Why should investors explore alternatives to traditional finance and traditional assets?

Defending the US dollar hegemony

The way we invest, spend, save, and manage our money remains cumbersome, inaccessible, expensive, and locally isolated. The legacy financial system has been struggling to keep pace with the speed of technological advancements in a global and digitally connected society, resulting in a need for a new, inherently digital financial system. Lack of access to core banking, high costs of transacting and costly alternatives has contributed to inequality across the globe.

The lack of transparency and accountability over the management of investors’ money adds to the inefficiencies of the traditional financial system and reinforces the case for a more equitable alternative.

Current inflationary pressures and rising interest rates is concerning and a call for action for investors to re-assess allocation to traditional assets and perhaps explore alternative investment opportunities.

Inefficiencies in the legacy financial system

• Outdated IT architecture

The traditional financial system was built on an IT architecture dating back to the 50s. As a result, it still takes 3 days to clear a BAC/CHAPs payment and clearing trades can take T+3 days. Many providers have purposely made switching to cheaper alternatives costly and unduly complicated.?

• Unequal access to the banking system

Traditional finance has failed to cater to the mass. Billions of people around the world notably across Southeast Asia, Africa and South America remain unbanked. Financial exclusion means that poverty is still prevalent across those nations. Their inability to have a bank account means those people are not able to borrow to buy a property or set up a business which would inevitably result in creation of more economic growth, thus helping poorer nations emerge financially stronger.

• High transaction costs

Whilst billions remain unbanked around the world, those who are lucky enough to have a bank account have to contend with extortionate borrowing rates and transaction charges.?

Under the current financial system, we are at the mercy of banks who set and control interest rates. Simple transactions using traditional finance channels cost trillions of dollars in the form of fees, commission, interest and other charges.?Banks levy charges to their customers merely for holding a bank account.?Deposits earn a fraction of the amount banks earn on their lending book.?Clearly, the lion share of the wealth created in traditional financial transactions goes to financial institutions such as banks, insurers and mortgage brokers.??

• Lack of transparency and accountability

Customers do not have visibility over the financial health of banks and can be exposed if the banks are over leveraged. The 2008 crisis demonstrated just how much power, influence and free way the banks have.

Despite being responsible for the collapse of the financial system, rather than being held accountable, the CEOS of those banks were compensated for being reckless and walked away with millions in bonuses after gambling with savers' hard-earned money. Sadly, it was all forgotten as the world settled into its daily grind with the average taxpayer left to foot the bill of the bailouts.

Recently the UK’s government scrapped the cap on bankers’ bonuses in a deregulation move to drive “growth”, with even more deregulation on the horizon. The cap was originally introduced by the European Union to prevent a culture of excessive risk.

Before the implementation of the Retail Distribution Review (“RDR”) and Markets in Financial Instrument Directive (MiFID 2), financial advisors recommended investment products to retail investors based on their commissions, as opposed to the investment goals of the investor. Many of those products underperformed the S&P 500 with investors having to pay high management fees, ongoing platform charges and commissions which ultimately reduces their net return. Unfortunately, some wall street gurus and mainstream media continue to advocate the status quo.

The frailty of the modern monetary framework

Under the current monetary framework, control is centralised in the hands of an elite minority. Access is limited and the system is not transparent. Banks around the world can manipulate and control the supply of all fiat currencies. Excess money supply has contributed to increasing inflationary pressures and continued devaluation of the world’s reserve currency.

Whilst money was initially introduced as a medium of exchange and a store of value, today’s non-collateralised fiat currency is no longer a store of value since it is no longer pegged to gold. The massive quantitative easing programme (money printing at will) instigated by the Fed since the 2008 crisis means there is an excess money supply in the system. As a result, the value of the US dollar continues to depreciate.?

This of course raises concerns over the legitimacy of the US dollar as the world’s reserve currency, with China now eyeing for the top spot to establish the Renminbi as the new reserve currency, as its economy overtakes that of the US.??Already, we have seen a shift in Saudi Arabia’s allegiance to the US. Mohamed Bin Salman has given the Biden administration the cold shoulder as Riyadh cosied up to Beijing to discuss selling some of its oil in Yuan.

For context, it is perhaps a lesser-known fact that in 1974 US Secretary of State, Henry Kissinger along with William Simon, the US Treasury secretary embarked on a secret mission to Saudi Arabia. They threatened to wipe out the Monarch if Saudi Arabia did not agree to sell oil to the US on their terms. King Faisal had previously sought to weaponise its oil reserves after the US supported Israel during the Yom-Kippur. The US ultimately succeeded in getting Saudi Arabia to finance America’s widening deficit by forcing them to buy US Treasuries, contributing to the US dollar modern day hegemony.

