and increasingly rely on the next generation of tax payers for their welfare.  Here again the US, while still aging, is relatively young and demographically well positioned relative to the rest of the World, Mr. Zeihan argues.

The book club members welcomed Mr. Zeihan’s geographic and demographic analysis as a compliment to traditional economic and financial modes of analysis. The members did, however, cast doubt on some of his conclusions and predictions.  The first was the premise and title of the book, Accidental Superpower.  One member noted that the Founders were quite deliberate in their desires to build the US into a military and economic superpower, the subject of a recent popular musical.  No one gave serious credence to Mr. Zeihan’s prediction that Alberta, Canada, might become the 51st state.  If Mr. Zeihan had cast a critical eye towards the US and applied some of the same analysis that he applied to the rest of the world, he might have found similar fissures.  Many Western and Southern US States are net beneficiaries of federal aid and lament the federal government’s intrusions in their lives.  If armed standoffs like 2014 one with Amon Bundy in Nevada become more commonplace, it’s at least as plausible as some of Mr. Zeihan’s other claims that net-contributor states might leave those states to fend for themselves.  More importantly, Mr. Zeihan’s arguments about geography and physical capital didn’t seem as relevant to the Members as the author claimed them to be in the internet age, and one certainly doesn’t have to be a naval power to wreak havoc in the cyberwar era, as the US again learned in the 2016 election of Mr. Trump as President.

Alberta, Canada, might indeed become the 51st and prove the Club Members wrong, and even with its other potential omissions and shortcomings, Accidental Superpower was an eminently enjoyable and worthwhile read.

CFA Society Chicago Book Club:

The Only Game in Town by Mohamed El-Erian

the-only-game-in-townExtraordinary central bank interventions during economic crises aren’t new.  In his Pulitzer Prize-winning Lords of Finance, Liaquat Ahamed mentions Emperor Tiberius injecting one million gold pieces into the Roman economy to keep it from collapsing in 33 AD.  Extraordinary central bank policy coordination similarly isn’t new, as Mr. Ahamed notes with the frequent meetings between the heads of British, French, US, and German Central Banks and the resulting coordinated policy actions during the First World War and the Great Depression.  What is new is the extent and duration of those interventions and the absence of any corresponding fiscal or structural reforms. After Tiberius’s intervention, Rome soon returned its focus to commerce, conquest, and imperial assassination.  Roman merchants and farmers didn’t sit idly waiting for the next round of monetary stimulus and then dispose of their wares and crops in panicked fire sales when cheap money didn’t materialize.  Contrast that with our times.  Six years into an economic expansion, interest rates remain at historic lows—even negative in several major economies—with little hope of fiscal or structural reform.  A small uptick in volatility can elicit calls for further quantitative easing (college campuses apparently aren’t the only places where people are clamoring for safe spaces).  Central banks have become The Only Game in Town, the title of Dr. El-Erian’s book and the subject of the CFA Society Chicago’s July 19, 2016, Book Club meeting.

Dr. El-Erian brings uniquely diverse cultural, educational, and professional perspectives to the financial crisis and the ensuing central bank interventions.  His mother is French and his Father is Egyptian, and he spent time growing up in Egypt, in France, where his father was the Egyptian Ambassador to that country, and in New York City, where his father worked at the United Nations.  His enrichment continued in the United Kingdom where he attended boarding school, Cambridge, and finally Oxford, where he earned a doctorate in economics.  His professional resume is equally diverse and impressive.  It includes the International Monetary Fund (IMF), Harvard University’s endowment, and PIMCO, one of the world’s largest bond investors with approximately $2 trillion under management.  It’s there where Dr. El-Erian served as co-CIO along with PIMCO-founder Bill Gross.  That’s in addition to his numerous publications, boards and committees, and his previous book, When Markets Collide, which won the Financial Times and Goldman Sachs Business Book of the Year Award as well as The Economist’s Book of the Year Award in 2008.

