Why China Wants A Super-Sovereign Reserve Currency

Background:

On the 23rd of March 2009, a top functionary from the People's Bank of China, named Zhou Xiaochuan, made a forthright appeal for the reformation of the international monetary system.

His assertions—given the strong ties that the People's Bank of China has with the Chinese government—leave one with the indelible impression that the Chinese establishment is currently alarmed by the prospect of economic pandemonium materializing in China - owing to the continued use of the U.S. dollar as the international reserve currency.

In his speech, Mr. Xiaochuan enunciated that the international reserve currency should be super-sovereign (read: 'disconnected from economic conditions and sovereign interests of any single nation'), to insulate the densely-interconnected global economy from its vulnerability to the contagion effect (which is a systemic risk).

Furthermore, he suggested that it would be prudent to award Special Drawing Rights (SDRs) the role of a super-sovereign reserve currency, because their features are identical to the theoretically-depicted features of a super-sovereign reserve currency, which include: 1) Disconnection from the economic conditions and sovereign interests of any single country; 2) The ability to remain durable in the long-run, and; 3) Multi-territorial integrity.

Succinctly expressed: Mr. Xiaochuan is subtly petitioning the International Monetary Fund (IMF) to abandon the usage of the U.S. dollar as the international reserve currency, and to instead adopt Special Drawing Rights (SDRs) as a super-sovereign reserve currency.

Evidently, his proposal is underpinned by the following line of reasoning: "The U.S. is currently teetering on the brink of a protracted recession because of the credit crisis it has endured since 2007. Thus, the continued usage of the U.S. dollar as the international reserve currency is tantamount to globalization of the U.S.'s economic woes."

Currently, there is a crescendo of echoes of this line of reasoning emanating from different parts of the globe, and this may culminate in unequivocal remonstrations (against the usage of the U.S. dollar as the international reserve currency) during forthcoming IMF-organized events.

Introduction:

My aim in writing this commentary, is to explore a dystopian scenario that could materialize in China if an unstable U.S. dollar maintains its status as the international reserve currency: I'm going to be exploring the Finagle's Law scenario - where anything that can go wrong, goes wrong—at the worst possible moment.

*****

Currently, China's currency, like that of Dubai, is fixed to the U.S. Dollar, that is; China has a fixed nominal exchange rate policy. What this simply means is that x dollars will always translate into y yuan regardless of changes in China's macro economic stamina.

Therefore, this implies that the health of the Chinese yuan is tied to that of the U.S. dollar.

Finagle's Law Scenario:

Let us postulate the Finagle's Law scenario, where anything that can go wrong goes wrong—at the worst possible moment, or where the perversity of the Universe tends towards a maximum;

It is now December 2009, and the U.S. economic crisis has become more acute. This has caused the U.S. dollar's fiat value to plummet in terms of other currencies. Hence, since the Chinese yuan's nominal value is fixed to that of the U.S. dollar, it becomes more grossly undervalued, ceteris paribus, with respect to the U.S. dollar than it was in the past.

Therefore, because of this, speculators are increasingly selling their dollars to accumulate undervalued yuan, resulting in excess demand for Chinese yuan. (Why? Because if two different currencies trade at a fixed exchange rate and one currency is undervalued with respect to the other, the undervalued currency will be in excess demand).

Thus, China is faced with two choices to: either increase the supplies of the yuan to meet the excess demand, or; adjust the par value of the yuan upward enough to eliminate the excess demand.

Obviously, the Chinese government has a marked preference for the former.

Therefore, the Chinese government, in a bid to relieve the upward pressure on the par value of the yuan with respect to the U.S. dollar, decides to intervene in the foreign exchange markets by buying dollars with yuan. This causes an automatic increase in the supply of the yuan to take place, and the real relative value of the yuan falls, albeit temporarily.

Unfortunately, this makes the yuan even more attractive to speculators, who now demand even more yuan (as they'll perceive the yuan to be more acutely undervalued than it was before the intervention). This triggers another similar intervention (i.e. buying dollars with yuan) by the Chinese monetary authorities, which starts the fruitless cycle again.

Eventually, the Chinese government is forced to adjust the value of the yuan upwards enough to eliminate the excess demand for the currency. However, this move would, in essence, threaten China's current account surplus; as Chinese exports would become more expensive because of this (which means that international demand for them would fall).

