1. The Importance of Big Data Analysis for Risk Management

    As technology evolves and becomes a more integral part of financial services, the amount of data available is growing significantly, and this has already begun to benefit the niche companies that have gotten on board. There are now many different opportunities for using big data in a variety of areas, particularly in the area of risk management. Thus far, big data has already contributed a lot to the development of risk management solutions, particularly in the world of finance. However, what has already been uncovered is only the tip of the iceberg; the many potential applications of big data for risk management is only now beginning to be fully realized.

    Big Data Definition

    Big data is defined as large amounts of data, as well as the use of this data in making decisions and managing processes. Financial institutions have long used internal data to accomplish this, but more and more external data is being used to manage financial risk. External data may be directly given to a financial institution, already prepared and organized, or they may collect the data themselves; for example, through social media.

    The Potential of Big Data

    Big data is capable of enhancing the quality of risk management models because of the increasing availability and diversity of statistics. Now, big data can be used to simulate a variety of scenarios in order to realize all of the potential risks, leading to faster reactions to developments within the market. Big data also allows financial institutions to identify fraud quicker and with more precision by comparing internal and external data.

    Beyond the risk management applications, big data can be applied to other areas in the world of finance. For example, big data provides far more ability to customize products through the use of location data, click streams, and social media analysis. This will enable financial institutions to better retain their client base, as well as attract new clientele. It is also worth noting that implementing the use of algorithms and big data to anticipate market exchanges has great potential.

    Current Big Data Success Stories

    Financial institutions are already in the process of implementing big data measures. One example of this can be see in Singapore’s UOB bank. It recently tested a risk management system that used big data to streamline the calculation of total-bank risk, reducing calculation time from 18 hours to mere minutes. In the future, stress tests can be carried out in real time, allowing quicker reactions to new risks. Another example of the successful implementation of big data for a financial institution is Morgan Stanley. The bank launched a big data program to better their analysis of their portfolio’s size and results. With technology that enables pattern recognition, this analysis is set to improve risk management significantly.

    Kreditech, a German business that offers credit scores for individuals, has also implemented a successful big data project. They use location data, social media analysis, online purchasing behavior, and web analysis for risk management. Similarly, American company Kabbage uses big data to analyze the risks of providing loans to corporate customers, using external data from social media and online delivery services. Finally, Paymint, a U.S. company that specializes in compliance, combats credit card fraud using big data analysis to recognize fraud patterns. Their big data software analyzes millions of transactions each month to manage risk.

    How to Successfully Use Big Data

    To successfully use big data for risk management, it’s prudent to implement a structured evolutionary approach in order to accommodate the broad scope of big data. First, internal data should be collected and used. After that, you will have a clearer idea of data sources that will benefit you, so you can go to external sources, provided the benefit outweighs the cost. More important than amount of data is an integrated process of analysis. Taking small steps towards implementing big data programs allows you to identify any weaknesses or areas of risk.

    The biggest obstacle to using big data is data protection, according to a recent study from the Fraunhofer Institute. Other obstacles include lack of knowledge, budgetary restrictions, lack of access to expertise, and prioritizing other programs first. There are also smaller technical problems, such as immature technology, that are a factor, but they are much easier to fix. The importance of big data in risk management will be fully realized once these hurdles are addressed by a skilled financial data analytics company.

    Conclusion

    In conclusion, the success of several financial service providers exemplifies the benefits big data can provide to risk management, but the full extent of how powerful this can be has not yet been realized. In order to get the full range of advantages big data analysis can provide you, it is wise to contract a financial data analytics company for assistance. At Meraglim™, we have both the expertise and risk assessment software necessary to provide comprehensive data analytics to manage risk. If you have questions about how Meraglim™ could help you, contact us today.


    Sources

    Big Data: Opportunities and Privacy Challenges – Fraunhofer Institute

    Big Data & Risk Management in Financial Markets – Francesco Corea

    Big Data: Potentials From a Risk Management Perspective – Banking Hub

    The Big Data Opportunity for Audit, Risk Management, and Compliance – John Verver

  2. Autonomous Vehicles: The New Normal in the Near Future

    There is a lot of buzz about driverless cars right now as automotive and technology companies have begun to roll out these autonomous vehicles. If you have been following the developments in self-driving cars, you are likely familiar with all the benefits that are touted by its advocates: fewer accidents, less congestion and pollution, improved land use, and more mobility for the disabled.1 Many people are quite excited for this technology, while others remain skeptical and fearful of it. Regardless of which side of the spectrum you fall on, the technology is fascinating and presents many possible applications that are important to consider. It is likely that in the near future, autonomous vehicles will be a part of our daily lives, so it is best to gain an understanding of how this new technological development could impact you.

    History and Development

    The first attempt at a driverless car was in 1925 by a man named Francis P. Houdina.2 Houdina toured the country that summer, demonstrating how his invention worked. The automobile, called the American Wonder, was controlled via radio by a driver who followed the driverless car in a separate vehicle. While Houdina continued to tour the car for several years, it had significant safety issues; at one point, it crashed into a car filled with cameramen. Therefore, it was never mass produced or sold commercially.

    After this, technology focused more on developing automatic highways rather than automatic cars. In 1956, GM introduced the concept of the Firebird II, a car that would be steered with an electric highway.3 This idea was taken a step further in 1959 by the Radio Corporation of America. A test model for this “highway of the future” was built in Princeton, NJ, which featured an electrical cable that warned the car of any obstructions ahead, which then triggered the car to either brake or switch lanes. The engineer behind this project, Vladimir Zworykin, believed that the widespread use of this technology would address the growing problem of automobile accidents in America, and anticipated these electric highways to become the norm within a decade or two. However, the infrastructure costs both in installation and maintenance stopped the project before it really began. In 1977, Japan’s Tsukuba Mechanical Engineering Lab released what was considered the first truly autonomous car.4 The vehicle worked using analog computer technology and two cameras for signal processing. It was able to drive up to 18.6 MPH with the help of an elevated rail.