In addition to his qualifications to write on the subject, Mr. El-Erian served as CFA Society Chicago’s keynote speaker at its 2015 Annual Dinner, which further piqued Book Club members’ interest.  In his exposition of the issues facing global markets and central banks’ responses to them, Dr El-Erian didn’t disappoint the assembled Book Club Members.  In the plain-spoken fashion that made When Markets Collide a classic, he explained complex, interdisciplinary phenomenon in simple terms with the assistance of helpful metaphors.

For example, he explained the collapse in confidence and liquidity during the crisis in terms of a drive through: Customers pay at the first window and receive their food at the second.  When customers aren’t confident that they’ll receive their food at the second window, they’ll demand it at the first window.  When restaurants don’t relent, both parties that otherwise wish to transact will walk away – market failure.  As another example, he explained that trying to push certain products and activities out of the banking system was like pushing on a waterbed.  Rather than remove the activity, pushing simply displaces the activity to elsewhere in the bank and non-bank financial sectors.

Dr. El-Erian also noted the increase in the size and power of the end-users of capital, the buy-side, relative to financial intermediaries, the sell-side.  The phenomenon has been noted, among others, by John Rogers, the former CEO and President of the CFA Institute, in A New Era of Fiduciary Capitalism? Let’s Hope So, which appeared in the May/June 2014 edition of the Financial Analysts Journal.  Dr. El-Erian explained the consequence of that transformation, namely that the growing end-users are trying to force more transactions through the shrinking pipes of the financial intermediaries.  The result in the financial world is as calamitous as the result in the plumbing world.

In all, Dr. El-Erian noted nine challenging trends in global economies related to extraordinary extended central bank interventions, the subject of Part Three of his book: inadequate growth models, high unemployment, increased inequality, decreased institutional credibility, political gridlock, increased trade imbalances and tensions between the core and the periphery of the global economy, the rise of shadow banking, decreased liquidity (the pipes mentioned above), and finally the increased complacency among market participants due to a perceived central bank put.  In that exposition Dr. El-Erian touched on several insightful points.  For example, he noted the Bank of International Settlements (BIS) meetings allowing for back-channel discussions and problem solving between the monetary authorities of different economies.  A similar mechanism for averting armed conflicts through international organizations such as the United Nations has been noted in Bruce Russett and John O’Neal’s Triangulating Peace.  Perhaps a longer book would have allowed those points to be developed further.  The Only Game in Town is only 296 pages, including appendix.

That largely concluded the exposition of the problem, where Book Club Members gave Dr. El-Erian high marks.  The remainder of the book was a meandering attempt to solve the problems noted in the first part of the book, which left members disappointed.  The desultory journey covered bi-modal distributions, behavioral finance, several other topics, and even a section on diversity in the workplace.  One member quipped that the last chapter of the book was probably a last-gasp effort to fulfill a contractual minimum page requirement with the publisher.  Dr. El-Erian had a similar chapter on organizational leadership at the end of When Markets Collide.  In that book he also noted the failure of macro-prudential regulators such as the IMF, his former employer, to balance their academic training with technical knowledge gleaned from actual market participants.  Perhaps better institutional leadership and reforms, including more diversity, could foster economic stability and growth, but Dr. El-Erian failed to argue the point persuasively, at least in the judgement of the participating Book Club members.

The Only Game in Town is a worthwhile addition to the discussion about the continued role of central banks in the current economy and the potential pitfalls of continuing down the current path.  Even though Dr. El-Erian ultimately failed to solve the problems he elucidated, he’s hardly alone in that regard.

CFA Society Chicago Book Club:

Age of Ambition: Chasing Fortune, Truth, and Faith in the New China by Evan Osnos

age of ambitionMost of us have a well-formed macro perspective on China. It’s the world’s second largest economy and a key U.S. trading partner with growing influence in Asia and globally. In Age of Ambition Evan Osnos takes us beyond the statistics, building a complex portrait of China through its people. The author introduces us to citizens from all walks of life with widely different views on politics, the economy, social issues and the Country’s future. He reveals the monumental changes, challenges and contradictions China faces by telling their stories, tracing their lives over the years and exploring their goals, aspirations and attitudes. It’s an up close and personal look that’s highly engaging.

