We believe that the global economy is closed, that cycles repeat, and that investors are emotional and can make mistakes. This time, it is not different, and history holds clues as to how global financial markets may evolve. In a closed economy, the only way the economy can experience growth is through stealing market share, opening a new market, population growth/demographics, or experiencing the introduction of a new technology innovation. Long periods of chronic, slow, economic growth, that reduces the standard of living of the educated middle class, can lead to the rise of populism. Elections in Italy, demonstrations in Brazil, and the recent election in the province of Ontario provide evidence that this rise in populism is not local, but global in nature. The era of globalization that started after World War II is coming to an end. The sooner investors realize this, the better.

History reveals, that every 80 years or so, the global economy needs a reset. Global imbalances get too large and the rise of populism puts pressure on those in power to take drastic action. Without an internal, rule-based adjustment system (that equalizes the economies that manufacture too much and consume too little, think Germany and China), military force is typically used to solve the problem. The Trump Administration is trying to get the global leaders to realize that the existing trading system can no longer be supported by the American economy. John Maynard Keynes warned of this in 1945 at Bretton Woods. You can’t have a sovereign currency be the medium of exchange of the global economy and the global economy without a Trade Adjustment Mechanism. Countries will enter into currency wars, that devalue their currencies against the U.S. dollar, to make the products they produce more competitive. Furthermore, the World Trade Organization will be ineffective in solving trade disputes. Keynes also warned that eventually the country absorbing the excess capacity of the global economy (the USA) will reach its limits, thus changing its domestic policy to protect its economy. We have reached that point.

The trade deficit of the United States equals the summation of the world’s trade surplus. Since 1945, the USA has gone from a creditor nation to a debtor nation. With the unfunded liabilities growing, and because of its aging population, it must adjust. President Trump correctly states that the USA can no longer be the piggy bank that the rest of world borrows from. We have seen this narrative play out many times in history. In the past, military action has been the policy choice of action to remedy this problem. Let’s hope history does not repeat.

The hollowing out of the manufacturing base, zero interest rates, quantitative easing and austerity has ushered in a period referred to as “The New Normal”, or Secular Stagnation. Secular Stagnation is when chronic slow growth and declining standards of living gave rise to populism in the Western world. As many educated citizens realized that the policies of globalization did not deliver the economic fruits that were promised, voters surprised the elites and elected candidates that promised a new future. Think “Make America Great Again”. This is not so much about Trump as it is about the middle class worker in the Western world wanting change. President Obama promised an era of “Hope and Change” and ironically President Trump is continuing on with this same narrative. The establishment will fight for the status quo, but investors must realize there is no turning back. With the election of Doug Ford as Premier in Ontario, the populist movement now has a strong foot hold in the economic center of the country, investors need to discount the fact that the global economy is going through an adjustment period.

Dr. James E. Thorne

Chief Capital Market Strategist & Senior Portfolio Manager

“If I have seen further, it is by standing on the shoulder of giants.” - Sir Isaac Newton

At the heart of the Blockchain is complex mathematics. Cryptography is what lies at the core of the distributed ledger technology that provides trust, which, in turn, allows transaction to be completed and recorded. To understand cryptography, one needs to have the tools and the ability to understand complex mathematics, which is beyond the scope of the average investor. The inability to navigate this roadblock leads many investors to incorrectly conclude that the Blockchain is nothing more than rat poison to the global economy. Forgetting the theory of mathematics for a moment, we thought it would be helpful to research the core technology of this innovation. Through doing so, it was concluded that the distributed ledger technology is the digital manifestation of double entry bookkeeping accounting. Too few realize that the history and evolution of accounting is tied to the history of global trade and therefore, the history of human progress. Accounting is an extremely important influential innovation that gets taken for granted. Its digitization will have profound effects on the recording, transaction, and record keeping that play a central role in our global economic, legal, and political systems. In addition to the establishment of identity and governing interactions among nations, industries, political organizations, health care institutions, businesses, and individuals, the Blockchain allows the global economy to evolve into its true native digital state. Hardly, rat poison.

Since the 1950’s, the global economy has been slowly evolving from an analogue world (where process is controlled by humans and paper), to a digital world. However, to truly understand how profound this innovation is, shrouded in complex mathematics, we need to go back to the 1400’s and the Italian Renaissance. It has been well documented and researched that the history of human progress can be explained through a narrative, with a focus on global trade and the history of accounting. Commerce connects countries, industries, businesses, and the citizens of the world. This connection, in many cases, has long been facilitated through double entry bookkeeping, accounting and banking.

Modern banking is over 700 years old. It was invented in the early Italian Renaissance, first modelled by the “Medici Bank” in Florence, Italy. In 1474, a Franciscan Monk named Fra Luca Bartolomeo de Pacioli (the tutor of Leonardo da Vinci) published the first major work on double entry bookkeeping accounting. With his findings, the recording of transactions was introduced into the world of commerce and trade, thus becoming a core business process. From the 1400’s until today, the recording of transactions and transferring of property rights has been done with an analogue process. Simply put, the process has not evolved. This fact has slowed the evolution of the global economy and society from an analogue world to a world in its true native digital state.

