Financial Cryptography

The Elliot Wave has arrived at stage 5, so it's all over for the dollar!

I just had to write about this one:

The greenback is heading for the trough of a super-cycle that started in August 1971, Uno said, referring to the Elliot Wave theory, which holds that market swings follow a predictable five-stage pattern of three steps forward, two steps back.

The dollar is now at wave five of the 40-year cycle, Uno said. It dropped to 92 yen during wave one that ended in March 1973. The dollar will target 50 yen during the current wave, based on multiplying 92 with 0.764, a number in the Fibonacci sequence, and subtracting from the 123.17 yen level seen in the second quarter of 2007, according to Uno.

The Elliot Wave was developed by accountant Ralph Nelson Elliott during the Great Depression. Wave sizes are often related by a series of numbers known as the Fibonacci sequence, pioneered by 13th century mathematician Leonardo Pisano, who discerned them from proportions found in nature.

! Well, I'll bet all the technical traders are packing up their books and retiring, now that they've heard this news.

More seriously, the problem with fundamental analysis (like the above) is that although it can be very right, it can also be very hard to time. Point in fact, I predicted the shift in the dollar (and so did a lot of others). But I predicted it around 2001, and it just didn't happen according to any schedule I could see. So this information is interesting but relatively worthless on a daily basis.

On the other hand, the technical trader works to patterns. To scientists this seems more like voodoo or interpreting the future from chicken entrails, and to all objective metrics it is like that. But the technical traders swear by it, and they promise it makes them money.

What's the truth? I think it is clear that complexity is such that fundamentals can't be time-predicted so easily. Which means that day-to-day is unpredictable, being the random walk. But something has to happen (never forget the Stiglitz observation), and it happens in the minds of the traders. Ideas for patterns emerge: cat droppings & bouncings, peaks & troughs, decision points. The ideas that are consistent over time are probably decided by the efficiency of meme-spreading more than anything else, which then leads to the patterns becoming self-confirming.

So where are we heading? Well, the dollar is no longer the undisputed champion. But it will still retain leadership for some time, a steady decline into a more dispersed market. People talk about alternates:

Uno said after the dollar loses its reserve currency status, the U.S., Europe and Asia will form separate economic blocs. The International Monetary Fund’s special drawing rights may be used as a temporary measure, and global currency trading will shrink in the long run, he said.

But that doesn't make sense; as Chris says:

As a bear of little economic brain but with market experience approaching 25 years, I prefer to deal with the practical, rather than the theoretical. I observe that the transaction currency is relatively unimportant, because the foreign exchange market allows an alternative currency to be used in a microsecond. What matters is, for a consumer, the capability to make future payments in the transaction currency; and for a producer, where and in what currency and asset class the proceeds of sale may be invested.

Right.

I propose an entirely different approach, and that is to distinguish between the value standard we use, and the currencies we exchange by reference to the standard.

Firstly, a fixed amount of energy - for instance the energy value of a liter of gasoline, or its equivalent in kilowatt hours - would be intuitively obvious as a pricing reference. Most people could relate to that, and whether the unit is called a petro, electro, or an energy dollar is irrelevant.

Secondly, there is the need for nationally and globally acceptable units of currency as a store of value. A unit redeemable in land rental value could perhaps be a nationally acceptable currency, but for international acceptance or "fungibility" the obvious candidates are electricity, which is pure energy, and carbon-based fuels, such as natural gas, gasoline, kerosene, heating oil and fuel oil.

If a new force is to emerge, it won't be a political unit like the IMF's accounting thing, nor will it be a historical thing like gold, but will be backed by something substantial. Energy is one universal, and if anything it is going up in value and demand, not down (so it doesn't equate to Moore's law or technology reductions, nor to natural commodity pricing).

But also, we should be very important not to attach the dollar's pain to the American Economy. Although it will suffer one hell of a hangover, bear in mind this observation from the Economist:

Only one thing seems sure about the future of the digital skies: the company or companies that dominate it will be American. European or Asian firms have yet to make much of an appearance in cloud computing. Nokia, the world’s biggest handset-maker, is trying to form a cloud with its set of online services called Ovi, but its efforts are still in their infancy. Governments outside America may harbour ambitious plans for state-funded clouds. They would do better simply to let their citizens make the most of the competition among the American colossi.

Practically all new value is created in North America. They may have sacrificed their dollar over the irrational exuberance, but the attitudes in creating new value run deep; Europe can't do it, and most all other new countries copy the essential model of post WWII Japan: copy and out-perform.

(So much for a quick post!)

Posted by iang at October 16, 2009 09:53 AM | TrackBack