We follow several progressive reformers like Ai Weiwei, a famous artist who publicly mocks inequities; Han Han, a snarky and wildly popular blogger who takes aim at rampant hypocrisy; Liu Xiaobo, a leading voice for human rights who won a Nobel Peace Prize while imprisoned for advocating political reforms; and Chen Guangcheng, the “blind peasant lawyer” who helps his poor rural neighbors fight injustice by local officials.

We also meet conservative nationalists like Lin Yifu who defected from Taiwan to China in 1979 with the dream of helping China reclaim its greatness. He became a chief economist at World Bank and evangelized China’s central planning methods. Tang Jie is a graduate student whose viral patriotic video inspired Chinese people to stand against protests of China’s repression in Tibet. He and other nationalists view foreign criticism as part of an ongoing plot to encircle and weaken China. Interviews with these and other personalities span years and it’s fascinating to observe how their views develop as the country rapidly evolves.

The author takes us beyond the headlines of scandals and disasters like China’s real estate boom, organized crime and explosive growth in Macau, riots in the Uighur region, earthquake in Sichuan, conflict with Japan over the Diaoyu Islands and the “Harmony Express” bullet train crash. State controlled media tries to shape these stories but is often undermined when details emerge. The collapse of schools in the Sichuan earthquake and the “Harmony Express” crash were eventually linked to corruption that allowed shoddy building practices. Fraud was so widespread in the railroad ministry that its chief Liu Zhijun was convicted of taking kickbacks and bribery to win a Party Central Committee post. However, the truth-seeking public also can pay a price. After the Sichuan earthquake, parents who demanded information about missing children were detained.

Several book club attendees thought the author could have quantified the material better. And we also noted he doesn’t take a position or recommend action to resolve the country’s challenges. It’s true, Age of Ambition isn’t China-by-the-numbers, but it does offer rich insight into the Chinese worldview and their perspective on the country’s challenges. Our discussion was made especially interesting having Yunjin Wang and Yang Xu, CFA, add clarity and context about their home country. Both felt the book was accurate, but also noted significant changes have occurred in the short time since it was published in 2014, including the crack down on fraud and tightening of the “Great Firewall” by incoming President Xi Jinping, as well as the profound effects of ongoing economic shifts.

Key takeaways from Age of Ambition were the existential threats facing the Communist Party and their hold on power:

EXTREME WEALTH INEQUALITY

Market-based policies have created dramatic growth, but the benefits have gone mostly to politically connected businessmen and officials. China’s true Gini coefficient of wealth distribution is estimated at 0.61, among the world’s worst. This inequality stands in stark contrast to the Party’s ideal of a classless society. There’s growing frustration with the lack of social mobility. Wages for college grads have been flat since 2003 and there are six million new college grads per year. Meanwhile economic growth is slowing. “Parental connections” were found to be the most decisive factor in a child’s earning potential instead of “parental education,” the typical factor in other countries.

THE INTERNET

The Party is wary of fast-moving ideas, even those that support the government. Control of information is absolutely crucial to them and the book gives a fascinating look at their methods: the “Great Firewall,” text message monitoring, “Fifty Centers” paid to disrupt sensitive online conversations, orders issued to news outlets and publishers on forbidden words and topics, etc. But despite this censorship we see how artists, bloggers and activists use the internet to expose corruption and express their views, often with tragic consequences. Internet and mobile phone penetration are growing fast, so this challenge will continue.

INNOVATION

To transition its economy toward domestic consumption and grow its service industries, China needs to foster innovation, but official propaganda aiming to have citizens “sing as one voice” and a deeply-rooted requirement for conformity work directly against building a culture of creativity and innovation.