    In the ‘80s, movies such as “Christine” and “Knight Rider” brought into the public eye the idea of an autonomous vehicle.5 Simultaneously, more research started being conducted into making driverless cars a reality. One research team at Bundeswehr University in Munich turned a van into a self-driving vehicle that they called the VaMoRs. At the same time, researchers at the Carnegie Mellon Robotics Institute started a line of robotic cards with the transformation of a panel van into an autonomous car. These projects required vans in order to hold all of the necessary equipment.

    In 2004, the Defense Advanced Research Projects Agency (DARPA) unveiled the Grand Challenge series, which is a competition that gives robotics departments at universities and robotics companies the opportunity to develop an autonomous vehicle.6 While DARPA is clearly concerned with this technology for military purposes, the technology that is coming out of this project are directly creating the commercial driverless cars that are being developed. Google has hired the best researchers to come out of the Grand Challenge series to develop the Google car.

    How They Work

    Current models of self-driving cars build on several features that are already used in driver-controlled cars. For example, developments in the ‘80s and ‘90s in vehicles focused on automation to enhance safety.7 An example of this is anti-lock brakes; while previously, the driver needed to pump the brakes to prevent them from locking, anti-lock brakes do the pumping for you. About a decade of the development of anti-lock brakes, automobile manufacturers took this technology a step further to create sensors that adding traction and stability control. These steps in safety development of standard cars represents the move towards driverless cars. Additionally, the evolution of other technologies has contributed to the development of autonomous vehicles.

    LiDAR

    Light Detection and Ranging (LiDAR) is a technology that autonomous vehicles use to create a three-dimensional map and detect hazards by using laser beams to determine the distance between the car and other objects.8 In the Google Car, a Velodyne 64-beam laser is mounted on the top of the car so it has an unobstructed, 360-degree view on a custom-built, rotating base.

    Radar

    While LiDAR works to accurately map surroundings, it is unable to monitor speed of surrounding vehicles. Therefore, autonomous vehicles also use bumper-mounted radar units for this purpose.9 Driverless cars are outfitted with two sensors on the front bumper and two on the back bumper, which send signals to the on-board processors to move out of the way or apply the brakes. Radar technology works with other technologies in the car, such as gyroscopes, a wheel encoder, and inertial measurement units, in order to help the car make informed decisions to avoid crashes.

    Cameras

    The cameras used in the different models of driverless cars vary, but cameras are commonly used.10 One example is that it is mounted to the exterior, allowing the car to get an overlapping view of its surroundings. Just as the human eye uses different overlapping images for peripheral vision, depth, and dimensionality, the driverless car uses multiple cameras to create a complete image. The camera has a 50-degree view up to 30 meters. Cameras are just one piece of the puzzle that is a driverless car; if they were to malfunction, the car could still work.

    Sonar

    Some prototypes of autonomous vehicles also include sonar technology.11 Sonar technology has some disadvantages when compared to LiDAR and radar technologies; namely, it has a narrow field of view and a short effective range. What sonar technology truly adds is a redundancy that allows the car to cross-reference multiple sources of data to make its decisions.

    GPS

    In order to get anywhere, autonomous vehicles require advanced positioning systems to keep on course and to route to its destination.12 In the case of the Google Car, it uses Google Maps, GPS satellites, a wheel encoder, and inertial measurement units to maintain correct driving speed and route the car. Using real-time data from the cameras combined with GPS, the system can determine the speed of cars surrounding it, while correcting for things like construction or traffic.

    Advanced Software

    The software required to power driverless cars is quite impressive. Using all the data that it acquires from the sensors, cameras, and GPS, this software create algorithms to make its important decisions.13 The car is hardwired to respond in certain ways, such as stopping at a stop sign, but many responses are learned from experience. Every time a self-driving car is used, it learned more solutions that can be used in different situations, just like a human driver. This software also processes the data of other cars in order to learn.

    Military Applications

    Like many forms of technology, autonomous vehicles as we know them today developed out of military research. In 2016, the U.S. Army began testing self-driving vehicles, part of a long-term plan to implement driverless technology in the battlefield.14 First, they tested semi-autonomous trucks in Michigan, driving as a convoy over the course of seven miles.15 A three-phase pilot program is run by the Army Tank Automotive Research, Development and Engineering Center (TARFEC) out of Fort Bragg, NC.16 The vehicles are essentially autonomous golf carts which are used to pick up injured soldiers at the barracks and take them to the medical center, which is about a half-mile distance. One goal of this project is to cut military costs; as appointments at the medical center are quite expensive, if a soldier fails to show up, it is a huge cost. The hope is that by providing this transportation, they will cut down on missed appointments.

    A more military important goal for this technology is to improve safety for soldiers.17 Driverless technology could enable the military to send supplies into dangerous areas without putting soldiers at risk. By removing the need to have soldiers drive convoy vehicles, they are removed from roads that potentially contain IEDs. Additionally, the implementation of driverless cars could speed the deployment process, allowing freight trucks to move at maximum efficiency in large platoons without the concern of human error. Additionally, the military uses autonomous helicopters to carry cargo to risky areas in which a human would be unable to safely and efficiently deploy.18 Between 2011 and 2014, these autonomous helicopters carried more than 4.5 pounds of cargo throughout thousands of missions in Afghanistan.

