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  • Writer's pictureGerard Kavanagh

We keep talking about our collectible and the fact it is a store of value.

, but let's look at the practicalities of that - why is a store of value useful? The Corporate Finance Institute (CFI) defines a store of value thus: "If an item can be held and converted into money in the future without a decrease in value, it is considered a good store of value. Various commodities are considered stores of value by virtue of their divisibility, durability, and portability." Not a foreign concept to those in the crypto-verse, especially as many see BTC as a hedge if not an equivalent to gold (history's most noted store of value). As previously discussed in "Can NFTs be used as currency", volatility and a relatively short track record make that assertion hard to back up. But, again as previously discussed, a Ruby does have a long successful history as a store of value and its digitalised version loses none of that potency, indeed it might even enhance that attribute. A store of value is a noncorrelating asset, a real hedge, and as the CFI explains: "Essentially, any asset, currency, or commodity that can reliably be converted to another at a later date can serve as a store of value. The conditions upon which an item qualifies to be a store of value depend on whether it can be saved, retrieved, and exchanged while maintaining its purchasing power. Risk aversion is the central concept behind a store of value, and prices will be maintained if there is perpetual demand for the underlying item. To illustrate, gold and other precious metals are stores of value because they yield utility due to their prolonged shelf life, without diminishing in value." But markets and asset values have risen dramatically and annually since the crisis back in 2008, so why would you want a store of value to purchase when it lacks the allure of a growth stock or contrived financial instrument promising so much more in terms of return? Well, you're being offered a crypto version of a genuine store of value, that is new, its method of delivery and the disruption that heralds to existing (not to mention vast) closed markets offers stupendous growth prospects. But let's leave the sexy side of things aside for the basis of this blog. What are the risks, the reasons for diversifying into a store of value? The shifting sands upon which that recovery has been built is the flippant, off-the-cuff response. Historically low-interest rates coupled with ever more extreme monetary policies as each bubble bursts and is resuscitated, the panacea to all crises over the last 50 years, has caused debts to spiral from what were deemed systemically dangerous during the 2008 crisis, with inordinate amounts of malinvestment, to explode to even greater heights with regard to both private and public debt. Here is an IMF blog just talking about its explosion to 2020: "In 2020, we observed the largest one-year debt surge since World War II, with global debt rising to $226 trillion as the world was hit by a global health crisis and a deep recession. Debt was already elevated going into the crisis, but now governments must navigate a world of record-high public and private debt levels, new virus mutations, and rising inflation. Global debt rose by 28 percentage points to 256 percent of GDP, in 2020, according to the latest update of the IMF’s Global Debt Database. Borrowing by governments accounted for slightly more than half of the increase, as the global public debt ratio jumped to a record 99 percent of GDP. Private debt from non-financial corporations and households also reached new highs. The debt surge amplifies vulnerabilities, especially as financing conditions tighten. Debt increases are particularly striking in advanced economies, where public debt rose from around 70 percent of GDP, in 2007, to 124 percent of GDP, in 2020. Private debt, on the other hand, rose at a more moderate pace from 164 to 178 percent of GDP, in the same period.

Public debt now accounts for almost 40 percent of total global debt, the highest share since the mid-1960s. The accumulation of public debt since 2007 is largely attributable to the two major economic crises governments have faced—first the global financial crisis, and then the COVID-19 pandemic." Authorities were barely able to resuscitate the last bubble and beyond extraordinary monetary gymnastics, and yet more debt, it also required heavy involvement from China and "dirty" money ..... and they are tapped out this time around!

The apparatus designed to shield us and restrain the more venal aspects of personal greed and corruption have been hollowed out. From the repealing Glass Steagall act in 1999, merging investment and commercial banks, to the unpunished and unregulated bond rating companies, to protecting Private Equity firms with public money while allowing them to avoid any form of regulation, the dismantling of the major accountancy firms from risk-averse partnerships to LLC's that will sign off on anything and have no fear of consequences to themselves. And here is another article, care of the great Andrew Smithers, highlighting the absurdity that is the guiding light (or rather excuse) for the ludicrous concept of shareholder value:

