1. Currency Wars and the IMPACT Method

    In 2011, founder Jim Rickards published his book “Currency Wars: The Making of the Next Global Crisis,” which revealed the potentially devastating impact of the current currency war on the US. The current currency war may seem unpredictable; however, with the assistance of Meraglim’s innovative financial models and risk assessment software, you can have greater insight to the global market movements before anyone else. In this blog, we will go over a brief history of currency wars and dive into the current one, as well as how Meraglim™ can put you in the best position to take advantage of the currency war.

    A History of Currency Wars

    Before 1930, global trade was uncommon, so while governments often devalued their currency, exchange rates were not a concern and therefore, currency wars did not exist. Currency debasement was used to increase the supply of money domestically, particularly to pay debts or finance wars. When nations competed economically, they used mercantilism, which, while it still attempted to limit imports while increasing exports, did not do so using devaluation. In the late 18th century, mercantilism began to fall out of popularity as the free trade model became favored. During this time, the gold standard was first adopted, creating conditions for currency wars to occur as money held an intrinsic value; yet, there was no opportunity. Opportunity presented itself after World War I, when several countries faced recessions and only a few returned to the gold standard. However, a currency war did not take place, as the United Kingdom wanted to bring its currency’s value back to where it was before the war, and therefore, cooperate with other countries. By 1925, many countries re-joined the gold standard.

    currencywars_blog_innerimageThen the Great Depression happened. During this time, the gold standard was largely abandoned. Unemployment was widespread, making devaluation quite common; however, this was not competitive, as devaluation was so prevalent that it was rare for nations to gain an advantage that lasted. When the 1930s currency war actually started is controversial, but it involved the US, France, and Britain. In the 1920s, these countries had parallel interests, and worked collectively to strengthen the British Sterling. However, after the Wall Street crash of 1929, France began to sell the Sterling, having lost faith in its value. The US and France began sterilizing the inflows of money, hoarding gold instead of using it to increase their supplies of money. This contributed to the Sterling crisis of 1931, which caused Britain to take their currency off the gold standard. For years afterwards, competitive devaluation and retaliatory tariffs disrupted international trade. This currency war finally ended in 1936, with the Tripartite monetary agreement.

    The end of World War II until 1971 is considered the Bretton Woods area, when competitive devaluation could not occur because of the semi-fixed exchange rates of the Bretton Woods system. There was also high growth during this period on a global level, so even if a currency war were possible, there was not much motivation to do so. From 1973 to 2000, there were conditions for currency wars to occur, but not enough states wanted to devalue money simultaneously to result in a currency war. In the ‘80s, the US wanted to devalue, but did so with cooperation per the Plaza Accord. In the 1990s, a renewed movement for free markets made the prevailing attitude one that emphasized not intervening with economies, even to correct current account deficits.

    However, free market influences were destroyed during the 1997 Asian crisis, when economies in Asia were forced to accept low prices for their assets due to running low on foreign reserves. This caused them to intervene regularly and they adopted a strategy of finding export opportunities while building foreign reserves. This did not result in a currency war because it was widely accepted by other economies because it benefited their citizens, who could now buy the cheap imports Asia supplied. While the current account deficit in the US grew, there was not much concern among economists.

    By 2009, currency war conditions were back, as the economic downturn affected global trade. Economics were very concerned with their deficits and export led growth became the idealized strategy due to Asia’s success with it. During this time, the US and China were the major players in this currency war, pushing the value of many other economies up. The US began putting more pressure on China to allow appreciation of their currency. China did allow a two percent appreciation after much pressure, but this did little to ease Western concerns. US pressure finally came to a head in September 2010, when the yuan rapidly appreciated steeply. In 2012, there was a movement for major economies to work more

    currencywars_blog_bonds_innerimageFor a while, panic about a currency war quieted, but was re-sparked when the central bank of Japan announced that it would begin a bond-buying program that would probably devalue the yen. This caused panic, with many analysts claiming that Japan was intentionally trying to start a currency war. However, ultimately, the act was recognized as a strategy for boosting the economy as opposed to competitive devaluation. While commentators concerns about the currency war continuing eased, the possibility still loomed, this time not between Japan and the US, but the US and Germany. In October 2013, the US criticized Germany for its large current account surplus which slowed the global economy.