    Commercial Applications

    There are currently several automobile and technology companies developing self-driving cars. Last October, Tesla announced that it would begin equipping their cars with technology that would eventually allow them to become completely autonomous.19 GM has announced that within a year, it will be testing self-driving electric taxis with Lyft.20 Uber currently has 100 driverless cars in use in Pittsburgh, which are free as they are only part of a test at the moment.21 Additionally, a Singapore-based company called nuTonomy is testing a self-driving taxi service. Other automobile companies that are currently looking into driverless cars include Ford, Volvo, Honda, and Fiat.22

    Everyone has heard of the Google Car, and currently, it looks as though it is well on its way to be commercialized; Google recently created a new company named Wayno, indicating that it is past the research phase and it now ready to release the car on the market.23 Meanwhile, it seems Apple’s efforts to create their own self-driving vehicle is being downgraded in light of lack of progress and the success of other companies.24 Clearly, the market of driverless cars is quickly developing, with some saying that they could be commonly used on the road by 2025. The eminence of this change is demonstrated by the United States Department of Transportation, which released the Federal Automated Vehicles Policy as a guideline for automakers.25

    What’s Next

    Given the speed with which this technology is now developing, we can expect to see more and more autonomous vehicles come to the commercial market within the next 10 years.26 Beyond cars, we will see many other autonomous transportation. Most intriguingly, Rolls-Royce is currently developing autonomous vessels under a project called Advanced Autonomous Waterborne Applications.27 This has fascinating implications for the maritime industry. Robotic ships could make cargo shipping safer, more efficient, and less expensive.28 Not only would it reduce accidents, it would also reduce the threat of piracy, because the ship could not be overtaken by any intruders. Additionally, with no need to accommodate a crew, these ships would have larger capacity for shipping, and make the ships lighter with fewer operating costs. This would also solve the issue of fewer and fewer people having maritime skills as seafaring becomes less and less attractive for work; instead, people with mechanical and electrical skills would be required more than people who could steer ships. Given how advantageous autonomous vessels could be, it is likely that by 2025, self-steering ships will be commercially used.

    The technology behind autonomous vehicles will certainly have a dramatic impact in the coming years. In as little as a decade, we can expect the market to be saturated with self-driving cars. As with all new technology, there will be advantages and disadvantages, but one thing is for certain: autonomous vehicles will be revolutionary.

    Further Reading

    Interested in learning more about the technology and future of autonomous vehicles? Read the links below for more information.

    How Lidar Works – Lidar-uk.com
    When Cars Drive Themselves – New York Times
    Auto Correct – The New Yorker
    The Ethics of Autonomous Cars – The Atlantic
    Autonomous Vehicle Technology: A Guide for Policymakers – Rand Corporation
    How Will Self-Driving Cars Change Cities? – Slate
    Forget Autonomous Cars – Autonomous Ships Are Almost Here – IEEE Spectrum


    1. http://www.rand.org/pubs/research_reports/RR443-2.html
    2. https://www.engadget.com/gallery/self-driving-cars/#gallery=312063&slide=3580756&index=0
    3. http://spectrum.ieee.org/geek-life/history/selfdriving-cars-were-just-around-the-cornerin-1960
    4. https://www.wired.com/2012/02/autonomous-vehicle-history/
    5. https://www.theatlantic.com/magazine/archive/2014/11/the-secret-history-of-the-robot-car/380791/
    6. http://www.darpa.mil/news-events/2014-03-13
    7. http://auto.howstuffworks.com/under-the-hood/trends-innovations/driverless-car2.htm
    8. http://www.lidar-uk.com/how-lidar-works/
    9. http://www.makeuseof.com/tag/how-self-driving-cars-work-the-nuts-and-bolts-behind-googles-autonomous-car-program/
    10. https://www.nytimes.com/interactive/2016/12/14/technology/how-self-driving-cars-work.html?_r=0
    11. http://spectrum.ieee.org/cars-that-think/transportation/self-driving/teslas-model-s-will-offer-360degree-sonar
    12. https://www.2025ad.com/in-the-news/news/driverless-cars-gps-systems/
    13. https://www.technologyreview.com/s/601910/oxboticas-new-autonomous-vehicle-software-learns-as-it-goes/
    14. https://www.trafficsafetystore.com/blog/military-testing-autonomous-vehicles/
    15. https://www.wired.com/2016/07/armys-self-driving-trucks-hit-highway-prepare-battle/
    16. http://www.autonews.com/article/20160822/OEM06/308229999/army-develops-autonomous-vehicles-for-use-on-bases-first-battlefields-
    17. https://www.forbes.com/sites/jeffmcmahon/2016/10/21/behind-teslas-headlines-the-military-drives-autonomous-vehicles/#7bc9d3f0247e
    18. https://www.wired.com/2014/11/militarys-self-flying-helicopter-gets-modded-fight-wildfires/
    19. https://www.nytimes.com/2016/10/20/business/tesla-autonomous-autopilot-vehicles.html
    20. https://www.wsj.com/articles/gm-lyft-to-test-self-driving-electric-taxis-1462460094
    21. http://www.slate.com/blogs/future_tense/2016/08/18/uber_driverless_cars_in_pittsburgh_actually_have_drivers.html
    22. https://www.nytimes.com/interactive/2016/12/14/technology/how-self-driving-cars-work.html?_r=0
    23. https://www.nytimes.com/2016/12/13/technology/google-parent-company-spins-off-waymo-self-driving-car-business.html
    24. https://www.nytimes.com/2016/09/10/technology/apple-is-said-to-be-rethinking-strategy-on-self-driving-cars.html
    25. https://www.transportation.gov/sites/dot.gov/files/docs/AV%20policy%20guidance%20PDF.pdf
    26. http://www.driverless-future.com/?page_id=384
    27. http://www.rolls-royce.com/~/media/Files/R/Rolls-Royce/documents/customers/marine/ship-intel/rr-ship-intel-aawa-8pg.pdf
    28. http://spectrum.ieee.org/transportation/marine/forget-autonomous-cars-autonomous-ships-are-almost-here
  3. The Fragility of China’s Economy

    In the current global landscape, China teeters on the edge of financial collapse.1 Between current foreign military pressures and their domestic economic insecurity, they remain in a precarious position, set to be crushed by these two opposing forces. Currently, foreign military issues can be traced to their expansion into the South China Sea.

    South China Sea

    Much of the foreign military pressure on China comes from their recent actions in the South China Sea. In recent years, China has acquired 90 percent of the South China Sea, creating artificial islands using dredging equipment.2 This is much to the distaste of their neighbors who have competing claims. In 2016, it was discovered that China was using these artificial islands for military purposes. While this is hardly a surprise, it does bring to question exactly how helpful these territories will be for their military strategy.

