Notes from Camp Kotok 2021

Brent Donnelly is a senior risk-taker and FX market maker, and has been trading foreign exchange sin

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  1. Great stuff Brent! As a former long time TradFi guy who fell down the crypto rabbit hole and went full time into crypto in 2017, and am now focused on DeFi, your note was very interesting. I agree with all of your points re: CBDC’s, the potential for ETH and DeFi to be completely revolutionary, etc. You gave some color that many in attendance were crypto haters, but I am curious what their arguments were against DeFi, for example. It seems to me that more and more former skeptics or haters - especially financial industry professionals who see how these products directly compete with their products - are having their ‘A-HA!’ moment when they see the actual utility and use cases of things like Compound and Aave, and realize that the narrative that crypto is just for "money launderers, drug dealers, tax evaders and terrorists’ is nonsense.

    But so many people still have not heard about DeFi, so have not had the chance yet to have their ‘A-HA’ moment. This summer I talked to family who are professional Millenials working at tech companies in Silicon Valley and who have known about and invested in Bitcoin for a few years, and NONE of them had heard anything about DeFi. This was very surprising to me, but is one data point that DeFi is still extremely niche. Of course that is potentially very bullish, as it indicates we are still far away from mainstream adoption (and its associated asset price impact). Did you change any skeptics minds over the weekend?

  2. Hey there… I think the remaining skeptics are mostly people that have very strong priors and are not Bayesian types , or people that have just never read about crypto and have a reflexive revulsion to the virtual world. To me, the “it’s not even real!” arguments are not very smart and ignore the inevitable transition from real to virtual that has been going on for years and has accelerated like mad with Fortnite and Ready Player One and Oculus etc. Seems to me most of the remaining minds are not going to be changed. It’s very particular to age with most extreme skeptics 50 years old ++

  3. Avatar for glarri glarri says:

    I see news reports of studies predicting that massive solar flares could take out the internet. I wonder how crypto currencies would react if the internet is out of action for a few months. Maybe there are scenarios where crypto wins, and scenarios where gold wins, and it would be wise to have some of each. Or maybe silver coins.

    Camp Kotok sounds like a really fun event. And DeFi is clearly something I need to learn more about.

    Thank you for the interesting article.

  4. Week 2 was pretty good, too. Bill Kenedy Co-Founder, CEO, and Chief Investment Officer of RiskBridge made his comments public, so I will share what he wrote.

    Camp Kotok
    August 19, 2021

    Camp Kotok is an invitation-only gathering of prominent economists, asset allocators, strategists, traders, bankers, scientists, policymakers, diplomats, and journalists. The event has taken place for 20 years in early August in the Downeast Lakes region of Maine near the Canadian border. It is a mash-up of an economics conference and adult summer camp with several days of fishing and fellowship.

    This year’s event was split into two separate weeks to accommodate serious COVID-19 health protocols. I missed friends who attended week one, but this year’s smaller gathering enabled lots of deep discussion and debate on many curious topics.

    Generally, each day starts with a question over breakfast, then two campers and a highly skilled guide spend five hours in a canoe chatting, solving world problems, and fishing (sometimes catching, too).

    discussions are held under Chatham House Rules, where participants are free to use the information received, but neither the identity nor the affiliation of the participant or speakers may be revealed without their express consent.

    Here are ten things I learned at this year’s Camp Kotok.

    1. What Happened to Modern Monetary Theory (MMT)?

    MMT argues that countries that issue their own currencies can never “run out of money” the way people or businesses can. MMT dominated the 2019 Camp Kotok discussion and investors’ imaginations with a view that monetary policy was transitioning from “Q.E. for the banks to Q.E. for the people.” This year it was as if the campers forgot how to spell MMT. The topic disappeared like a fish on a hot August afternoon.

    It’s unclear whether MMT has been debunked (“it’s neither modern nor a theory”) or if the MMT narrative took a back seat to the pandemic. Perhaps unprecedented monetary and fiscal stimulus in response to the Great Lockdown is MMT-in-disguise?

    Key Takeaway: We have short memories, and it is still hard to make sense of economic data post the Great Lockdown.

    1. Will the World Ever Be the Same?

    A common topic was whether rising wages, tech regulation, and ESG investing (environmental, social, and governance) turn the tide in how we split the spoils of capitalism between capital and labor.

    Prior assumptions about the workplace (9-5 office hours, 1 ½ hour one-way train commutes), the labor force (hospitality workers are replaceable, universities are producing more capitalists), and the global order (nationalism vs. globalism) are up for reexamination.

    There was debate whether the U.S. university system is the best in the world or a house built on sand (interdependencies with student debt and international student enrollment). The average size of a U.S. student loan is $38,000. Total U.S. student loan debt outstanding is $1.7 trillion.

    Most colleges and universities are seeing a steep decline in applications from students from China due to COVID-19 and U.S. visa restrictions. It is a massive enterprise risk management dilemma for schools taking a serious hit to revenue.