    In 2014, currency war still loomed, this time as nations began devaluing their currencies to address concerns with deflation. In January 2015, the European Central Bank began a quantitative-easing program that many believe to be the escalation of the currency war, though it was not intended to devalue the Euro. In August 2015, China devalued the yuan because of poor export numbers in July. This resulted in a loss for other major export companies where they have drastically devalued the currency previously. This caused more devaluation in Asian economies, including Vietnam and Kazakhstan.

    Despite what certain analysts say, the currency war continues today. Just as a real war, there are times of quiet in currency wars. Fortunately, with Meraglim™, you can have an inside look into when the next event will occur. While the currency war rages on, you and your team can benefit from it with Meraglim’s help.

    IMPACT Method

    Jim Rickards, one of our founders, created the IMPACT method to forecast these turning points to allow investors to take advantage of them. IMPACT stands for International Monetary Policy Analysis and Currency Trading. This model is one of the many Meraglim™ implements to help our clients navigate global capital markets. How do we know that this brand new, powerful model is effective? After a year of research, we have found many examples of trading opportunities that could have benefited our clients with incredible exponential growth throughout the last 20 years.

    With the aid of the IMPACT model, we identify emergent properties, giving you the opportunity to benefit from our predictions. This revolutionary model is only the tip of the iceberg in terms of what Meraglim™ can offer to your team. If you are a global leader or institutional investor, you can benefit from Meraglim’s expertise in a variety of fields and innovative risk assessment software. Contact us today to learn more about how Meraglim™ can help your team in the global money market.

  2. The Inextricable Link Between Psychology and Economics

    There has long been a debate in the world of economics about the influence that behavioral psychology has over markets. Much of traditional economic theory, such as the Efficient Market Hypothesis (EMH), works under the assumption that major players make rational and logical decisions objectively, leading to rational prices, and further analysis is largely useless. However, psychologists have found that individual behavior has more of an effect on market movements than previously explored, and that analyzing these behaviors may enable investors to more accurately predict the market.


    dreamstime_xxl_39576370The Psychology/Economics Connection

    Recent research shows that psychology has a clear influence on capital markets in a variety of ways. One analysis published in the Proceedings of the National Academy of Sciences looked into partition dependence, an effect in which breaking down possible outcomes of an event in a detailed way makes people believe that they are more likely to happen. The researchers in this study look at several different prediction markets in which people place bets on the outcomes of future events. In these markets, people buy and sell claims on outcomes, and the prices of the claims are a reflection of beliefs about the likelihood of each outcome. They created two of these markets in a lab experiment and then studied two real-world examples.

    In one lab experiment, participants traded claims on the number of games an NBA team would win in the playoffs, and how many goals each team would score in the World Cup. They traded claims on 16 teams for both the events. One group of participants was asked how many games the Miami Heat would win, choosing between a few ranges, such as 4-7 games or 8-11 games. A second group was then offered a wider range, which combined the two intervals of the first group. The participants then traded claims on each interval within the group. As it is with all prediction markets, the traded claim’s price reflected the estimation of what range the total number of games would fall in.

    According to economic theory, the first group’s perceived probability of the team winning 4-7 games and the probability of winning 8-11 added together should sum to a total that is close to the probability perceived by the second group. However, when they totalled the numbers, they found that the first group thought the likelihood of the team winning games within those two ranges was higher than that of the second group. This implies that when the possible outcome is framed more specifically, people believe that the outcome is more likely.

    Researchers also saw similar results in another experiment on horse races. In general, people will bet more money on a horse that is a long shot because the potential payoff is significantly higher, and they also overestimate a longshot horse’s chance to win. Statistically speaking, a horse’s chance of winning is the same, regardless of the number of horses with which it is competing; if a horse wins 10 percent of the time, it will do so whether it is racing five horses or 10. However, the researchers analysis of betting data from 6.3 million horse races found that partition dependence affected betters, who believed that long-shot horses had better odds if fewer horses were in the race.

