Blog: You, us, everyone

Background 

We believe that COVID-19 will be entering the history books as a turning point in terms of an unbounded approach for central bank policies and measures taken to kick-start the economy. The manner and the persistence of the central banks’ actions to counter-act the market dislocation of February/March 2020 was unprecedented in terms of form and size. Still, as of now,  it appears the distribution of magic money is not enough to make the legacy industry segments catch up with Economy 2.0.

The doctrine of “do-what-it-takes” was formulated and implemented during the GFC of 2007/2008; while precursors of instabilities were visible long before the GFC, referenced macro-economic models were generating data sets that persistently mis-shot reference values for inflation, growth, and money flows.

By addressing the issue of COVID-19, central banks facilitated the emergence and acceptance of new technologies. Yet, the spending bonanza occurred on the removal of constraints on government spending and the perception that the central bank toolbox would contain limitless utensils to address imbalances and the malfunctioning of an economy.

We are not arguing that things are utterly bad; we simply want to highlight that things are not as cool as one could imagine and that CBs are most likely on the lookout for new tools to manage any oncoming market dislocation more efficiently than in the past.

When looking at historic markers, financial and economic systems experienced a similar disintegration in 1971, though on evident contextual differences. At that time, the change in the reflationary regime spurred the creation of the EU, the Euro, and its economic strength today. It is true that in Europe fortunes are not created as quickly as in the United States of America, but nevertheless, the created fortunes have a higher degree of sustainability over time.

The current spending spree of the US administration is first and foremost promoting local investments. Yet, since we are in a world that is more than ever interconnected via trade, communication, and monetary flows, it is plausible that the present US narrative is creating a financial and fiscal trap for them.

We note that discourse and actions implemented by some other central banks are different. For instance, China through its POBC actions proudly declared its exit from crisis management. Obviously, one could argue that there was no change of status ever since 9/11 and that the broadcasted figures could be manipulated, hence what is the real value of promoting such!

While we can provide some benefits to these arguments, we would draw the reader’s attention to the fact that China wants to establish creditworthiness by a tactical move. The promoted exit clearly indicated that POBC wants to dissociate itself from debt-dependent capitalism, which is inherently not sustainable without any real growth.

In conjunction with 50 years ago, the breakdown of the Breton Wood monetary system led, in extension, to the creation of the Euro. Today, the reshuffling of the debt-loaded developed market economies could lead to the creation of a new tool, i.e., Central Bank Digital Currency (CBDC). Provided CBDC go alive, it will provide central banks much-needed muscle power to address the oncoming challenges. 

The need for CBDC

Imagine a currency that is as easy to share as your Instagram story or the e-payment of your croissant and coffee at the nearby coffee bar! If so, in this futuristic view, coins and notes could become obsolete. We don’t think so quite yet, but Central Bank Digital Currencies (CBDCs) have undeniably made an important step ahead. With the concept for CBDC at the ready, an increasing number of central banks are now assessing its implementation.

The requirement for change comes on the back of a mature economic system which is more than ever interconnected, fast, and dependent on a few major players. While the economy works globally, each country or jurisdiction is maintaining control of its payment system, sometimes with rather outdated concepts. Developments in the financial ecosystem, in particular in the payment industry, are supporting the use of cryptocurrencies, stablecoins, and, in the future, CBDCs at the expense of cash. 

Today, the flow of money is regulated by central banks, and money is made by banks that grant loans to their clients for commercial or other activities. Tomorrow, the use of digitalized money will: a) facilitate efficient payments, b) offer greater security, c) eliminate intermediaries, d) reduce the level of people that are unbanked today, and e) monitor transparency standards thereby limiting illicit activities. At the current point, CBs do not envisage exercising the key position (c) but rather delegating it to existing service providers.

Payment scenario A with CB holding a key position:

Payment scenario B with a commercial bank holding a key position:

The scope of CBDC

According to a recent note published by Morgan Stanley, CBDC initiatives are not intended to disrupt the banking system but rather to reinforce its credibility, exercisability, and improvise its efficiency. Yet, the implementation will likely have some unintended disruptive consequences. The move away from physical currency opens the way for more innovation and a greater scope for new payment providers.

Up to now, cryptocurrencies have been lacking price stability. Recent price fluctuations, when measured as standard deviation, were higher than most equity indices. The dramatic price fluctuation of privately organized coins does not comply with the fundamental requirement of a currency [stability!], i.e., hence the call for central bank organized digital currencies.

Other reasons in favor of CBDC include allowing the public to hold digital currency accounts at central banks would resolve issues around institutions deemed “too big to fail,” and under payment scenario A, bank runs would definitely be part of history.