INDIVIDUALITY

The Party controls the legal system, education, industry, media, communications and faith groups, but as Chinese people become educated, urbanized and wealthier they’re craving more autonomy in their work, family and spiritual lives. This works against Party efforts to “harmonize” society.

Overall, Age of Ambition is a well-written and highly insightful book that’s sure to enrich your understanding of China’s people, challenges and future.

CFA Society Chicago Book Club:

The Green and the Black: The Complete Story of the Shale Revolution, the Fight Over Fracking, and the Future of Energy by Gary Senovitz

GreenBlackOne of the benefits of being a part of the book club is learning about industries, markets, or products that are outside one’s normal course of life.  I know little of the oil and gas industry, having spent most of my life researching and working in the financial service industry.  I would encourage everyone to keep an eye on the Book Club upcoming lists, and choose one or two that would increase your breadth of knowledge and join us for the discussion.

What happens when a self-described New York liberal (the Green) meets an oilman (the Black)?  Or in an interesting twist of fate they are the same person?  Senovitz is a Managing Director of a Private Equity firm (Lime Rock) in New York that specializes in the oil and gas industry, and is also a devout liberal worried about environmental issues and the future effects of climate change.   The end result is a very entertaining and even handed account of hydraulic fracking and a great story of its history and development.

The book begins with the history of hydraulic fracking and with riveting accounts of its biggest pioneers such as Audrey McClendon of Chesapeake Energy, George Mitchell of Mitchell Energy, Mark Papa of EOG Resources  and Harold Hamm of Continental Resources.  The four are described as the Mount Rushmore of the Shale Revolution.  Their stories are a big part of the boom that led to the success of fracking: risk takers always seemingly on the edge of bankruptcy.  They persevered by staying true to their beliefs and their refusal to give up while others scoffed and laughed at them.  Many accomplished their success, simply because they did not know what else to do but continue to try.

The narrative continues to wind through many of the issues surrounding fracking.  The author breaks down the Documentary Gasland as more staged propaganda than facts and leading to an unneeded public hysteria, but also highlights real concerns such as surface contamination and noise which are very damaging and must be properly managed.  Senovitz remains tortured that fracking will lead to more carbon use, but he runs through large amount of statistics to make his case that it is really a natural gas boom that has led to the United States greatly reducing its dependence on coal and lowering its carbon emissions.  Other benefits include creating jobs, reducing American dependency on foreign energy and improving lives globally by spreading cheaper energy worldwide.

The author also describes the ongoing battle between the Yes in My Backyard (YIMBY) vs. the Not in My Backyard (NIMBY) factions.  States like New York and California (NIMBYs) have no problem utilizing massive amounts of the energy from states like North Dakota and Pennsylvania (YIMBYs), but refuse to let fracking on their home turf.  This visible hypocrisy is well discussed, and the author leaves no doubt that the NIMBY’s arguments are more political than sensible economic or scientific positions.

We found the book to be quick paced, and enjoyable.  The narrative provides a wealth of information that is important for all to consider on this controversial activity.  The Green and the Black is one of those special books which keep many of us returning to the book club.  Please join us in the future; we believe you will not regret the time.

CFA Society Chicago Book Club:

While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Looms as the Next Financial Crisis by Roger Lowenstein

While America AgedThe specter of unfunded pension liabilities haunts many of our major cities and a large number of public companies. This is especially true in the city of Chicago as public unions continue to threaten to strike over benefits and unfunded pension liabilities. We discussed Roger Lowenstein’s book about this topic at a well-attended CFA Society Chicago Book Club meeting held in April. The book attempts to answer why the private pension system as conceived in the United States has failed.

Mr. Lowenstein divides his book into three parts. Each part addresses the pension crisis from the perspective of; a public company (General Motors), public service workers in New York, and the public service worker pension plan for the city of San Diego.

Part One: Who Owns General Motors?