    While partition dependence has been studied before, this research was revolutionary because this concept had not yet been applied to predictive markets. It is also especially significant because the phenomenon was studied across several research studies, including two lab experiments, an analysis of traders of Deutsche Bank and Goldman Sachs, and the analysis of the horse-racing data. This research shows that psychology clearly has an effect on prediction markets, and therefore, has significance in capital markets. Institutional investors have seen this data and have started adopting predictive models that use behavioral psychology, such as behavioral finance.


    dreamstime_16061051Behavioral Finance

    The connection between many institutional investors is that they are now using the behavioral finance model to construct their portfolios. While behavioral finance is still in its infancy in many ways, it has seen an uptick in popularity after the 2008 financial crisis.

    In 2005, Yale University professor of economics Robert Shiller predicted the housing market bubble burst that would happen two years later using behavioral finance analysis. Shiller is one of the founders of this school of thought, and an adamant opponent of traditional economic models. As successful as the behavioral finance model might have been at predicting this type of bubble burst, it’s hard to say how helpful this information is from an investor standpoint. Betting against bubbles by creating funds based on these predictions would not be worth the risks.

    However, fund managers are using behavioral finance to assess mispricings in the market. The theory is that investors hold onto cognitive and emotional biases that cause equity prices to over or underreact to market events. Fund managers have been using this to their advantage over the past 15 years, and have seen success. One example is J.P. Morgan, who has implemented behavioral finance strategies to choose their equities for their portfolios, and have exceeded market benchmarks over time.


    dreamstime_xxl_3556402Criticism

    However, not everyone is convinced of the merits of behavioral finance for predicting the market. Critics generally point to a lack of empirical evidence to support its efficacy, and many think of it more of a collection of ideas rather than a true predictive model. Skeptics say that behavioral finance is simply choosing value stocks with a higher cost of capital, from which people naturally expect higher returns. This issue seems to be applying psychology, which is inherently subjective, to economics, that require hard figures, and is not quantifiable enough for critics of this theory. Too much is promised without any guarantees.

    Yet even if it is true that behavioral finance promises too much, it is clear that considering psychology when choosing funds offers an advantage. Take for example Thaler & Fuller Asset Management. They developed a strategy called the cap-growth strategy, which enables investors to choose companies with consistently positive earnings over time. The premise is that the market consensus incorrectly determines a company’s profitability due to positive information because analysts unconsciously make cognitive errors when estimating. The model essentially begins with earning surprises. The company goes through earning surprises to determine which are likely to cause an underreaction, leading to underpriced stocks. The most important part of this is ensuring that the surprise is not temporary. An example of this would be an earning surprise in oil stock due to the price of oil going up; this is so variable, there is no point paying attention to it. In contrast, if an oil company found a way to refine oil more efficiently, this surprise is likely to have more long-term implications. Thaler & Fuller has seen success with this model, successfully identifying these companies four out of five times.


    Conclusion

    While behavioral finance has interesting implications of building portfolios, it is not the end-all-be-all of predicting capital markets. It is important to consider psychology when creating funds, but there are many other factors to consider as well. Meraglim™ combines the powers of a variety of schools of thought, including behavioral psychology, to offer reliable global financial data analytics to institutional investors and global leaders. Contact us today to learn more about what our services can do for you.

  3. Financial Data Analytics: The REACTION Model

    As the old models of financial analysis and risk management continue to fail us, we need to innovate new ones. At Meraglim™, we provide financial data analytics to institutional investors and global leaders, turning traditional financial analytics on its head by bringing together experts from a variety of backgrounds. By implementing the innovations of multi-disciplinary science, we use our unique interdisciplinary model to help you navigate global markets on a large scale. To demonstrate exactly what our diverse panel of experts has to offer, we will profile different innovations by our leadership team that show we are leading the industry in creating new, more effective financial models.