Our thesis is the combination of mathematics, economic incentives, and digital ledger technology (to solve the double spend problem), which creates the innovation necessary to replace the analogue aspects of accounting theory that has been hindering the evolution of the global economy. History reveals the power of an innovation mostly ignored by society. There could be no double entry bookkeeping accounting without the invention of the number zero. Without accounting, there would be no corporations, financial markets, global trade, and no financial theory, everything used by those who refer to this new technology as rat poison (Mr. Buffett). To get to this conclusion, one must leave behind the basics of mathematics, have an open mind, and ask the question: “What would the world be like if transactions took place in a pure digital state, where the databases were decentralized, security was ensured and no human intervention was needed?” The answer? An economy with lower transaction cost, less friction, and less fraud, where individuals control their identities - an economy in its true native digital state. For many, the complex mathematics at the foundation of the Blockchain will deter investment. Others realize that the technology is a digital advancement to a process started in the Italian Renaissance and a method by which the global economy can evolve. To paraphrase Sir Isaac Newton, we are able to see further by standing on the shoulder of the giants that came before us.

Dr. James E. Thorne

Chief Capital Market Strategist & Senior Portfolio Manager

When a high level of entropy exists, people tend to just shut down. When events occur too frequently, chaos develops, volatility increases to extreme levels and risk aversion ensues. With President Trump, through the desire to implement trade policy through the unconventional means of social media, the level of entropy has hit an extreme high. In reality, the trade war was actually lost decades ago. The key issue is the fact that in China’s 2025 economic strategy high tech industries are the main focus, and this is the battle ground.

The reality is that this is not so much about trade wars but trade theatre. With mid-term elections coming in the fall, the President needs to be seen fulfilling his election promises. A deal on intellectual property rights will be made and it may take some time. In the end President Trump’s bark is bigger then his bite.

The United States can on longer absorb the excess capacity generated by Germany and China. John Maynard Keynes warned that this bridge would eventually be crossed during the negotiations at Bretton Woods in 1944. He rightly predicted that the World Trade Organization was not strong enough to deal with the inherent problems created by a closed economy. Countries that manufacture trade surpluses are reticent to back up or create conditions to consume more internally. This is known, and will be dealt with through negotiations.

While economic conditions point to a period of strong company earnings, the heightened political risk, caused by concern regarding an impending trade war, has caused extreme volatility in the financial markets. Prudence suggests investors reduce exposure, and we have with the Pendragon Fund. While earnings will be strong, we expect the market to be volatile in the short-term and a deal will be made before the mid-term election season starts. When this happens, fundamentals will again take center stage. Until then, a high level of entropy will exist in the markets.

This does not mean the evolutionary process and the global economy has stopped. If the politicians and regulators step aside, the financial markets and the global economy will continue to grow and the new data driven economy will continue to evolve at a rapid pace.

Investors should look at this period as the pause that refreshes.

Dr. James E. Thorne

Chief Capital Market Strategist & Senior Portfolio Manager

“See, the world is full of things more powerful than us. But if you know how to catch a ride, you can go places,”
- Neal Stephenson, Snow Crash

The world continually changes and evolves. This has always been true and those that fail to innovate and adapt will be left behind. The evolution of the global economy is a force more powerful then us. The ride today is provided by the innovation called the Blockchain, and yes, if you catch this ride it will take you places. Do we know who the long-term winners will be with certainty? No. But we must recognize that the status quo is being attacked by very strong disruptive forces. Simply put, data is the new oil. Decentralization is upon us and the world is evolving very quickly from its analogue foundations, which were developed in the 1800’s, into its true native digital form. This is the ride that Pendragon is catching.

Throughout history, when a major innovation has been introduced, it tends to absorbed into the economy in two distinct steps. Step one, the technology is initially introduced, the 80’s and the 90’s introduced the computer and the internet to the world. Step two, the economy absorbs the technology to the point where it dramatically changes the world we live in. Today the Internet of Things, Alternative Intelligence, Machine Learning, and the Blockchain, are now dramatically changing the way we live and do business. Academics label the former Gilded Age, while the latter is labeled the Golden Age. The Blockchain, a data base innovation which applies cryptography, is front and centre catching the imaginations of many. To some, this new data model may be as significant as the printing press or double entry book keeping accounting. To others, it’s referred to as a tulip bulb. To be sure no one knows what the future holds, but it would be folly to assume that the status quo will be maintained.

In the past, civilizations were organized and settled in a centralized manner. The introduction of the internet into our society started the pendulum to swing back towards a decentralization. The Blockchain allows data bases to be secure, transparent and decentralized. The introduction of a decentralized accounting ledger, that you can only add information to and cannot be hacked, releases profound forces of disruption into the economy. Just imagine a tamper proof ledger of transactions (cannot be hacked) that exists in multiple (decentralized) locations for everyone to see. The joint forces of the internet and the Blockchain will now accelerate the rate upon which society decentralizes, and digitizes.