    Starting in 2009, China began their efforts to militarize the South China Sea by submitting a map to the UN with the (now infamous) Nine-Dash Line, boundary dashes across the South China Sea that declared it the territory of China. Since that time, China has expanded a minimum of seven different reefs and islets by using sand from the ocean floor, include Mischief Reef, Hughes Reef, Subi Reef, Johnson Reef, Fiery Cross Reef, Cuarteron Reef, and Gaven Reef. They have created more than 3,200 acres of land, according to the Asia Maritime Transparency Initiative.3

    At first, China claimed to be using the South China Sea for non-military purposes, such as humanitarian aid and scientific research, yet several of these islands are now home to airfields, antiaircraft/antimissile guns, and naval guns. For example, Cuarteron Reef has a High Frequency radar for detecting aircrafts, which is hard to claim for “peaceful purposes”. On Woody Island, they have installed HQ-9 long-range missiles.

    When considering former leader Hu Jintao’s movement towards “peaceful rise,” this clear territorial grab seems out of character.4 These actions have alienated their neighbors and brought in other powers such as India, Japan, and the US. A theory to rise out of these actions is that leadership decided that it was worth the potential diplomatic trouble to have a secure sea-based deterrent bastion.

    This echoes the Soviet Union’s actions during the Cold War, when their missile submarines were operated from “bastions” in the Barents Sea and Sea of Okhotsk. This made it so that Soviet missile submarines could be covered by land-based and naval forces in the event of enemy attacks.

    China’s land- and sea-based missile rely upon four Jin-class submarines. It is China’s belief that the US’s ballistic-missile defense are a threat to the credibility of their nuclear deterrent, which makes these protective bastions in the South China Sea much more important. Due to China’s geography, there is essentially one ocean for their bastion. The Northern Pacific is out due to the U.S. Navy and the Japan Maritime Self-Defense Force. In contrast, the South China Sea is bordered by countries that are no threat to China’s nuclear missile submarines.

    By installing a permanent presence in the South China Sea, China’s regional dominance is unquestionable. It also allows for China to install a permanent sensor system. Further construction will most certainly lead to complete defense against any submarine warfare against China’s sea-based nuclear weapons. They will also likely develop more surface-to-air weapons and land-based antiship missiles to, at the very least, protect their current military installations. Heavier defenses are being justified due to freedom-of-navigation operations the US and other allies.

    This shows the main weakness to China’s series of islands; there is only so long they can be defended. While ships can move, islands cannot. An island cannot be stocked with enough weaponry, food, water, and electricity to be a viable defense outpost. Islands’ inability to defend themselves is exemplified by Iwo Jima and Okinawa. Should a military confrontation arise between China and the US in the South China Sea, China’s at-sea outposts would have to be rolled back quickly in response to missile attacks and airstrikes, which would strand People’s Liberation Army Navy personnel on the island. The way China would respond to such an attack is an important question to be considered, as this victory could actually be a dangerous turn of events. While these islands offer strategic value, as a defensive solution, they are prone to destruction in the event of war. These military islands are a violation of China’s agreement to not militarize the sea, which is why it is of such concern to foreign militaries.5 This tension is putting more pressure on China’s economy.

    fragility_china_blog_innerimageDomestic Economic Health

    China’s economy is not only in peril due to foreign military pressures, but their own domestic economic well-being. Increasingly, central bankers fear a systemic collapse of China’s market. Their fears stand to reason: before the 2008 financial crisis, their debt-to-GDP ratio was 147 percent; now, it is at about 250 percent. Quietly, Chinese leadership has begun to lower growth expectations. While the official growth rate given was 7.5 percent, privately, the government believes that 6.5 percent is more realistic over the next year.6

    The methodology used to calculate this figure is not publicly known, but it uses economic data that can be manipulated to make it appear that they have more success with their economic plans than is true. What components are used to determine GDP are shifted between quarters, and the aggregate numbers are often built upon inaccurate or intentionally manipulated data.

    There are other metrics by which to analyze economic growth, such as through the ISM manufacturing index, which many countries use. The ISM can be somewhat unreliable, however, because the surveys upon which it is based may be inaccurate. Other indicators include coal, iron, cement, and copper inventories; though these can still be unreliable measures of growth. Recently, before taking his current position, Premier Li Keqiang suggested indicators such as electricity consumption and auto and excavator sales, indicating that this could be what China uses. However, these measures have actually recently seemed to suggest growth deceleration.

    Domestically, there is growing anxiety about China’s financial market as well. Local banks are failing to perform, with non-performing debt increasing. Non-bank financial institutions referred to as the “shadow banking system” are spreading, with little regulation or common understanding. There is so little regulation that meaningful data about these systems is difficult to come by. While two of these financial intermediaries have failed at this point, it’s hard to say how quickly or how many more may fail. While the government claims to be trying to better control this system, they seem to be having difficulty balancing regulation with the possibility of systemic collapse. There also seems to be a degree of corruption, with local government official tolerating and perhaps even encouraging sketchy practices by investors, such as hyperbolic assessment of assets and little documentation to prove their claims. Between this and short-term debts from foreign banks, the entire shadow banking system is threatened with collapse.

    Another Chinese economic issue is the real estate market. Commercial real estate bubbles are abundant, and residential real estate values have begun to fall. This threatens the possibility of social unrest, as many families begin to lose more and more money to this problem. As is typical with many countries, the Chinese government measures inflation by adjusting it downwards to conceal the impact it has on households.