    Our Chief Global Strategist, James Rickards, recently published a brand new financial model in his newsletter, Strategic Intelligence. This five-stage model is called the REACTION model, and it can be used to analyze times of financial distress to determine their level of severity. In this blog, we will review the five stages of the REACTION model: Repricing, Acceleration, Transmissions, Irrationality, and Oblivion.


    dreamstime_xxl_25681895The REACTION Model

    STAGE ONE: Repricing

    The beginning of any market adversity begins with the repricing of a specific instrument or asset class. Usually, this occurs because the market set the value of an asset at an unrealistic level, and this can sometimes escalate for years before people realize that they have fallen victim to wishful thinking. A stock may have a high valuation, all while the company plummets toward bankruptcy, until a financial analyst finally points out the truth, panic ensues, and the stock quickly crashes. Alternatively, a major event can serve as a smack in the face to the market, such as an election. There are countless examples of this; one recent one can be seen in the market after the Brexit vote.

    Earlier this year, the United Kingdom vote on the Brexit referendum to determine whether or not they would leave the European Union. While the polls leading up to the vote on June 23 were consistently close and the outcome unclear, the media favored Remain, the side that dictated they would stay in the Union. This perception showed in the markets, and assets were valued based on a Remain outcome, despite the fact it was ambiguous if this would actually be the outcome. The day of the election, the GBP/USD exchange rate for the pound was at a high $1.49, and gold fell from $1,300 to $1,255 per ounce. Once it became apparent that the vote was actually in favor of leaving the EU, the market went haywire. The exchange rate fell to $1.30 almost instantly, and the value of gold rose to $1,315 per ounce. These assets were repriced to an extreme level to reflect the reality that shattered delusions.

    Sometimes, such repricing occurs as an isolated incident. Other times, the repercussions continue into the next phase of the REACTION model: acceleration.

    dreamstime_xxl_12649751STAGE TWO: Acceleration

    The next stage, acceleration, occurs when the repricing continues based on different market dynamics, separate from the initial igniting event. The three main reasons that acceleration occurs are leverage, margin, and stop losses.

    In hedge funds, leverage refers to the use of borrowed money to place a bet. There are two types of leverage: explicit and implicit. Explicit leverage is money that is borrowed in exchange for a fee, such as bank loans, and appears on a balance sheet. In contrast, implicit leverage is off-balance-sheet financing, and comes in a variety of forms, including forwards, futures, and swaps. Money is not exchanged until the bet is settled. Whether explicit or implicit, leverage amplifies whatever is happening in the markets, both in terms of gains and losses. This makes gains much larger, but losses significantly worse than they would be without leverage. With a very large loss, the counterparty (who is usually a bank) will be concerned about the losing party actually being able to pay the losses, and will typically ask for collateral for protection. This is referred to as a margin call, and can be for a larger amount than the actual loss and must be high quality, such as cash. If a trader loses and cannot come up with high-quality collateral, they will lose out on the trade and will be unable to recover from the loss should the market move in a positive direction.

    Keeping in mind how risky the combination of leverage and margin calls is, a leveraged trader will protect themselves using a stop loss. A stop loss is a sale that is pre-arranged with a broker to close out automatically once a losing position reaches a certain point. This ensures that the position is closed before too much loss occurs. Depending on the position, these stop losses can be very “tight,” meaning a small percentage; for example, a 1% loss would be a tight stop loss. These are generally automated by a computer and do not involve human judgment, so the position will be sold regardless of how it is valued.

    To demonstrate how disastrously these factors can affect the market, consider this simplified example. An asset is valued at 100, and five hedge funds have set five different stop loss levels.

    Fund A: 99 (1% loss)
    Fund B: 98 (2%)
    Fund C: 97 (3%)
    Fund D: 96 (4%)
    Fund E: 95 (5%)

    Then, the market experiences a shock that triggers repricing, the asset is repriced at 99, and the stop loss for Fund A is triggered, automatically selling the stock. The selling then causes the price to fall to 98, setting off the stop loss of Fund B, which then causes the stock to fall further, trigger the stop loss for Fund C, and so on and so forth until it triggers Fund E’s stop loss. While this is a simplified example of what happens in real life, this is why leverage, margin calls, and stop losses can cause further market chaos after repricing. In this example of acceleration, automated stop losses exacerbate the initial repricing issue. These types of crashes are highly likely to happen again, given that leverage and stop loss algorithms are still used today. The next step after acceleration is transmission.