The question asks whether it is the shareholders or workers who own a publicly traded company.  GM was one of the most successful companies in the world, however due to labor union gains at the bargaining table, its future cash flow would not accrue to its shareholders, but rather to its pension obligations.

This part of the book revolves around Walter Reuther and the UAW. Mr. Reuther became the visionary leader of the UAW in the 1930’s. In 1950 Mr. Reuther crafted what Fortune Magazine dubbed the “Treaty of Detroit”. It was a 5-year agreement which committed GM to guarantee a pension, wage increases with a cost of living formula and hospital and medical insurance at half cost. It was the inability to fund these ever-growing commitments which eventually led to the downfall of GM.

Part Two: The Public Freight

Pension plans for city workers help to guarantee a stable work force; a highly desirable trait for teachers, firemen and transportation workers. Reliable bus and train service is critical for the economy of a city. The second part of the book examines the history of wages and pensions for the public workers of New York City.

The most effective union leader was Michael Quill, an Irish immigrant who was a member of the IRA and fought in the rebellion against the British. In the 1930’s, the Transit Workers Union (“TWU”) was led by a coalition of Communists and former IRA activists. In 1937, Mr. Quill became President of the TWU. A 13-day strike in 1965 permanently changed the dynamic between the unions and the city. New Yorkers endured the worst traffic-jams in its history during this strike. The state government reacted by passing stricter laws prohibiting strikes by public workers. These laws were ignored as union leaders happily went to jail. The citizens of any municipality are captive customers and are unable to shop elsewhere for subway service or police protection.

Part Three: Debacle in San Diego

The risk that the government will put the expense of a pension plan onto future generations is illustrated by the city of San Diego. By the summer of 2005, the municipal pension fund in San Diego, the San Diego City Employees Retirement System (“SDCERS”) was underfunded by $1.7 billion. How it got that way is addressed in the third part of this book.

In 2005 the national press referred to San Diego as “Enron-by-the-Sea”. The cause of the underfunding was the extreme reluctance of local politicians to raise money by increasing taxes. The political climate in the city was very conservative with a mistrust of any tax. The city covered its cash shortfalls by continuing to avoid making the required pension contributions.

Labor unions in the city began to contribute heavily to political campaigns; this was more effective in San Diego which had a weak form of city government where a relatively small amount of votes could sway elections. In the end, public employee unions had political clout on par with business interests. City managers became more adept at structuring solutions which circumvented state laws regarding the required funding of SDCERS.

Conclusion: The Way Out?

The author has a few suggestions as to how to mitigate some of the risks endemic to these pension and health care schemes. However, most participants at the Book Club thought they were rather weak. The author is of the opinion that the 401K is not an adequate substitution for a pension and advocates a “national” 401K offering matching credits to lower wage earners. He also suggests that 401K providers be required to offer an annuity as a default option. The author ends the book with a plea to strengthen social security by raising taxes, an unpopular but perhaps necessary measure.

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CFA Society Chicago Book Club:

My Side of the Street: Why Wolves, Flash Boys, Quants, and Masters of the Universe Don’t Represent the Real Wall Street by Jason DeSena Trennert

my sideIf you have a history in this business or seeking to pursue it, have read any of the popular finance books, or simply sat back and enjoyed some of the classic Wall Street movies, you will certainly appreciate this well-crafted and first hand perspective of the finance industry.  The title was quite interesting because if you are a voracious reader of investment literature, you will reflect back on the excesses in the Wolf of Wall Street, the questionable high frequency trading dark pools in Flash Boys, or the so called “Master of the Universe” in Bonfire of the Vanities.  The author paints a much different picture for people who have formed their views on Wall Street based on the financial crisis, outsized bonuses, insider trading scandals, options back-dating, and movies like Boiler Room.  He describes the hundreds of thousands of finance professionals that work hard every day to support their families, pay their mortgage, and act with ethics in their business practices.