    While China has been able to rapidly grow recently with global trade, the Lehman collapse plateaued world trade, hitting China where it hurt, as exports accounted for more than 40 percent of their GDP. While global trade did pick back up eventually, but more recently, as started to slow again, rising slower than world production rates when in the past, it grew twice as fast. With this slow growth, China is losing competitiveness in the market place. With the growth of the Chinese economy came the need for higher wages. In turn, China escalated their export products to a higher value, beginning to manufacture more technologically advanced and complicated products. In turn, quality suffered, which caused foreign markets to stray away from Chinese components. More and more, foreign manufacturers moved away from China in favor of other countries, such as Vietnam. China is no longer the place for overseas production; foreign companies only enter when they are targeting the domestic market. World trade growth continues to slow as the consequences of the 2008 financial crisis live on today. Therefore, China must focus more on building their domestic economy. With a shrinking population, the aged population with be responsible for more and more economic output. This will prove to be difficult, and only more so given the fractious nature of their government.

    A Fractious Regime

    From an outside perspective, the Chinese government seems unified and orderly. However, this is hardly the case. In the United States, we are aware of the competitive powers in place. In the two-party system, we often see tension between the people in power, particularly if we have a democratic president and a republican Congress or vice versa. Yet we often fail to recognize these tensions in foreign governments. In China, just as in the United States, different political groups hold different views on what policies should be put in place and how they should be enforced. This stands true even within the Politburo itself.7

    Currently, there are two separate factions within the Politburo that came out of Deng Tsao Ping’s death. These are the Shanghai bang, which is led by Jiang Zemin (former leader of China), and the Youth League Faction, led by Hu Jintao (another former leader). Xi Jinping, current leader, is of the Shangbai bang. However, once Jiang Zemin passes away, it could be that the Shangbai bang breaks into even more different segments. Two other political factors are the New Left (which emphasizes disciplined management) and the Princelings (sons of former Party leaders and their families).

    Bo Xilai, now disgraced, was a Princeling, and used this to create a network within the New Left as well as with military and state security leaders, as well as a political base within the Chongqing province.8 Currently, Xi Jinping is leading an effort to eliminate this power network by accusing those connected with it of corruption. Xi has reformed the Politburo, Central Committee, and Standing Committee as of this time. He has also started in on state security, going so far as to arrest former head Zhou Yongkang for corruption. Xi has also begun a reconfiguration of the PLA leadership, but this has proven to be tricky.

    The PLA is present in seven different military districts, the most power of which is the Shenyang district, which borders North Korea. The connection with the PLA, Bo Xilai, and Zhou Yongkang are quite strong in this region, and there are rumors that the generals are involved with North Korea. One way Xi has attempted to take greater power is by putting more of the military budget behind the Navy and Air Force, granting less money to the land-based military.

    Thus far, Xi’s leadership has not been tested to see how long it can be sustained. While efforts against corruption have been launched, it is not expected that all corruption will be removed. In reality, some parts of Chinese authority are likely to lose power, while others will gain more. Since Xi came to power, many wealthy Chinese people have anticipated moving their wealth abroad, as little has been known about how Xi’s power will come to affect them. This can be demonstrated by the elevated demand by Chinese residents for properties in cities all around the world, including New York, London, Toronto, and Sydney. Wealthy Chinese children are increasingly educated abroad and left to manage the family wealth overseas.

    fragility_china_blog_innerimage2Given the political turmoil, it is understandable why foreign central and private bankers are questioning whether the Chinese can handle reconfiguration of the financial market. The ability to make unified decisions is severely questioned by the fractured nature of the government. Bankers are apprehensive of China’s ability to navigate their bubble-ridden economy at the moment.

    At the moment, China’s number one goal is to prevent social unrest. There are greater efforts to unify China as a whole against their neighbors (in particular, Japan) so that its citizens feel loyal to their country against another. While China may be able to reform certain economic issues such as that of shadow banking, it is also likely that they will damage their foreign interests in the process.

    The fragility of China’s economy is important to understand given the current state of the global market. An understanding of the big-picture impact of the turmoil of foreign economies is one of the many ways our team of experts at Meraglim™ can help you understand what actions to take within the global market. If you need financial data analytics, we can help with our experienced staff and unique risk assessment software. Contact us today to learn more.


    1. http://www.tradingeconomics.com/china/gdp-growth-annual
    2. http://nationalinterest.org/blog/the-buzz/what-makes-chinas-fake-island-military-bases-the-south-china-19399
    3. https://amti.csis.org/long-term-strategy-scs/
    4. http://nationalinterest.org/feature/the-real-reason-chinas-massive-military-buildup-12502
    5. http://thediplomat.com/2017/01/the-civilization-of-chinas-military-presence-in-the-south-china-sea/
    6. http://www.sldinfo.com/chinese-economic-difficulties-exploiting-global-tensions/
    7. http://www.strategicstudiesinstitute.army.mil/pdffiles/PUB995.pdf
    8. https://muse.jhu.edu/book/1385
  4. How to Invest in Gold

    dreamstime_xxl_18339679Gold is the categorical dollar hedge investment. To counter the falling dollar, the best course of action is to invest in gold, whether you invest directly in the metal itself, purchase gold mining stock, or choose mutual funds. As the dollar falls, gold rises. The American blue chip industry cannot compete in the global economy anymore. Gold will be the key to growth. Even if we do not return to the gold standard, the value of gold has always been high (as you can see by reading our History of Gold post), and this will not change. Therefore, it is in your best interest to invest in gold now. Fortunately, there are several different ways you can invest in gold, which we will outline below.1

    Direct Ownership

    The gold bullion is pure value. This can be seen by man’s relationship with gold throughout the centuries. This can be demonstrated by ancient Egyptian civilizations that buried mountains of gold with their pharaohs as they believe it would be necessary to use in the afterlife. Gold has started many wars, and we can see people’s desperation for this precious resource by the conditions endured during the Gold Rushes. This stands to reason, as gold is far more valuable than paper money could ever be. Gold cannot be controlled by governments the way paper money can; hence why governments go off the gold standard.