    dreamstime_13321620STAGE THREE: Transmission

    Transmission is also known as “spillover” or “contagion,” and it occurs when these market disruptions spread to other unrelated markets. This causes these uncorrelated market to unexpectedly become correlated based on current conditions. An example of this can be seen in the 2008 stock market panic. Before this, the correlation between Japanese and US stocks was a low 0.37. When the US stock market bottomed at the height of the crisis, the two markets became perfectly correlated at 1.0. When considering why this may occur, it makes sense to look at this event in context. The 2008 US stock panic was caused by subprime mortgages, an issue that has absolutely nothing to do with Japan. However, because hedge funds needed cash to meet the margin calls, they sold their Japanese stocks for collateral, and the selling pressure and illiquidity of US stocks translated to Japanese stocks. Illiquidity can spread to markets all over the world, which leads to the next phase of the REACTION model: irrationality.

    STAGE FOUR: Irrationality

    After transmission, panic ensues across markets and people begin irrationally selling their assets for cash. The uncertainty of the market causes everyone to realize that their assets are not actually money, and they become desperate to secure all of their money. They don’t care about the long-term potential and relative value of their stock — they just want the certainty of cash. All of the selling drives prices lower, and it becomes a perpetuating cycle of panic.

    In recent panics, banks have worked with the government to figure out a way to give investors the money they seek through money market funds and making cash available through swap line and asset purchases. By infusing liquidity in the market, banks generally ease the panic, and this can stop the market crisis before it reaches the final stage of the REACTION model, Oblivion.

    The issue here is that this puts us in an extremely precarious position in the future. The Federal Reserve expanded its balance sheet to $4 trillion in order to ease the 2008 panic. This would be fine if they had somehow been able to normalize the balance sheet, but instead, it remains at $4 trillion. The other central banks are similarly overloaded, which means that during the next market panic, the re-liquefying will fall to the International Monetary Fund. The IMF will have to print trillions of dollars, which will result in high inflation and significantly decrease the value of the US dollar in the global market. Should this fail, it will lead to the freezing of all bank accounts and the closing markets, or the last stage of REACTION: Oblivion.

    STAGE FIVE: Oblivion

    Oblivion is a subjective term that essentially means a complete collapse. During Oblivion, the markets aren’t just crashing; the entire system no longer functions. In the worst case scenario, this would result in the extinction of the species.

    Smaller scale oblivion can be seen in capital market collapses throughout history, such as in 1933, when every bank in America was closed for eight days. While these collapses are not inevitable, they do happen, and could easily happen again with the right catalysts. While no one catalyst is likely to collapse the market, a combination of factors such as war, natural disaster, and social unrest could come together to start the next collapse.

    In the event of a collapse, the wealthy, who have both the most to lose and the greatest political resources, will respond with truncation, often freezing banks on a temporary basis. For the average investor, this will make no difference; once their money is lost, it is lost forever. Either result, whether the collapse of capital markets or the freezing of markets in response, has disastrous consequences for the average investor.


    dreamstime_xxl_28670895REACTION Application

    Now that you have an understanding of the REACTION model, you can understand what happens during financial panics. Again, keep in mind that every market disruption does not lead to all five stages. Repricing occurs often, but can be recovered from should the markets adjust, or may experience acceleration, but never reach the point of transmission or irrationality. The point is not to assume that oblivion is inevitable, but that it could happen, and when you see signs of repricing, it is important to remain observant of the environment for potential collapse. By keeping this in mind, you can take steps to protect your financial well-being.

    At Meraglim™, our panel of experts have created models such as the REACTION model that put them at an advantage for accurately predicting movements within the global money market. Contact us to learn more about what we can do for you and your team.

    Contact Us For More Information Today
  4. Using The REACTION Model


    Financial Data Analytics: The REACTION Model

    As the old models of financial analysis and risk management continue to fail us, we need to innovate new ones. At Meraglim™, we provide financial data analytics to institutional investors and global leaders, turning traditional financial analytics on its head by bringing together experts from a variety of backgrounds. By implementing the innovations of multi-disciplinary science, we use our unique interdisciplinary model to help you navigate global markets on a large scale. To demonstrate exactly what our diverse panel of experts has to offer, we will profile different innovations by our leadership team that show we are leading the industry in creating new, more effective financial models.