You can learn a significant amount from someone as successful as Mr. Jason Trennert.  The opportunity to learn his side of the street can be very valuable to our own careers.  Mr. Trennert, also known as “Jase” by those close to him, takes us through his experiences starting off as a cold caller, moving on to institutional sales with extensive travel and client facing interaction, business school at Wharton, and eventually starting his own firm.  Ultimately, it seems that his love for macro, entrepreneurial spirit, and past experiences set him on the path to start Strategas.  You can learn from Mr. Trennert’s experiences on how to break into Wall Street, build connections, go from back to front office, the value of reading both investment literature and non-fiction, the importance of curbing the late night entertaining, when to say no to opportunities, and perhaps when to know it’s time to become the captain of your own ship.  At the end of the book, Mr. Trennert offers some wise career tips such as assuming no one will help you until you’ve accomplished something, focus on achievement rather than status, live CAPM, play your strengths, Wall Street is both large and small, and finally….Read!

 

Upcoming Schedule:

April 19, 2016: While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next Financial Crisis by Roger Lowenstein

May 17, 2016: The Green and the Black: The Complete Story of the Shale Revolution, the Fight over Fracking, and the Future of Energy by Gary Sernovitz

June 21, 2016: Age of Ambition: Chasing Fortune, Truth, and Faith in the New China by Evan Osnos

 

To sign up for a future book club event, please click here:

http://www.cfachicago.org/apps/eve_events.asp

CFA Society Chicago Book Club: “The Age of CryptoCurrency: How Bitcoin and Digital Money are Challenging the Global Economic Order” by Paul Vigna and Michael J. Casey

Bitcoin with its underlying blockchain technology is by far the most controversial and least understood of the fintech innovations revolutionizing financial services. Since it was conceived in 2008 it has generally been viewed with suspicion, even outright derision. But both the currency and the technology are gaining legitimacy and there’s growing interest in its potential, as shown by these informal indicators:

  • Strong growth in startup funding by top VCs and investors: bitbetween 2013 and 2015 venture investments grew from $95M to $622M per this recap http://www.coindesk.com/bitcoin-venture-capital/
  • Improvement in price volatility (but still far from stable): high/low in 2013 was $1,147/$13, and in 2015 was $456/$214
  • Robust discussions at the 2016 World Economic Forum, European Parliament, IMF, CFTC and other venues to consider the value, drawbacks and risks of bitcoin and blockchain
  • Continuing evolution of regulations: New York’s BitLicense requirements, IRS and CFTC rulings, general openness in the UK, Hong Kong, Switzerland, Bulgaria, Romania and elsewhere

At the February CFA Chicago Book Club meeting we discussed Paul Vigna’s and Michael J. Casey’s excellent book on all things bitcoin and blockchain. The two Wall Street Journal reporters thoroughly explored the origins, mechanics, personalities, motivations, recent developments and future of this fascinating technology.

There’s a shroud of ambiguity around bitcoin. It can be characterized as a currency, commodity, payment protocol or an expansive platform for trading anything of value, and the authors clearly explain each of these perspectives. They also describe the underlying technology and its two key breakthroughs: a universal ledger that captures every transaction and is continuously verified, and an incentive system for “nodes” to maintain the ledger. Bitcoin exists as a chain of digital signatures. Owners privately transfer coins by digitally signing a hash of the previous transaction and the public key of the next owner, adding their signatures to the end of the coin. Note, a “hash” is just a long string of characters and hashing is a common technique used in encryption and data-storage. The open source blockchain code tells computer nodes how to collaborate in maintaining the integrity of the universal bitcoin ledger via a process called mining.