    The value of gold rises based on the simple economic principle of supply and demand, regardless of policy around interest rates or the manipulation of paper money. The one significant disadvantage of gold is that there is wide spread between bid and ask prices, so you cannot expect a quick profit. You will buy it at retail price and sell it at a wholesale price, so the jump between these needs to be significantly even just to break even. That is why gold should not be seen as speculative asset; instead, consider it a defense asset to hold value. As your dollars will fall in value, gold allows you to preserve value. To own gold directly, it best to invest in minted coins, such as Canadian Maple Leafs, American Eagles, or South African Krugerrands.

    dreamstime_l_27669109Gold Exchange Funds

    Another way to invest in gold is a gold exchange traded fund (ETF). ETFs are kind of mutual fund that trade on the stock exchange; the portfolio is fixed and won’t change. So gold ETFs are composed solely of gold bullions as the asset. There are two ETFs in the U.S.; “GLD” (SPDR Gold Trust) and “IAU” (the iShares COMEX Gold Trust). Either is a sensible option for holding gold.

    Gold Mutual Funds

    Gold mutual funds are a sensible alternative for holding gold bullions for those who hesitate to invest in physical gold. Gold mutual funds hold stocks in companies that mine for gold. An example of this is Newmont Mining (NEM), a well-capitalized company with a good track record for making a profit. This is an example of a senior gold stock, which is invested in a company that owns well-established mines that produce a fair amount of gold every year. This is a more conservative play than investing in newer gold companies.

    Junior Gold Stocks

    Junior gold stocks are more uncertain than senior gold stocks. They are in companies that have less productive mines or may be exploring, which can lead toa large profit, but presents a greater risk. These stocks are best for investors with a wider risk tolerance, and who can accept potential losses for possible major gains.

    Gold Options and Futures

    Options may be the right move for seasoned investors. They allow you to speculate gold prices. In the options market, you can make guesses for movements in either direction. Buying a call means you will hope prices rise. A call fixes the purchase price; the higher that price goes, the larger the margin between your option price and the current market price. On the other hand, when you purchase a put, you anticipate the price falling.

    Buying options is a risky way to invest; most people fail. About 75 percent of all options bought are worthless. This is a complex market that requires vast knowledge. There are two primary traits of an option, one that is positive and one that is negative. The positive trait is that investors are able to control their large investment using a small amount of money. The negative trait is that options expire after a certain amount of time. As the expiration date comes closer, the time value of the option vanishes. For the majority of investors, the futures market is out of their league. Even experienced investors see how high risk the futures market is. Large profits can be made, but can be lost almost instantly.

    We don’t know when the dollar will collapse, or how long it will take. We just know that it will happen. After years of mismanaged monetary policy by the Federal Reserve, there is no question of its inevitability. The removal of the U.S. dollar from the gold standard has had a long-term impact. Nixon saw this as a way to solve the economic issues of the time, but as a result, we see ever-growing debt, trade deficits, and endless money-printing creating a credit-centered economy. Taking a broad view of the global economic market, an investor can see that problems are inevitable. We have delayed this trouble slightly due to China’s parallel economic troubles.

    China has built debt upon the troubled U.S. dollar, bringing with it other Asian economies. The fall of the dollar will be a major issue for not just the U.S., but many other countries with it. To offset this, commodities are a logical choice, such as oil, and yes, of course, gold.

    This exemplifies the ironically predictable pattern of monetary policy. Governments will overprint money, destroying their currency. Then, they will go back to gold, going through much expense and suffering. At this moment, we are at the precipice of another collapse, as poorly planned monetary policy fails us. However, we do not have to wait for the dollar to collapse. Respond today. By being proactive now, investors can anticipate this collapse by investing in tangible assets that will hold value regardless of what happens to the U.S. monetary system.

    Currency is not valuable in itself. It is essentially an IOU that today holds no real value. Once the national credit limit is reached, monetary policy will have to be changed, and investors will lose. Investors who hold stock in goods with a tangible value will be the ones who benefit. The key is starting from a good position before this collapse.

  5. Why We Use Team Science

    At Meraglim™, our team is composed of top-level leaders from a variety of industries, including defense, capital markets, intelligence, science, and the private sector. Our seemingly related disciplines come together to form one of the greatest strengths we can offer our clients: effective team science. In the world of science, as technology has advanced and enabled us to work more collaboratively, the benefits of pulling knowledge of different people from different fields are well-known. Today, most scientific articles are written by six to 10 individual scientists from several different institutions. We have all benefited from this new standard, as many scientific breakthroughs have occurred due to team science that otherwise would not be possible; for example, the development of antiretroviral AIDS medications would not have occurred without team science. Naturally, there are some challenges with this model as well. When working collaboratively, communication is king; team science fails when communication does. At Meraglim™, we pride ourselves on having effective communication skills to provide financial data analytics that take a global perspective.

    Challenges

    A recent study by the National Research Council identified seven primary challenges to team science, which we have outlined below.

    meraglim_blog_innerimageMembership diversity

    To address larger issues, it requires the contribution of the minds from many different backgrounds, disciplines, and communities. For certain groups, this may cause communication issues and difficulty identifying specific goals. The diversity of team members requires members to meet each other where they are, which isn’t easy on all teams.

    Knowledge integration

    As each member brings their own unique knowledge base into the equation, there may be a lack of common ground. Particularly for transdisciplinary teams, this can be difficult as integrating different tools from a variety of areas can be less seamless than desired. While some team members are extremely literate in one theory or model, other team members may need to start from scratch learning these concepts. This can slow progress and frustrate the team.

    Size

    When it comes to team science, the size of the team matters. The larger the team, the more difficult it is to coordinate all of the moving parts. Over the past 60 years, the size of groups have expanded, increasing with it the burden of coordinating tasks and communicating. While larger groups can potentially enhance productivity by distributing small tasks more evenly among group members, it can also inhibit the level of trust and intimacy developed by the group.

    Goal alignment

    Or rather, misalignment. If team members do not share a common goal, the clarity of the project comes into question. Even if the team does share a common goal, the members may have their own, separate goals as well. This can create conflict and requires proactive management.