Clearly, this would have adverse effects on China's hyper-aggressive economic growth rate and its clout in the global political arena (because international political power has a direct positive correlation to a nation's economic fortunes).

Conclusion:

The Finagle's Law scenario simply illustrates that China's exchange rate management policy is only sustainable when the U.S. is experiencing 'normal' or extraordinary economic growth. Whenever the U.S. is in a state of economic turmoil, China experiences extreme pressure to adjust the value of its currency upwards (with respect to the U.S. dollar).

Hence, China's calls for a super-sovereign currency simply mean that the country is desperately looking for a permanently stable currency to fix the value of the yuan to. If the value of the yuan were to be fixed to a super-sovereign currency, China would have immunity from market-pressures to adjust the value of its currency upwards (with respect to credit-based reserve currencies): something that is evidently, in China's best interests.

Why Hedge Funds Should Purchase Hardware-Producing Start-Ups

"The most curious part of the thing was, that the trees and the other things around them never changed their places at all. However fast they went, they never seemed to pass anything. 'I wonder if all the things move along with us?' Thought poor puzzled Alice."
—Lewis Carroll, Through the Looking-Glass

Although the population of quantitative hedge funds explodes in a geometric progression annually, it lacks diversity, and is in essence, homogeneous. To expound succinctly; most quantitative funds are like clones of each other in terms of; Trading Strategies, Human Resource Mixes, Risk Management Strategies, Organizational Structures and Trading Algorithms.


Usually, the uncanny similarities in the trading strategies practised by quantitative hedge funds are caused by either: widespread imitation or mimicking of the trading strategies of alpha quantitative hedge funds (usually by other less prominent quantitative trading organizations), and or; the gradual fragmentation/disintegration of large quantitative hedge funds into a plethora of organizations with identical/similar trading strategies.


To fully comprehend the latter: think in terms of Clifford Asness leaving Goldman Sachs Asset Management to establish/found AQR, OR, think of other countless Goldman Sachs Asset Management quantitative proprietary traders who left to found their own funds that (usually) replicated the trading strategies they practised at Goldman Sachs Asset Management.

Hence, this is the reason why the majority of quantitative hedge funds usually find themselves pursuing the very trading opportunities that are being pursued by their competitors. This usually results in overcrowding in trades.

Furthermore, this 'strategy-similarity' also has the concomitant effect of reducing the exploitable alpha opportunity-set (available to individual funds) in a best case scenario, or the loss of principal (by individual funds, or the majority of the participants in the overcrowded trades) in a worst case scenario.

Thus, this is the reason why quantitative hedge funds are always trying to exploit alpha-generating opportunities at ever-increasing speeds: they want to get to the trades before anyone else spots, or has the opportunity to exploit the trades.

Therefore, quantitative hedge funds are constantly upgrading their hardware systems in a bid to increase the speed with which trades are effected. However, as Rick Bookstaber observed, this is a negative sum game. If a quantitative hedge fund acquires hardware technology that expedites the manner in which transactions are executed, it will have a trading edge over its competitors.

However, this trading performance edge is only temporary, because hardware developers, usually market the technology they create to other quantitative hedge funds when they discover that it is useful in the quantitative trading arena.

Thus, when the rest of the quantitative hedge fund community knows that other similar/like funds are successfully-using the new performance-enhancing technology, more funds will acquire the technology until it becomes banal/ubiquitous. Hence, this has the effect of gradually canceling-out the trading edge that accrued to early adapters of the technology (as it gets adopted by other players who have an identical trading strategy with the early adapters).

Inevitably, trades will become over crowded again. Which simply means that the quantitative hedge funds would have invested money in performance-enhancing technologies, only to find themselves in the same relative position they were in before they acquired the said technologies. This concept is termed The Red Queen by biologists.

Hence, it doesn't make sense (for quantitative hedge funds) to invest in the acquisition of publicly/readily available trading performance-enhancing technologies, because other (similar) competing funds could easily acquire the same technologies, which would cancel-out any trading edge that can be derived from the technologies.

Thus, I strongly/firmly believe that it is far more practical for quantitative hedge funds to acquire trading performance-enhancing technologies and their associated intellectual property rights, direct from hardware development start-ups that create them.