Everyone’s heard about bitcoin “miners” who dig up newly minted electronic currency, but mining is really a misnomer. Networked computer nodes do the work of confirming that transactions are valid, verifying the ledger is correct, getting all other nodes to agree, closing the previous block of transactions and opening a new one. While doing so they can earn new bitcoin as a reward. There’s more to it, but essentially this is mining. The sequential blocks of transactions form the chronological blockchain ledger. One block, or group of transactions, is closed and a new one is opened every 10 minutes or so. Anyone with a computer and internet access can establish a node and mine, but to increase the likelihood of earning bitcoin miners employ massive computer power. There are dedicated server farms in the U.S. and abroad using computers designed just for this purpose. China is especially active in bitcoin mining.

The origins of bitcoin have contributed to its mystique and notoriety. A person or group named Satoshi Nakamoto conceived the open-source computer code on October 31st, 2008, by posting on a message board for cryptographers. It caught the attention of Hal Finney who dabbled in encryption technology in his off hours. He and Sathoshi worked to get the open-source protocol running in 2009, and slowly others began to adopt and use bitcoin. The cryptocurrency also appealed to “Cypherpunks”, an anarchic, libertarian group concerned with privacy protection and subverting the power of banks and governments to create economic crises and serve corporate interests at the expense of citizens. Satoshi’s true identity and motivation for introducing bitcoin aren’t known. He or she essentially disappeared in 2011 and past communications were encrypted, sparingly worded and didn’t elaborate on philosophy.

The current system for handling credit card transactions illustrates the problem bitcoin intends to solve. The authors walk through an everyday coffee purchase: seven entities are involved, including the merchant, front-end processors, payment processors, banks, credit card associations, clearing houses, etc. These entities share our banking and personal information, and of course earn fees which are paid by the merchant and ultimately you and I. Fees can total 3%, and much more when traveling abroad. This same transaction using bitcoin is strictly between the merchant and purchaser. The universal ledger confirms funds are available and validates the transaction. No personal information is shared because bitcoin is encrypted. No third party intermediaries are needed and no transaction fees are charged. In this scenario there’s no need for banks, credit cards, payment processors, dollars, euro or yen. Bitcoin proponents envision huge economic benefits from eliminating transaction fees.

A growing list of merchants accept bitcoin as payment for some or all of their products, including Dell, DISH Network, Microsoft, Expedia, Overstock, Newegg and many others. However, there are good reasons to be skeptical. Public perception suffered after several hacking incidents. For example, Mt. Gox, an early bitcoin exchange lost 650,000 of its client’s bitcoins and finally collapsed, impacting 127,000 users. Silk Road was another high-profile debacle. It was an Ebay-like site for trading in illegal drugs and assassinations that used encryption to hide web traffic and the anonymity of bitcoin to keep transactions private. Its operator, Ross Ulbricht was sentenced to life in prison for money laundering and trafficking narcotics. There’s also conflict within the bitcoin community itself, most recently related to a proposal to expand bitcoin transaction volume capacity, which is a small fraction of established payment systems. The argument exploded very publicly into death threats, virus attacks and censoring bitcoin discussion boards. Breakdowns like these, coupled with extreme price volatility in past years and other concerns damage public trust in bitcoin as a reliable currency.

Trust is a recurring theme in the book. In our current system banks and other central institutions maintain the central ledger that establishes the essential trust in who owes what to whom. Various parties in this system dedicate enormous resources to verify their records match and confirm trust. But with bitcoin, trust is automated. To be effective as currency bitcoin must be widely held and widely accepted. It’s the classic “chicken or egg” dilemma. Money must be a unit of account, a store of value and a medium of exchange, three conditions banks are currently tasked with safeguarding. But there’s an enormous cost for this in money, privacy, and economic damage banks are perceived to cause in crises. The authors deftly explore multiple perspectives on trust and the central role of banks:

  • In developing countries millions of people lack access to banks. Bitcoin may be an ideal solution for countries with limited banking infrastructure, weak legal systems, 10%-20% fees on transfers from citizens working abroad and a high degree of self-employment.
  • Russia’s and China’s national security depends on controlling their national currencies, so unregulated and encrypted bitcoin may be a threat to government’s hold on power.
  • Developed countries incur hundreds of billions in transaction fees that could be used productively. But unlike bitcoin, the incumbent system allows for Keynesian intervention during crises to offset currency hoarding.