    Permeable boundaries

    As the project moves forward, goals may change over time, which can be see in the permeable boundaries of the team. These changes can benefit the team with additional knowledge to address any problems, it can cause disagreement within the team.

    Geography

    Team science often requires working with team members who are dispersed all over the country or world. This can present some logistical challenges, such as greater dependency on technology to communicate, working across time zones, and managing cultural expectations.

    Task interdependence

    In team science, the members are dependent on one another to accomplish tasks. Because the goal is working collaboratively, every member must contribute in a timely manner and be willing to work cooperatively. Task interdependence can often cause conflict, and may require more effort in coordinating and communicating.

    meraglim_science_blog_innerimageThe value

    Despite its challenges, team science is incredibly valuable and worth the effort to overcome these obstacles. In the world of science, individuals still contribute critical discoveries to the field, as exemplified by Stephen Hawking’s work. However, more and more, collaborative research is becoming the norm. This can be seen in research into team science, which shows that group publications are more widely cited. Additionally, groups are more likely to expand upon previous research to create new ideas that have a lasting impact. A couple of studies exemplify this point: in 2012, one transdisciplinary study on tobacco use was more widely published and received more funding than smaller, similar projects. Additionally, one 2014 study looked into the effectiveness of team science by mapping the publications from transdisciplinary research centers and found that these resources spread exponentially across different disciplines. More and more, scientists are finding that team science produces more reliable and reputable results, which has led to more funding and higher publication rates for team science efforts. Given the obvious value of team science, Meraglim™ has adopted the principles behind it to ensure that our product offers the most comprehensive information to help our clients make informed decisions.

    The Science of Team Science

    Team science is complex in the sense that it has many dimensions to it. It occurs in so many different contexts that it is hard to study it in a quantifiable way. Therefore, a new field, the science of team science, has emerged to gain more knowledge about how to make team science more effective and support the current evidence that this an effective method to problem-solving and research. Team science scientists are concerned with the following:

    • A diverse range of units of analysis in order to promote team science,
    • An understanding of the structure of collaboration throughout a range of contexts,
    • An understanding of the potential of team science,
    • An understanding of the challenges facing team science,
    • An established criteria for evaluating the outcomes and processes of team science, and
    • The educational and scientific goals of team science.

    As the intricacies of team science develop further, more and more contexts will adopt team science as their primary method. Though we are not directly involved in the scientific community, we apply these principles to our work to ensure the maximum results for your goals.

    At Meraglim™, we have brought together a team with common goals, cohesion, and expertise is a wide knowledge base. We can help your team with financial data analytics. Contact us today to learn more.

  6. A Brief History of Gold

    Gold has a unique place in both human history and the modern global economy. No other metal parallels gold in terms of its influence on humankind. It has been used in virtually every civilization as currency throughout time and all over the globe. So what it is it about gold that makes it so valuable? Why has it endured for thousands of years with no signs of stopping? In this blog, we will first take a look into the practical reasons why gold makes sense as a currency, and then we will delve into the rich history of gold for a greater understanding of its relevance to the global economy today. Then, we will look towards the future, and what it means for you and your team.

    abriefhistoryofgold-blogimg1

    Practical Reasons

    First, consider these practical reasons why gold makes sense as a currency.

    It’s portable

    Consider carrying around a drum of oil to exchange for goods. Doesn’t make much sense, does it? Gold, on the other hand, while heavy, is extremely portable in the form of coins. In the past, you could put your entire wealth in a bag and carry it with you in the event of migration or a disaster.

    It lasts

    Gold is an inert metal that does not corrode or rust. This means that its value lasts for years to come. Families could pass their wealth from generation to generation without fear of it losing value. Imagine doing the same with paper money, which deteriorates and changes over time.

    Easy to spot counterfeiting

    You can trust gold because testing its purity is quite easy and inexpensive. In contrast, trying to test if a foreign note is counterfeit is a lot less simple.

    It’s stable

    Gold supplies are stable and have been for centuries. It is not likely that new gold mines will be discovered. While it’s easy to print more paper currency, debasing its value, the same cannot be done with gold. Only about 2,000 tons of gold are made each year.

    It’s liquid

    Gold is single grade, thus, singly priced. This translates to it being highly liquid. There is a variety of grades of oil and diamonds, for example, making them more difficult to trade.

    It’s universal

    All over the world, gold is recognized as currency, making it extremely flexible and easy to trade globally.

    It has few industrial uses

    While other metals such as platinum have many industrial uses, gold holds little value in this area. Therefore, by using gold as currency, countries are not taking valuable industrial materials away.

    Beyond the purely practical reasons for gold’s predominance as currency, it also has a long, storied history.
    When you look at gold’s history as currency, you can have a greater understanding of why this precious metal has remained so precious, still dictates our economy to this day, and will continue to for years and years to come.

    abriefhistoryofgold-blogimg2

    History

    Ancient civilizations

    Gold has fascinated humankind since the beginning of recorded history. Though the first instance of human interaction with gold is unknown, gold flakes have been found in Paleolithic caves, dating its use back as far as 40,000 B.C. Gold has been mentioned in ancient texts all throughout time and throughout the world, indicating the the first humans to interact with this precious metal were just as fascinated with it as we are today.

    Ancient Egypt

    The first evidence of humans finding gold was around 3,000 B.C. in ancient Egypt. Gold was present in much of Egyptian mythology, and was heavily revered by the pharaohs and priests. This is demonstrated by the fact that the Pyramids of Giza feature solid gold capstones.

    Ancient Egyptians were also the first to produce a currency exchange ratio between gold and silver. One piece of gold was equivalent to 2.5 pieces of silver. This is the first scale that demonstrated silver’s lower value to gold.

    Egyptians also used gold maps that revealed where gold mines and gold deposits were around the kingdom of Egypt. Some still survive today.

    Though gold was revered, it was never used for bartering. Instead, they used crops such as barley to act as money. The first civilization to use gold as currency was the Kingdom of Lydia in around 500 B.C., which is in present-day Turkey.