    Our Chief Global Strategist, James Rickards, recently published a brand new financial model in his newsletter,  Strategic Intelligence . This five-stage model is called the REACTION model, and it can be used to analyze times of financial distress to determine their level of severity. In this blog, we will review the five stages of the REACTION model: Repricing, Acceleration, Transmissions, Irrationality, and Oblivion.

    The REACTION Model

    STAGE ONE: Repricing

    The beginning of any market adversity begins with the repricing of a specific instrument or asset class. Usually, this occurs because the market set the value of an asset at an unrealistic level, and this can sometimes escalate for years before people realize that they have fallen victim to wishful thinking. A stock may have a high valuation, all while the company plummets toward bankruptcy, until a financial analyst finally points out the truth, panic ensues, and the stock quickly crashes. Alternatively, a major event can serve as a smack in the face to the market, such as an election. There are countless examples of this; one recent one can be seen in the market after the Brexit vote.

    Earlier this year, the United Kingdom vote on the Brexit referendum to determine whether or not they would leave the European Union. While the polls leading up to the vote on June 23 were consistently close and the outcome unclear, the media favored Remain, the side that dictated they would stay in the Union. This perception showed in the markets, and assets were valued based on a Remain outcome, despite the fact it was ambiguous if this would actually be the outcome. The day of the election, the GBP/USD exchange rate for the pound was at a high $1.49, and gold fell from $1,300 to $1,255 per ounce. Once it became apparent that the vote was actually in favor of leaving the EU, the market went haywire. The exchange rate fell to $1.30 almost instantly, and the value of gold rose to $1,315 per ounce. These assets were repriced to an extreme level to reflect the reality that shattered delusions.

    Sometimes, such repricing occurs as an isolated incident. Other times, the repercussions continue into the next phase of the REACTION model: acceleration.

    STAGE TWO: Acceleration

    The next stage, acceleration, occurs when the repricing continues based on different market dynamics, separate from the initial igniting event. The three main reasons that acceleration occurs are leverage, margin, and stop losses.

    In hedge funds, leverage refers to the use of borrowed money to place a bet. There are two types of leverage: explicit and implicit. Explicit leverage is money that is borrowed in exchange for a fee, such as bank loans, and appears on a balance sheet. In contrast, implicit leverage is off-balance-sheet financing, and comes in a variety of forms, including forwards, futures, and swaps. Money is not exchanged until the bet is settled. Whether explicit or implicit, leverage amplifies whatever is happening in the markets, both in terms of gains and losses. This makes gains much larger, but losses significantly worse than they would be without leverage. With a very large loss, the counterparty (who is usually a bank) will be concerned about the losing party actually being able to pay the losses, and will typically ask for collateral for protection. This is referred to as a margin call, and can be for a larger amount than the actual loss and must be high quality, such as cash. If a trader loses and cannot come up with high-quality collateral, they will lose out on the trade and will be unable to recover from the loss should the market move in a positive direction.

    Keeping in mind how risky the combination of leverage and margin calls is, a leveraged trader will protect themselves using a stop loss. A stop loss is a sale that is pre-arranged with a broker to close out automatically once a losing position reaches a certain point. This ensures that the position is closed before too much loss occurs. Depending on the position, these stop losses can be very “tight,” meaning a small percentage; for example, a 1% loss would be a tight stop loss. These are generally automated by a computer and do not involve human judgment, so the position will be sold regardless of how it is valued.

    To demonstrate how disastrously these factors can affect the market, consider this simplified example. An asset is valued at 100, and five hedge funds have set five different stop loss levels.