Many will be unhappy with this occurrence and will fight to maintain the status quo. Education is key to understanding the opportunities that lie ahead.

Dr. James E. Thorne

Chief Capital Market Strategist & Senior Portfolio Manager

"Those who fail to learn from history are doomed to repeat it." - Sir Winston Churchill, 1948

With all the noise created by many pundits concerning the innovation called the Blockchain and cryptocurrency, we found it very helpful to go back to first principles and analyze the genesis and evolution of the internet and the data set. Our thinking is that the global economy is at the intersection of three major themes: the Internet of Things, Artificial Intelligence, and the Blockchain. Together, these three concepts are important components of a theme we refer to as Web 3.0 or Decentralization.

As our society evolved from one based upon barter, to one based upon markets and manufacturing, a need to prove trust became necessary. Who was going to make sure that citizens or market participants could trust each other so that property rights could be transferred? In the analogue world, institutions, governments, and professions evolved to ensure that trust and property rights could be transferred. Thus our countries, cities, industries, and organizations were built to have a centralized benevolent dictator determine what was right and what was wrong. Our society has now reached a fork in the road. The rise of populism has put pressure on the existing institutions and social conventions. We are entering into a new regime, one characterized by the forces of “decentralization”. For investors, it is critical to recognize these evolutionary forces will be accelerated by three sub themes, the Internet of Things, Artificial Intelligence, and the Blockchain.

As the global economy continues to evolve from one that is centralized and built in an analogue world (with paper and humans at the center) to a decentralized digital world, one must accept the fact that the status quo will be under attack. Putting a computer chip into a machine, connecting the machine to the internet, having machines communicate to each other without human interference, while all the time learning, will have profound effects on society. Furthermore, the ability for machines to exchange value in a transparent, permanent, immutable, reliable and decentralized process, only begins to foreshadow the disruption ahead of us.

So while many in the media point to the Blockchain and cryptocurrencies as a bubble similar to tulips, our research suggests that when computer scientists solved the Byzantine Generals Problem, a problem which outlines how difficult unanimous trust is to coordinate, a critical research triumph was achieved. This accomplishment will now allow the global economy, to evolve at a faster pace into its true native digital decentralized form. So yes, we think it’s folly to suggest that Web 3.0, as some refer to it, is analogous to the tulips bulb mania. We also think this regime we have just entered into, might be the most transformative of our generation.

A brief review of history: In the 1950’s, the internet was designed to be free and decentralized. It was born out of the concern, during the cold war, that the United States needed a back up communication system in the event the Soviet Union attacked the telephone lines. This evolved into the world wide web. Unfortunately, the only way that companies could make money was to aggregate or centralize data, a far cry from the libertarian aspirations put forth by the founders of Facebook and Google. The Blockchain is the critical technology that will allow our society to evolve into its true native digital form. To prove trust in the Blockchain we need computers solving mathematical questions, proof of their work, and then their reward is a token that can be use in the network or exchanged for fiat currency. This is hardly a tulip.

Dr. James E. Thorne

Chief Capital Market Strategist & Senior Portfolio Manager

The creators of South Park, Trey Parker and Matt Stone, called it “Space Cash”, we call it Bitcoin. Bitcoin has been addressed in the mainstream media, and while it is true that Bitcoin may have reached a high in popularity, a quick review of history suggests that at its core, Bitcoin or something like it has been expected for some time. Technology needed to advance in order for cryptocurrencies to evolve. In 1999, Milton Friedman predicted that the evolution of the internet would have profound ramifications on our society. He also saw a role for a digital currency, as quoted below:

Blockchain is a digital decentralized system and a transparent distributed ledger, which everyone in a network can see. It facilitates the implementation and recording of transactions significantly reducing transaction costs. Blockchain has been responsible for disrupting what economists refer to as “rents that traditional middlemen get from facilitating traditional analogue transactions” and has contributed to a reduction of both time and money of transaction costs.

In 1904, William Sydney Porter, the author known as O. Henry wrote the short story “The Admiral”, which was set in the imaginary country of Achuria, a small maritime country with one export: bananas. Achuria was ruled by the company that controlled the export of bananas to the rest of the world. The foundation of this tropical paradise was no longer policed by the rule of law and it became known as a “Banana Republic”. From this short story the term “Banana Republic” became synonymous with a country were the rule of law no longer applies. Paradoxically, the term is now being applied to describe the current environment pertaining to the financial crisis in the United States.

William Shakespeare, in his play The Tempest, uses the statement “The Past is Prologue” to suggest that all the events that have happened before have presented us with the opportunity we now face. Simply put, history sets the context for the present. Yet, in this world of instant gratification, few investors anchor their expectations using history as a guide.