Andrew Smithers warning for stock market investors (Edward Chancellor) ( "Economic theory today is far removed from what happens in the real world. Its canonical models portray the corporate sector as a single representative firm that acts in the interests of its owners. Anyone who has worked in finance knows these models are contrived. In his latest book, “The Economics of the Stock Market”, veteran economist Andrew Smithers lifts the corporate veil to reveal a world in which the managers of public companies put their own interests first and seek to maximise current share prices rather fundamental values. In the United States, their actions have produced an overvalued stock market, excessive corporate debt and inadequate levels of investment. Smithers, who started work in the City of London six decades ago and once ran the fund management arm of the merchant bank S. G. Warburg, belongs to a venerable tradition of economists whose theory is shaped by practical experience. David Ricardo started his career as a stockbroker, while John Maynard Keynes was the bursar of his Cambridge college and chairman of a life insurance company. Economic models, says Smithers, should fit with known human behaviour and be tested by data from the real world. Theory suggests that company managers have the same interests as shareholders. In reality, they have different priorities. Corporate executives aim to hang on to their jobs and enhance the value of their stock-based compensation. If managements aimed to maximise the net worth of their businesses, they would issue shares when the cost of equity is low (and shares are highly valued in the market) and use the capital for investment. They don’t act in this manner because the immediate effect of new investment is to lower a company’s earnings per share. Along with issuing new shares, this tends to temporarily depress stock prices. Instead, managers prefer to take on debt to buy back shares at inflated prices. Finance theory suggests that a company’s valuation should not change whether it is financed with equity or debt. In reality, debt-financed buybacks serve to boost share prices, says Smithers. He also observes that companies seek to maintain a stable ratio of interest payments to profits. Thus, as long-term interest rates have declined, U.S. companies have taken on more and more debt to repurchase their shares. As a result, the valuation of the U.S. stock market has significantly diverged from its fair value, says Smithers. Finance theory denies that we can identify a stock market bubble in real time: future share price movements are unpredictable. This is true in the near term, says Smithers. Over longer periods, however, the behaviour of the stock market has been anything but random. In the past 200 years, U.S. equities have delivered an annual average real return of 6.7%. Periods of above-average returns have been followed by sub-par returns and vice versa. This shows the stock market is governed by the principle that returns will revert to their long-run mean. Smithers suggests the best way to value equities is to compare their market price to the cost of replacing underlying corporate assets. This measure, known as Tobin’s Q, is named after the Nobel laureate economist, James Tobin. The snag is that the process of mean reversion can take decades, well beyond the time horizon of most investors. Because Tobin’s Q is not a practical valuation tool, most investors prefer to compare earnings yields – a company’s earnings per share divided by its share price – with bond yields. In recent years, as bond yields fell to their lowest level in history, the valuation of U.S. stocks has soared. But Smithers maintains that comparing the two makes little sense. After all, stocks are claims on real assets whereas bonds represent paper claims. Over time, the difference in their respective investment returns (known as the equity risk premium) has neither been stable nor mean-reverting. Besides, Smithers argues, stocks should deliver a significantly higher return than bonds. Most investment is intended for retirement and savers are concerned primarily with maintaining their future spending power. Stocks are risky assets, whose value can remain depressed for long periods. After the October 1929 crash, it took around a quarter of a century for the market to regain its previous peak. The marginal investor, says Smithers, requires a significant return to compensate for the market’s inherent volatility. Smithers’ analysis suggests that the U.S. stock market today is perilously positioned. In recent decades, corporate managers have diverted resources from investment toward share repurchases. A prolonged period of underinvestment has put American public companies at a competitive disadvantage over foreign-owned firms. The corporate sector has also taken on near-record amounts of leverage. On a replacement-cost basis, the stock market trades at more than twice fair value. The risks of another financial crisis appear elevated, says Smithers. Naysayers will point out that American equities have looked overvalued relative to Tobin’s Q for the best part of 30 years. Besides, just because the return from stocks has been stable in the past doesn’t mean that equities must deliver the same return in the future. Naysayers may also suggest that the increasing importance of intangible assets has rendered Tobin’s Q obsolete – though Smithers vehemently rejects this. The natural monopolies created by the internet have also allowed technology companies to earn excess returns on equity for prolonged periods. Yet one reason why the valuation of U.S. stocks has remained elevated for so long is because the Federal Reserve has supported Wall Street with ever-lower interest rates and successive bouts of quantitative easing. Now the return of inflation has forced the Fed to reverse tack. Inflation tends to push up interest costs faster than corporate cash flows, forcing companies to deleverage and cut investment. Under those circumstances, the valuation of U.S. stocks could tumble. Smithers was one of the few economists to warn about the internet bubble and the dangers posed by the ensuing global credit boom. His current concerns shouldn’t be dismissed lightly." As Jim Chanos put it this is "the golden age of fraud". And as Warren Buffet warned, “Only when the tide goes out do you discover who's been swimming naked.” Given what we discovered in 2008 and the fact there is even more debt, malinvestment and outright frauds yet to be discovered can imagine the carnage when markets inevitably have their next crisis. In that reality why wouldn't you be diversifying into stores of value, noncorrelated hedges, to protect yourself? Especially portable stores of value and that is something we will discuss in more detail when we look into inflation and financial repression in the next blog ....

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