    Ancient Greece

    Later, ancient Greeks saw gold as a status symbol and proof of the glory to the gods and demigods. Mortals used gold to indicate their wealth, as it was used as currency. However, the gold medals of the Olympics is a modern tradition; this did not start with the Greeks.

    The Bible

    Evidence of gold’s ancient value is also evident in the Bible. In Genesis 2:10-12, the lands of Havilah is described as a place where good gold is found.

    Other ancient civilizations also used gold, such as the Incas and Aztecs. Gold was used during religious ceremonies and as a part of the architecture. One trend can be seen in the use of gold in all these ancient civilization: it was a status symbol that separated the classes. If you held gold, you held power.

    United States, 1792

    The modern history of gold was forever changed in 1792 when the United States adopted a gold and silver standard. Congress passed the Mint and Coinage Act, which set a fixed price of gold using U.S. dollars. With the passage of this act, silver and gold coins became legal tender.

    During this time, gold was 15 times the value of silver. Silver was for small purchases and gold was for larger denominations. The U.S. Mint was required to trade gold and silver at 15 parts silver to one part gold, which meant gold’s market value was relatively stable.

    This ratio changed after the Civil War. The United States was unable to pay its debts with silver or gold; therefore, they turned to paper money in 1862. This was the first time the US adopted a fiat currency (meaning it could not be converted at a fixed rate) as official currency.

    In 1873, with the passage of the Coinage Act, silver was removed from the Mint’s fixed rate system. This ended the silver dollar’s use, though small coins still contained small amounts of silver. Silver dollars were never adopted by the US again, and this was a hot political topic throughout the end of the 19th century. In 1900, the gold dollar was announced as the standard unit of account, and paper dollars issued represented the gold reserves.

    1870s gold rushes

    In the 1800s, gold rushes were prevalent. As one piece of gold could make you a millionaire, people from all over the country rushed to be the first to find some.

    Some important gold rushes include:

    • 1799, North Carolina: The first significant US gold rush occurred when a child found a 17-pound gold nugget in North Carolina in 1799.
    • 1848/49, California: Prospectors from all over the world came to San Francisco during this gold rush in 1848/49, hence the football team’s name, the 49ers. Before then, the population of San Francisco was 1,000; within two years, it exploded to 25,000.
    • 1896, Klondike: During this time, gold was discovered in British Columbia in the Klondike River. Prospectors fought against the bitterly cold climate in order to claim their fortune.
    • 1850s-1890s, Australia: Australia had several gold rushes after 1850, which helped to populate the desolate Outback. The existence of many towns still around today are due to the gold rushes that occurred during this time in New South Wales, Victoria, and later, in Western Australia.

    1944 – Bretton Woods Agreements

    World War I and World War II caused great chaos on the global economy, made worse by the Great Depression. After so much conflict, in 1944, the major world leaders came together for the Bretton Woods Agreements. This created the gold exchange standard, which fixed the price of gold according to the dollar. This new method gave the USA incredible power in the world market. The dollar was chosen because the US’s economy was the strongest after WWII. This is because the US did not have to repair infrastructure that had been destroyed during the war, unlike many European nations. This was the beginning of the US dollar as the economic power player it is in the global economy today. The price of gold was fixed at $35/ounce.

    1970s – End of the gold standard

    The gold standard collapsed with the Vietnam War. After this tumultuous war, the US economy was in shambles, causing President Nixon to end the Bretton Woods system in a move that is now known as the Nixon Shock.

    Between 1971 and 1976, attempts were made to save the gold standard, but the price rose and rose beyond any currency. As a result, gold pricing charts were created in the early 1970s. Between 1970 and ‘71, the price was rather flat, but jumped to a record high in 1980 at $800/ounce.

    Today

    Today, no world currency uses the gold standard. The last currency to use it was the Swiss Franc until it changed in 2000. However, most countries have a large gold reserve they use as defense for their currencies in the case of emergency.

    US gold reserves as held at Fort Knox in Kentucky, though the exact amount of gold is unknown by the general public. It is generally believed that the US has more gold than any other country.

    While investing in gold has always been considered wise, it saw a large surge in popularity after 1971 with the end of the Bretton Woods system. The price of gold was increased steadily since this time, but not on a straight upward trajectory. Like any investment, it has gone through ups and downs in recent history. It’s important to take any gold investment charts with a grain of salt, accounting for inflation; however, major spikes in gold prices have occurred in the last few decades; once in 1980, as stated above, as well as in 2011.

    2000s and 2010s

    Gold has changed over the last 20 years in a few major ways. In 1999, the price of gold dropped to $251.70, when rumors spread about the central world banks reducing their gold reserves and mining companies sold gold in forward markets.

    However, by 2003, gold was back on top with the US invasion of Iraq, as many saw gold as a safety net during this politically tumultuous time. The price of gold continued to elevate under these political pressures, and with the 2008 financial crisis, the price rose even more. It reached an all-time high in 2011 at $1,900/ounce, but has fallen since then. In 2015, the Federal Reserve hiked the interest rates slightly, which benefited gold throughout 2016, but tanked the stock market. With knowledge of our REACTION model that we discussed in a previous blog, you can see why the future looks bleak.

    The future

    In the near future, we can anticipate major issues with the US dollar, with inflation in some areas and deflation in others. As we remain balancing on the knife’s edge of global economic collapse, the Federal Reserve can no longer fall back on their tradition of rate-cutting. Economies around the world are not in a better position, so they will not be able to save the US economy either. Many of these countries will probably rely on SDRs to protect themselves; however, on an individual level, investing in gold will be the best way to protect yourself. With an understanding of financial data analytics, you can anticipate the movements in gold, investing strategically to ensure maximum benefits to you and your team.

    However, without an intimate and extensive knowledge of gold, there is little you can do. Fortunately, Meraglim™ provides the financial data analytics that institutional investors and global leaders need to anticipate changes in the global money market to their advantage. To find out if you could benefit from our services, contact us today.

  7. 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