    Key Takeaway: Uncertainty prevails. We won’t know what the future holds until we get there.

    1. Cold War II: U.S./China

    Experts suggest Wall Street is now falling in line with Washington D.C.'s stricter stance on China. This has important implications for investing in emerging markets (E.M.). It’s unclear if the 13% decline in emerging market stocks since February has fully priced in Cold War II.

    What does a terrorist-led Afghanistan mean for China’s Belt and Road initiative? The biggest project of China’s Belt and Road Initiative is the China-Pakistan Economic Corridor (CPEC). The CPEC has come into question with growing attacks targeting Chinese workers by Pakistan and Afghanistan-based Taliban. With the U.S. military presence removed, China’s business plans in the region have plunged into uncertainty.

    Key Takeaway: Regime change is messy. We believe China has exchanged one unpredictable regime (U.S.) with another (Taliban).

    1. Transitory versus Persistent

    A majority of campers surveyed said inflation would persist, but only two said they expect the Fed to raise policy rates before year-end.

    The persistent-nistas argued that permanent shifts in global supply chains and demographics would lead to a permanent change to supply and demand curves, leading to higher inflation.

    Transitory-nados argued that the world economy “only opens up once.” Lumber, plywood, steel, used cars, hotels, and airfares account for less than 10% of the CPI basket, and recent price spikes have already fallen back to earth.

    Extreme weather is damaging the global crop supply. Watch for rising food prices.

    One creative comment was that inflation might be both transitory and persistent. If one loses their job, this is likely to induce both a transitory shock (temporary loss of earnings) and a persistent effect (a new job may come at lower wages, fewer benefits, or a requirement to relocate).

    Key Takeaway: Inflation may be both transitory and persistent.

    1. Arranging the (FOMC) Deck Chairs

    In consultation with the Treasury Department, the President has to decide whether to reappoint or replace the Fed’s FOMC chair (Powell) and two vice-chairs (Clarida and Quarles) when their terms expire. Vice Chair Quarles’s term expires in October 2021, Chair Powell’s in February 2022, and Vice Chair Clarida’s in September 2022.

    Someone quipped Chair Powell’s reign might be more transitory than inflation. There’s speculation whether he will be renominated. Personalities and politics sometimes get in the way of rational decision-making.

    It seems there can be no decision on tapering the Fed’s balance sheet purchases before a decision is made on the new FOMC chair (Sep/Oct) and until after the mid-term elections (Nov 2022).

    Key Takeaway: Taper talk has elements of Kabuki theater. Fed action requires Fed leadership. Delayed tapering or changing the FOMC guard would likely catalyze a spike in market volatility.

    1. “2 plus 2”

    An entire generation of economists, portfolio managers, and investors have only experienced 2% real U.S. GDP growth and 2% U.S. inflation (2 plus 2). This year, the configuration is expected to be 7% real U.S. GDP growth and 3% U.S. inflation or “7 plus 3”. Will the post-pandemic economy revert to “2 plus 2,” or will it have some new configuration? How will markets respond if growth is low or inflation higher?

    RiskBridge anticipates the U.S. economic glide path over the next couple of years to be something like “2.0 plus 3.5”.

    Key Takeaway: Our view is that the transition away from the unusual “7 plus 3” will be bumpy as capital market flows and valuations adjust. We are adjusting investment portfolios to prepare for below-trend growth and above-trend inflation.

    1. Second Chance Hiring

    The Second Chance Business Coalition includes 36 major U.S. companies committed to expanding employment opportunities and greater upward mobility for people with criminal records. For example, JPMorgan Chase boosted its commitment to giving people with criminal backgrounds across the U.S. a second chance by supporting their reentry into the workforce. The bank hired about 2,100 people with criminal backgrounds in 2020.

    Nearly 78 million Americans have a criminal record, and roughly 5 million have been formerly incarcerated. The unemployment rate for the formerly incarcerated cohort is 27%.

    The U.S. spends an estimated $182 billion annually to incarcerate 2.3 million people in the U.S. prison and correctional system. Of that population, 1.3 million are in state prisons, 631,000 in local jails, and 226,000 in federal prison (the rest are in other programs). Half of the $182 billion goes to paying staff.

    The average public defender handles an average of 400 cases at any one time.

    For local jails, 470,000 of the 631,000 (74%) of those locked up are held before trial or have not made bail. Pre-trial detention costs $13.6 billion annually.

    Key Takeaway: GDP growth = labor force growth + productivity growth. The U.S. labor force annual growth rate is expected to average 0.5%, a slower pace than in recent decades due to slower population growth, aging Boomers, and declining labor force participation. Second Chance hiring alone won’t solve our macro problems, but it might help. So, too, would better education (see “Will the World Ever Be the Same?”)

