Establishing the Usefulness of Complementary Currencies
Modern portfolio theory (MPT) is at the bedrock of finance and governs the allocation of most of the professional investment capital in the world. It would be almost unthinkable for any credible manager of hedge funds, mutual funds, funds of funds, or sovereign wealth funds to disclaim reliance on this body of knowledge that has been proven both theoretically and empirically over decades of research across wide investment classes and vehicles.
MPT holds that portfolio diversification, meaning the simultaneous holding of different assets whose expected performance characteristics are not correlated and therefore complementary, is essential to the optimization of the risk-reward paradigm, thereby maximizing the expected return for a given level of risk. In plain English, it is statistically more profitable and less risky over time to invest in a portfolio of complementary assets than it is to invest in any single asset within that portfolio.
Research has found that a surprisingly small portfolio can offer to the investor nearly all of the expected benefit of diversification. Notably, however, the greatest benefit is found from the first act of diversification; going from a single-asset portfolio to one with two non-correlated assets. Subsequent diversification benefits are significant but decline with each additional asset until nearly all of the potential benefit is captured at the threshold of six assets. Also, the more non-correlated the portfolio assets are, the fewer are required to achieve optimum diversification.
To date, policy makers have apparently not thought to apply MPT to monetary policy due to the fact that type of money has not been viewed as a diversifiable asset.
Money as a Diversifiable Asset
It is important at this juncture to make a critical distinction: by “diversifiable asset”, I am not referring to the differing national fiat currencies (NFC’s). While the diverse national fiat currencies have dissimilar appearances, they all share common characteristics. All are fractional reserve, debt-based, fiat forms of money that are backed by the full faith and credit of the sovereign nation issuer, each of which delegates this function to a central bank. There are…