That way, they can get unique technologies, that no other institution else has, which would give them a lasting trading edge over their competitors.

Otherwise, any technology expenditure they make, in a bid to enhance the performance of their portfolios, will be an exercise in futility.

A plausible explanation of decoherence in quantum systems

Quantum computing pundits and entrepreneurs have, thus far, failed to bring into being a robust quantum computing system that can solve NP-complete problems.

The key/main stumbling block in their path is the inexplicable onset of decoherence in the quantum computing systems they fashion to solve intractable problems.

To describe decoherence succinctly: Quantum data (which is measured in qubits) is extremely volatile/fragile, and it easily vaporizes, or dissipates into its environment during a computational process, before any decipherable output is produced (which results in the output of incomplete and incorrect results). This is known as decoherence in the field of quantum computing.

***

I was hunting for the possible causes of decoherence, and I think that I found a plausible cause of the phenomenon in a theory propounded by Messrs. John Conway and Simon Kochen, which they coined The Free Will Theorem.

The gist of the Conway-Kochen Free Will Theorem (which is, by the way, thoroughly enthralling) is this: Messrs. Conway and Kochen say they have proved that if human beings have free will, then elementary particles—like atoms, photons and electrons—possess free will as well.

Applied within the context of quantum computing: If we postulate that The Free Will Theorem holds, and if we assume that human beings have free will, then we can deduce that atoms, photons and electrons also have free will. Hence, this implies that decoherence in quantum computing systems is caused by atoms, photons and electrons that exercise their power of free will and choose not to be harnessed to manipulate data.

Kind of spooky isn't it?

Apocalypse: Rat population explosion

In his riveting text entitled Why We Make Mistakes, Joe Hallinan gives (compelling) empirical evidence, which suggests that optimists are overconfident, and that pessimists are realistic. Hence, since I place more value on being correct than on being optimistic; in this post I am going to adopt a pessimistic outlook on global warming: I'm going to let my imagination run wild—until it conjures-up an apocalyptic worst-case/dystopian scenario that may materialize if global warming is not arrested forthwith.

*****

The global collective consciousness is currently saturated with the fact that there has been a steady increase in the average temperature of the biosphere since the mid-twentieth century (global warming). As you probably know, pundits in the field of Climatology (from the IPCC) projected that this trend will spill-over into the twenty-first century, and, they currently conjecture that average global surface temperatures have the likelihood of rising a further 1.1 °C to 6.4 °C (2.0°F to 11.5 °F) by the end of the twenty-first century.

Currently, the known universe of the adverse effects of Global Warming includes:

• Negative changes in agricultural yields (owing to climatic change; especially because of extreme fluctuations in rainfall patterns).
• Sub-optimum changes in transportation routes - in response to climatically-influenced terrestrial morphing.
  
• Extinction of flora and fauna species; as a direct result of climatic changes, which I'll further elaborate-on in this post.

...Which animals will become extinct?

The key difference between the brains of mammalians and reptilians is that; mammalian brains have a neocortex and reptilian brains don't. According to the Laboratory of Neural Microcircuitry, the "neocortex is a repeating stereotypical microcircuit of neurons. This neural microcircuit lies at the heart of the information processing capability of the neocortex, the capability of mammals to adapt to a rapidly changing environment, memory, and higher cognitive functions."

Hence, the absence of a neocortex in the reptilian brain implies that reptiles, (and this is a generalization) will find it difficult to adapt to rapidly changing climatic conditions (that are caused by global warming). Thus, it is reasonable to say that reptiles, ceteris paribus, face stronger chances of extinction (because of the effects of Global Warming) than mammals.

Therefore, this means that reptiles, like snakes, that regulate the population increase of disease-carrying-mammalian vermin, like rats, will be increasingly vanishing from the face of the earth in the future. Hence, it is reasonable to say that the global population of mammalian vermin will grow exponentially, because of the rapid extinction of some of their main natural predators. In the future, may come a time when rats greatly outnumber all the other inhabitants of this planet (in an environment characterized by rapidly depleting resources). Thus, it is reasonable to say that: In the future, human-beings face the strong risk of being mauled-to-extinction by hungry armies of rats.

We'll need a real Pied Piper of Hamelin to play a tune that will seduce rats from human settlements into rivers. :-) Either that, or we need to start an intensive cat-breeding programme.