Recently, the world mourned the death of beloved actor Leonard Nimoy. Mr. Nimoy, of course, was renowned for his portrayal of the iconic character Mr. Spock on the 1966 television series "Star Trek."
One of the most memorable "Star Trek" inventions was the transporter beam that effortlessly moved people and other solid objects through space in an instant.
Indeed, "Beam me up, Scotty" became part of the pop culture lexicon during the height of the show's popularity and remains there today.
Today's investors expecting central bankers to solve the world's economic problems might just as well believe that Janet Yellen is capable of beaming them straight into the Marriner S. Eccles Federal Reserve Board Building in Washington, D.C., which houses the main offices of the Board of Governors of the Federal Reserve System.
The world is suffering from a solvency problem - there is too much debt that can't be serviced or repaid.
It shouldn't take a Vulcan with the cool logic and super-intelligence of Spock to understand the massive threat (and lucrative opportunity) the situation poses for the global economy and our money.
Three-Dimensional Economic Checkmate
In the face of crushing global debt central banks are employing policies designed to deal with a liquidity crisis - lowering interest rates - rather than policies designed to deal with a solvency crisis.
As a result, their policies are doomed to fail.
In fact, they are not only failing to generate the types of growth that could create the income necessary to pay the interest on this debt and ultimately repay it, they are actually increasing debt levels while contributing to epic levels of wealth inequality to boot!
Central banks that purport to be promoting financial stability are actually undermining it - with the able assistance of regulators who have drained liquidity from the world's most important markets. Investors who fail to recognize these facts are going to lose a lot of money because markets are going to figure them out sooner or later and sell off hard.
Another enduring image of Mr. Spock was watching him play three-dimensional chess, a game that demonstrated both his superior intellect and his ability to see the complexities of the universe in ways far beyond the limited abilities of mere humans.
Rather than think in only two dimensions, Spock was able to think in three (or even more). This is something that investors must be able to do in a "digitalized" world, particularly when currencies start to move as dramatically as they have since last summer.
As a citizen of the twenty-third century, Spock was able to envision a digital world that we are only beginning to experience. Today, we inhabit a world in which we are just beginning to explore the consequences of being able to deconstruct every conceivable kind of data into different combinations of ones and zeroes that can then be reconfigured and transmitted around the world in the blink of an eye.
As investors, we are seeing this phenomenon played out around the world, and it gives us opportunities to take big gains in the "digitalized" economy...
Two Profit Plays for the "Digitalization of Finance"
An example of using seemingly limitless data in support of a new technology is found in Israeli cybersecurity company CyActive, which was just acquired by PayPal Inc., itself a subsidiary of eBay Inc. (Nasdaq: EBAY).
CyActive's specific area of expertise is predicting malware before it hits a network based on the premise that malware behaves like a virus; it mutates as it spreads. So CyActive uses evolutionary biology algorithms to track malware behavior.
Algorithms are a common digital language that can be applied across biological and non-biological systems. The possibilities of the common digital language of mathematics are truly as limitless as the space explored by Spock and his shipmates on the Enterprise.
The digitalization concept goes beyond technology, however.
In the financial world, every stock, bond, loan, currency, commodity, or derivative can be broken down into its constituent digital parts. Financial technology exposes the fundamental truth that all financial instruments are different expressions of the same underlying economic reality.
Global currency moves are another example where we see the "digitalization" theme playing out in real time.
Currencies and interest rates are just different versions of the same underlying phenomenon - the cost of money. And while economists have taught us to think about the difference between "real" and "nominal" returns primarily in terms of inflation effects, it is also necessary to broaden that understanding to include currency effects in periods of currency volatility like today.
The dollar has surged by more than 20% against the euro since last July. When the currencies in which their investments are denominated experience historic levels of volatility, a new dimension enters the investment landscape.
An unstable currency regime creates a highly unstable investment environment. With interest rates at or near zero and traditional inflation measures suppressed, currencies have picked up the mantle from interest rates for the transmission of real returns on capital.
"Real" returns are intended to measure the return on capital in constant currencies which today means adjusting them more for changes in the value of fiat currencies than inflation.
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Investors are pouring money into European stocks, which have outperformed U.S. stocks in the first quarter by a mile before currency adjustments.
While the S&P 500 was up +1.3% in the first quarter as of the end of trading on March 30, European stocks were up a rip-roaring 18% before taking into account the roughly 10% decline in the euro over that same period. That still leaves a handsome 8% return net of currency losses for the quarter but demonstrates the impact of currency volatility on real returns.
Investors who were thinking in three dimensions and hedged their currency risks did much better. The Wisdom Tree Europe Hedged Equity ETF (NYSE Arca: HEDJ) was up 19.9% over that same period, demonstrating the importance of paying attention to currency effects.
On a fundamental basis, investors should be cautious about chasing European stocks in a European economy whose major attraction is a weak currency. Sooner or later, economic reality will trump the false promise of a monetary policy that is doomed to fail.
For the moment, however, the elixir of currency debauchment is pushing stocks higher for those wise enough to view the world like Spock.
We may have lost a great deal in the passing of Mr. Nimoy, but we can all learn to "live long and prosper" by understanding the opportunities presented in this new world of "digitalization."
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.