For the past four decades the US acted as the global watchdog, patrolling the international waters to ensure global oil supply remains uninterrupted but also to maintain the US dollar supremacy. In the process several countries saw their government topple following attempted coups. After all, maintaining world order comes at a price.

As the US starts to move away from Saudi Oil dependence, it is not inconceivable in a deglobalized world, we may return to a state of chaos without a global watchdog. Given the income disparity caused by the current monetary framework, we are at risk of increased social upheaval and unrest across many parts of the world. Tension could flare up in regional hubs as the battle for commodities and natural resources intensifies. To add fuel to the fire, many countries face a debt crisis and stand on the verge of sovereign debt default.

Blame the macro environment

2022 was a difficult year for equities and fixed income. The Fed adopted a hawkish stance, pivoting from being a whale buyer of bonds to a tapering program. Bonds had to trade freely after a very long time with the largest buyer out. We saw the yield curve inverting. With rising interest rates, we spiralled into a bond crisis.

Moving into 2023, should we stick to the traditional asset allocation in the current macro environment? Equities remain overpriced despite a modest correction last year. Fixed income remains in bearish territory as well. If rates continue to rise in the near term, bond prices could decline further.?The Fed continues to maintain its hawkish stance, more resolved than ever to kill demand in a desperate attempt to reign-in inflation.

Amidst a looming recession this year and current inflation rate at 7.1%, there’s probably more pain ahead if the Fed maintains its aggressive stance and continues to raise short-term interest rates all the way into 2024. This will make borrowing more expensive, reduce spending in the economy which should lead to falling inflationary pressures.

However, the Fed is constrained by the interest burden on its $31 trillion debt which could become unmanageable if rates are too high.?

Following a tightening in financial conditions, looking at the impact of higher interest rates and real interest rates on cash flows this will translate into higher discounting on future cash flows which means lower prices for just about all assets and therefore more correction to equities is to be expected.?

Alternatives to traditional assets

In a low yield environment and in the context of overvalued stocks, the traditional allocation advocated by Wall Street gurus - 60% in equities and 40% in bonds does not work anymore. This may not get us to an annualised return to match the current rate of inflation (currently at 7.1%). After factoring fees and charges investors may be left out of pocket. Yet, this is a plan that many financial advisers still recommend.

Alternative assets such as real estate, private markets, commodities, gold and collectibles whilst arguably a better option in the current economic climate, are still closely correlated to traditional macro factors and remains largely inaccessible to retail investors.

Investors at large are also at the mercy of governments and legislators. For example, governments can introduce legislations that makes real estate investment unappealing. Buy-to-let landlords in the UK are already struggling to maintain returns on their portfolio as interest rates continue to rise and Section 24 tax changes kicks in. Compounded by the need to comply with an ever-increasing new landlord regulations, estate agent fees and the high cost of maintenance means real estate investing may no longer be as lucrative as it once used to be, although there are pockets of opportunities to the commercially savvy landlords.

Investment in physical gold means banks are at liberty to limit or restrict withdrawals from their gold vaults at any time. Under normal circumstances, withdrawal or liquidation of such assets can be time consuming and costly after factoring fees and charges. It is hard to imagine an investor being able to liquidate a ￡2 billion real estate portfolio or an equivalent collection of collectibles at short notice on a Sunday afternoon without taking a significant hit.

Moreover, real assets including collectibles are not readily portable. An investor cannot simply pack their real estate portfolio or their gold bars in their suitcase and move them to another part of the world in case of a government crackdown or political meltdown.

During the recent Ukraine war, we witnessed first-hand the US government weaponizing the US dollar whilst the UK government sought to confiscate the assets of Russian oligarchs in London.

The current monetary framework has its limitations as outlined above. Investors should therefore explore moving a portion of their allocation from traditional assets to other alternatives.

In particular, investors should explore an allocation to assets that are potentially:

• free from government interventions;
• a better store of value than Gold or the US dollar;
• readily accessible: anyone can participate, irrespective of the cost of the asset, through fractional ownership;?
• portable, accessible and tradable 24/7/365 from anywhere in the world;
• transferable at marginal costs.

In my next posts I will discuss where I see opportunities for long-term investors.

Hint: Disruptive technologies