In fact, the introduction of payment scenario B is most likely disrupting existing payment models established by predominant banks. The implementation of digital currencies can help establish a more balanced financial system where payment agents report to CBs and keep the accreditation valid.

The use of physical cash has been on the decline ever since the late 1990s; the pandemic has just accelerated this trend. By implementing CBDC, central banks offer households and commercial entities access to central bank money as an alternative to cash and as an alternative to privately managed stablecoins and bitcoins which we consider as ultra speculative since there is no value nor concept of contre-value.

The next generation of CBDC, i.e., 2.0, will most likely have a national or even a supranational level. These digital currencies will improve monetary policies, help mitigate inflationary risks, and monitor and manage purchase power inequality. As the next illustration showcases, digital currency statuses will not be equal. CBDC will have a dominant place of reference; consortiums of stablecoins are likely to create the most positive societal impact, while anonymous, closed-end cryptocurrencies and asset-backed stablecoins will most likely raise ethical issues that will limit their true value.

Gaming the numbers

Today, just a little less than half of all in-store purchases in China are made via a digital wallet, which is way above the levels observed in developed markets. As the main emerging market countries (China and India) are developing electronic peer-to-peer payment systems, the center of economic competencies is shifting a little further east, away from developed markets such as Europe and the United States. We would expect that companies doing business in these regions will be required to endorse the country’s digital currencies, thereby weakening the predominant position of the US Dollar and its subordinated financial system.

We consider that CBDCs will be introduced relatively quickly in order to address urgent reforms to ballooning central bank balance sheets as well as tax and income inequalities. Governments could endorse the creation of CBDCs to accelerate and implement a universal basic income (UBI) because the centralized roll-out of digital money could be dispersed efficiently to specific classes of the population.

Observation on costs: No doubt, the costs to print, transport, distribute, and manage the appropriate level of cash in circulation is high. In fact, the exact costs cannot be enumerated! Therefore, seeking a more transparent system appears to be obvious. While considering the replacement, one needs to yet address the level of costs associated with CBDC. They include development, deployment and maintenance of the infrastructure (servers/cloud services), software licensing costs, and BCP, as well as the implementation of fraud and cybersecurity protection tools. And finally, all that should be ESG compliant.

The investment opportunities

The present payment system needs a refresh, and digitalizing all of it appears opportune. Opinions of how and when obviously diverge. While central banks and government bodies, in particular in developed markets, appear to ignore the importance and the urgency, the industry is powering ahead with substantial developments of any kind.

In the absence of adequate regulation, any kind of hype is possible as privately owned cryptocurrencies try to fill the vacuum created. We believe that privately owned consortiums of stablecoins and cryptocurrencies may cohabit with CDBCs, but they will not be able to gain, by far, the equivalent status. This because a private organization will never be able to claim the legitimacy of a nation.

Provided we were to assume that one would overcome this obstacle, the provider would need to establish a robust digital financial system, enable unlimited access to it, and keep it free from shutdowns and cyberattacks. Therefore, only government-based digital currencies will have the legitimate political and democratic backing. Therefore, we consider the space of crypto (stablecoins and bitcoins) as ultra speculative.

In the absence of any valuable investment opportunity in CBDC, we consider opportunities in the digital payment ecosystem, in particular the service enablers. As of today, there are about 120 identified companies that are presently working or expected to work in the field of digital payments.

Investment selection

Most good chefs start preparing a meal for their guests with olive oil, onions, pepper, and salt. Only once this has been assembled can they start to add the extras! It doesn’t look like much of a science, but the way the chef adds the extras makes all the difference. In the same humble way, we perform for every company we follow the investment decision-making process. It is about collecting fundamental and top-down raw data and searching for patterns versus competition, history, and outlook. With the help of AI, findings are contextualized. Putting it all together means that we can, day after day, make the best possible opportunities in a particular field available, like the payment ecosystem.

Ever since 1990, just about 1.3% of all quoted companies worldwide have created the net wealth increase. It is for this reason that we do not recommend one particular company at the expense of another, but rather a basket of companies that are managed in an active manner. In this context, the Family Trust Fund offers opportune and unique access to digital-enabled companies. The Fund is seeking to invest in the winning tech-enabled companies of tomorrow with a market cap of between USD 50bn and 200bn.

Valuations

The low-interest rate environment has created a huge valuation gap between fast-growing technology-enabled entities and companies with more traditional business models. Lately, concerns about inflation, rising yields, and tax issues have put some pressure on the high valuations. Given that providers of digital services of any kind are exposed to secular growth trends and above-average earnings growth, their present valuations appear to be justified and reasonable.