    Fund A: 99 (1% loss)

    Fund B: 98 (2%)

    Fund C: 97 (3%)

    Fund D: 96 (4%)

    Fund E: 95 (5%)

    Then, the market experiences a shock that triggers repricing, the asset is repriced at 99, and the stop loss for Fund A is triggered, automatically selling the stock. The selling then causes the price to fall to 98, setting off the stop loss of Fund B, which then causes the stock to fall further, trigger the stop loss for Fund C, and so on and so forth until it triggers Fund E’s stop loss. While this is a simplified example of what happens in real life, this is why leverage, margin calls, and stop losses can cause further market chaos after repricing. In this example of acceleration, automated stop losses exacerbate the initial repricing issue. These types of crashes are highly likely to happen again, given that leverage and stop loss algorithms are still used today. The next step after acceleration is transmission.

    STAGE THREE: Transmission
    Transmission is also known as “spillover” or “contagion,” and it occurs when these market disruptions spread to other unrelated markets. This causes these uncorrelated market to unexpectedly become correlated based on current conditions. An example of this can be seen in the 2008 stock market panic. Before this, the correlation between Japanese and US stocks was a low 0.37. When the US stock market bottomed at the height of the crisis, the two markets became perfectly correlated at 1.0. When considering why this may occur, it makes sense to look at this event in context. The 2008 US stock panic was caused by subprime mortgages, an issue that has absolutely nothing to do with Japan. However, because hedge funds needed cash to meet the margin calls, they sold their Japanese stocks for collateral, and the selling pressure and illiquidity of US stocks translated to Japanese stocks. Illiquidity can spread to markets all over the world, which leads to the next phase of the REACTION model: irrationality.

    STAGE FOUR: Irrationality

    After transmission, panic ensues across markets and people begin irrationally selling their assets for cash. The uncertainty of the market causes everyone to realize that their assets are not actually money, and they become desperate to secure all of their money. They don’t care about the long-term potential and relative value of their stock — they just want the certainty of cash. All of the selling drives prices lower, and it becomes a perpetuating cycle of panic.

    In recent panics, banks have worked with the government to figure out a way to give investors the money they seek through money market funds and making cash available through swap line and asset purchases. By infusing liquidity in the market, banks generally ease the panic, and this can stop the market crisis before it reaches the final stage of the REACTION model, Oblivion.
    The issue here is that this puts us in an extremely precarious position in the future. The Federal Reserve expanded its balance sheet to $4 trillion in order to ease the 2008 panic. This would be fine if they had somehow been able to normalize the balance sheet, but instead, it remains at $4 trillion. The other central banks are similarly overloaded, which means that during the next market panic, the re-liquefying will fall to the International Monetary Fund. The IMF will have to print trillions of dollars, which will result in high inflation and significantly decrease the value of the US dollar in the global market. Should this fail, it will lead to the freezing of all bank accounts and the closing markets, or the last stage of REACTION: Oblivion.

    STAGE FIVE: Oblivion

    Oblivion is a subjective term that essentially means a complete collapse. During Oblivion, the markets aren’t just crashing; the entire system no longer functions. In the worst case scenario, this would result in the extinction of the species.

    Smaller scale oblivion can be seen in capital market collapses throughout history, such as in 1933, when every bank in America was closed for eight days. While these collapses are not inevitable, they do happen, and could easily happen again with the right catalysts. While no one catalyst is likely to collapse the market, a combination of factors such as war, natural disaster, and social unrest could come together to start the next collapse.

    In the event of a collapse, the wealthy, who have both the most to lose and the greatest political resources, will respond with truncation, often freezing banks on a temporary basis. For the average investor, this will make no difference; once their money is lost, it is lost forever. Either result, whether the collapse of capital markets or the freezing of markets in response, has disastrous consequences for the average investor.

    REACTION Application

    Now that you have an understanding of the REACTION model, you can understand what happens during financial panics. Again, keep in mind that every market disruption does not lead to all five stages. Repricing occurs often, but can be recovered from should the markets adjust, or may experience acceleration, but never reach the point of transmission or irrationality. The point is not to assume that oblivion is inevitable, but that it could happen, and when you see signs of repricing, it is important to remain observant of the environment for potential collapse. By keeping this in mind, you can take steps to protect your financial well-being.

    At Meraglim™, our panel of experts have created models such as the REACTION model that put them at an advantage for accurately predicting movements within the global money market. Contact us to learn more about what we can do for you and your team.