    1. Arctic Blast

    Earth’s climate has permanently changed naturally, but the recent rise and rate of change in global temperatures are unusual. Recent warming has reversed a slow, long-term cooling trend. The evidence rests on improved data collection methods, measured changes in the atmosphere, ocean, cryosphere, and biosphere, along with observed frequency and severity of heatwaves, droughts, wildfires, heavy rainfall, tropical cyclones, and the number of named tropical storms.

    The Gulf Stream influences weather patterns from the east coast of the U.S. to the west coast of Europe and has slowed by roughly a third since 1950, preventing storms and weather patterns from moving on and dissipating.

    In recent years, large swaths of the Arctic have become ice-free. Arctic landmass is controlled by Russia (45%), Canada (25%), and the U.S. (7%).

    The Arctic Council consists of eight Arctic states (Canada, Denmark, Finland, Iceland, Norway, Russia, Sweden, and the U.S.). I was intrigued to learn that equatorial Singapore attends the Arctic Council. This is because the city-state is vulnerable to rising sea levels. It’s also because Singapore remains the world’s most important shipping hub.

    They’re talking about a trans-Arctic passage cutting straight across the North Pole. A future Arctic shipping route could cut weeks off maritime transportation going through the Suez Canal and days off a traditional Northern Sea Route in a world where timeliness means the difference between profit and loss.

    Key Takeaway: The changing climate impacts growth and investment portfolios.

    1. Long COVID

    A growing number of adults and children infected by the coronavirus are suffering lingering physical, mental, and neurological symptoms known as “long COVID.” Long COVID is not a condition for which there are currently accepted objective diagnostics tests or biomarkers. It is a range of symptoms that can last weeks or months that can happen to anyone who has had COVID-19. The symptoms are similar to Gulf War syndrome, chronic fatigue syndrome, Lyme disease, or Barr-Epstein (mono).

    Forecasting the impact of long COVID is challenging due to a lack of data. The estimated number of Americans suffering from long COVID ranges from 3 million to 30 million. Women are reported to be 4-times more susceptible.

    Our medical community doesn’t do ambiguous well. Patients with long COVID face a tortuous and challenging experience with a medical system designed for organ-focused specialties. “Unless we proactively develop a health, care framework and strategy based on cooperative, patient-centric, supportive principles, we will leave millions of patients in the turbulent breach.”

    Key Takeaway: Long COVID is a debilitating state impacting our youth and working-age population. There’s not enough data or analysis to know if long COVID will impact the U.S. labor force. Excellence does not start with apathy.

    1. Cryptonite

    August 15th was the 50th anniversary of President Nixon taking the U.S. off of the gold standard. It was also the last night of Camp Kotok which provided a rich, animated debate about the future of fiat currency regimes, the ability for the U.S. to maintain the dollar’s global reserve currency status, and the future of cryptocurrencies, including central bank digital currencies (CBDCs) being introduced by global monetary policy authorities.

    The cryptocurrency market capitalization has gone from $350 billion to $1.9 trillion in the last 12 months. FOMO (fear of missing out).

    As cryptocurrencies and stablecoins have become more popular, the world’s central banks have realized they need to provide an alternative or risk letting the future of money pass them by.[1]

    81 countries are exploring CBDCs, virtual money backed and issued by a central bank. Only five have been launched (the Bahamas, St Kitts/Nevis, Antigua/Barbuda, Saint Lucia, and Grenada). Of the four largest central banks (the U.S. Federal Reserve, The European Central bank, the Bank of Japan, and the Bank of England), the Fed is the furthest behind.

    In the future, cryptocurrencies might allow fiscal stimulus to be microtargeted to a specific industry, region, or neighborhood. Digital dollars can be spent at restaurants, but Seattle dollars might only be spent inside the Seattle city limits. If you think there is too much central planning of the U.S. economy now, you wait.

    Key Takeaway: The USD may share the stage with other world reserve currencies in the future, perhaps the euro or IMF special drawing rights (SDRs) or a digital currency. Such a change is unlikely to (a) include the Chinese yuan, or (b) occur before 2030 in our opinion.

    Thank you to David Kotok, Chairman and Chief Investment Officer of Cumberland Advisors, and Jill Fornito, Executive Director of the Global Interdependence Center for excellent planning and execution of this event.

    I would add that the Sunday evening porch discussion about currency was epic. A couple people commented that they thought it best discussion of the entire week.

    I would add to the currency topic:

    1. The reserve currency status of the US Dollar is an underappreciated privilege. If the US loses that status it will have profound consequences. There are forces seeking to actively undermine it. Watch what happens in the 2022 Olympics in China with regards to China’s push towards a digital yuan.
    2. Blockchain and crypto are an unstoppable force that will revolutionize how financial transactions occur globally. While Bitcoin Maxis are probably out over their skis, they are not totally wrong. Today, crypto is the Wild West and a lot like the dot com era of 2000. There will be a lot of losers and a few winners.
    3. DeFi presents possibilities for great improvements for people’s lives globally - e.g., 1.7B unbanked people in the world - and loss of great power by a few.

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