To the extent bitcoin has obstacles; the underlying blockchain technology has opportunities. Financial institutions are using it to create more efficient financial payment, trading and settlement systems. Major firms actively exploring blockchain solutions include Bank of America, Banco Santander, IBM, ING, Mizuho, NASDAQ, PwC, UBS and many others. Meanwhile, startups like Next, Ripple, Mastercoin, Ethereum, BitShares, Counterparty, Stellar and others are developing digital asset exchanges for peer-to-peer trading. The authors explore a variety of blockchain applications that extend beyond digital currency. Decentralized autonomous corporations (DACs) are similar to crowd-funding but DAC shareholders participate in ownership and any increase or decrease in value. Reputation markets for restaurateurs, contractors, freelancers, etc. use blockchain to hold their record of customer reviews, which can then be securitized to monetize goodwill. Voting can use an encrypted private key to send a tiny amount of bitcoin to a polling wallet. Votes are time-stamped and permanent in the blockchain to prevent fraud. Smart contracts, where bitcoin payments are made to a neutral wallet and disbursements are triggered automatically. Examples include homeowner’s escrow for insurance and tax payments, and credit default swaps where a credit event automatically triggers payment to the CDS owner. Smart property, where digital ownership tokens are assigned as property deeds, titles and certifications of ownership, makes them easily tradable with other digital asset claims. There are endless applications using the blockchain platform, and it’s seen by some as the internet all over again.

Blockchain clearly has a very bright future. As for bitcoin as digital currency, the authors present several future scenarios and discuss potential government reactions and the impact on various stakeholders:

  • Bitcoin is adopted worldwide: The UK, Canada, Switzerland and Singapore are poised to lead due to their innovation-friendly regulations. The U.S. would take a back seat given the restrictions here. Banks and governments would have greatly diminished power. Millions of unbanked people in developing countries would gain access to an efficient financial system.
  • Bitcoin is not adopted: The obstacles to realizing the grand vision are never overcome and a ‘just good enough’ option with lower fees and greater efficiency takes hold within the existing system.
  • Hybrid system: Bitcoin grows alongside the existing system and national fiat currencies continue to be used. Exchanges are needed to convert to and from digital currency. Blockchain technology is used by institutions to improve transaction confirmations, payment systems, etc. Credit card companies, payment processors and currency traders could disappear. Or bitcoin could be adopted principally for online and certain other types of commerce.
  • Multi-coin world: Currency itself becomes less important. The principle means of exchange could be smart property trading on blockchain-based exchanges where property items are divided to level needed. Commerce becomes a form of barter without the limitations of trading physical property. The authors posited selling half a horse for a flight to LA!
  • National cryptocurrency: Countries launch their own digital currency using blockchain technology. People trade currency peer to peer without intermediaries, but control is still centralized leaving the state as the ultimate counterparty. Governments retain the ability to use policy measures to stimulate the economy. Cross-border transfers of digital currencies are difficult to restrict which undermines capital controls. The U.S. digital dollar has an enhanced role as a reserve currency, but the Fed is more accountable to the global marketplace. For example, if the U.S. digital dollar were mismanaged other currencies would become favored.

Regardless which of these scenarios is realized, bitcoin and blockchain have staggering potential to reshape financial services and other areas of the economy. They can no longer be dismissed as a fringe, radical movement. It will be fascinating to observe this space in the coming months and years.

 

Upcoming Schedule:

March 15, 2016: My Side of the Street: Why Wolves, Flash Boys, Quants, and Masters of the Universe Don’t Represent the Real Wall Street by Jason DeSena Trennert

April 19, 2016: While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next Financial Crisis by Roger Lowenstein

May 17, 2016: TBD

To sign up for a future book club event, please click here:

http://www.cfachicago.org/apps/eve_events.asp