Next week the retail trading platform Robinhood will go public under the ticker ‘HOOD’. Robinhood’s public offering will likely value it at over USD 35bn, and together with a recent fundraising round for European digital bank Revolut, the acquisition of wealth manager Nutmeg (by JPMorgan) and a listing for trading platform eToro (in a special purpose acquisition company), the Robinhood IPO marks a pivotal moment in the transition from ‘old’ banking and towards what is known as fintech. As such, it is a good milestone from which to judge a number of evolving trends in finance.
While the Robinhood IPO is a sign that the fintech world has ‘arrived’, like many totemic IPO’s it may also signal a top or high point for digitally driven companies. Bear in mind that a couple of months ago we pointed out that prominent market listings (e.g. from Glenore to Coinbase) tended to mark the end rather than the beginning of a market trend.
My own judgement is that from an industry point of view, the fintech megatrend is only beginning and will evolve over the next decade. It does also remind us that to a large extent investing in incumbent banks is fruitless, especially so in Europe and Asia, where apart from the ebb and flow of the yield curve, bank performance is undercut by poor governance, inefficient IT spend and short-termist management.
To put this in stark, performance terms, since May 2006 the MSCI European Equity market index has doubled, while the MSCI European banks index has halved. It doesn’t look like European banks will catch up any time soon even though these ‘dinosaur’ banks (that still collectively hold well over Eur 700bn in investor capital. In contrast the global fintech benchmark has doubled in the past three years.
That doubling has been the result of the emergence a number of new finance eco-systems – retail trading, the retail options market, and crypto to name three – each has its own luridness, excitement, specific sociology and anthropology (from master of the universe options traders to crypto ‘bros’ – the crypto universe is not a female friendly one), to the meme stock traders of the Wall Street (WSB) bets discussion forum on Reddit.
Mindful of the rise and fall and rise again of the WSB traders, the Robinhood IPO will be an excuse for many commentators to trot out the phrase that we are witnessing the ‘democratisation of finance’, but the reality is that we are seeing the democratisation of risk in the sense that different forms of financial risk (leverage, liquidity risk, information asymmetry) are being packaged and sold to the public.
At the other less democratic, indeed elite end of finance (established hedge funds and family offices), there is greater demand for ‘private assets’ (top quality credit funds, venture capital and stakes in growth companies) and in many respects this is one of the more interesting, less discussed parts of the financial world, and certainly the most lucrative.
Another trend that needs greater attention, especially from anyone looking to invest in fintech is how the fintech business model works or doesn’t work. From the outside the likes of Robinhood seem likely highly profitable trading engines, in fact, a perusal of the four-hundred-page SEC S-1 regulatory filing for the IPO (which has over 70 pages on ‘risk factors’) shows that despite USD 81bn in client assets, Robinhood makes the lionshare of its revenue from selling data on client trades to, predominantly, two large hedge funds. In that respect it is more like Facebook than it is like say UBS or Bank of America.
At the same time, there is a strategic, industrial structure-based shift in finance with the steady encroachment of technology companies into finance. The logic of fintech is allowing technology companies to enter the finance world – either as trading platforms, social networks devoted to finance or payment platforms that then develop a more complete service offering (TransferWise, which recently listed on the London Stock Exchange as ‘Wise’, is a good example).
What is not entirely clear here is the way in which the tech and fintech ecosystems will change both the incumbent banking system, and the overall financial system – with implications for monetary policy and regulation.
The Robinhood pre IPO documents also show that 14% of client assets are in crypto, which from a standard asset allocation of portfolio point of view is enormous (I can imagine that a proper portfolio theory approach would put it as 1-2%). Nonetheless, that shows that ‘crypto’ has captured the investment narrative, especially amongst young people and this has much to tell us -about the ‘spirit of the market’ today, not least for the dangers it presents to wealth.
In this respect one of the very significant trends in coming years will be the battle between centralised and decentralised finance – led by governments and regulators, but that will encompass many areas – law, philosophy, politics and technology. One of the coming challenges will be assigning responsibility across the US regulatory system for crypto assets like bitcoin and the infrastructure that drives them. What is worrying is that even ‘experts’ like Gary Gensler (head of the SEC) have not stepped forward to take this particular bull by the horns.
Theoretically the ‘defi’ world (decentralized finance) operates outside of the ‘old’ centralized financial world and its real economy, but ‘defi’ cannot viably operate independently of the much greater centralized finance world (made up of the likes of JPMorgan, central banks and governments). To that end, the ‘defi’ winners will be those who can adapt to the ‘old world’ and that are alert to geopolitical sensitivities around the evolution of the world financial order.
Have a great week ahead,
One of the more remarkable and still under-estimated films I have seen in recent years is ‘A Face in the Crowd’, a 1957 production by the two-time Oscar winner Elia Kazan. The film is remarkable in a number of senses, especially for the way in which it prefigures the populist use of media – radio and television for political purposes. Anyone watching Andy Griffiths play Larry Rhodes in the film will think immediately of a recent US president, and given the film is based on a book called ‘Your Arkansas Traveller’ by Budd Schulberg, it’s hard not to think of another President from Arkansas.
‘Face in the Crowd’ highlights not only the umbilical link between populism and the media but also the disastrous end that many populist figures face. Populism is one of the plights of our times, for a range of reasons – the dislocations of globalization, the side effects of immigration, poor policy responses to inequality and the rise of social media are a few.
An excellent analytical resource in this regard comes from three German economists (Manuel Funk, Moritz Schularick and Christoph Trebesch) who have previously carried out excellent work on the connection between financial crises and the rise of populism. The researchers have compiled a database of populism that tracks the rise and fall of the phenomenon over time and its economic and political consequences.
The most troubling aspect in their research is to show that populism is at its highest point historically – 25% of the countries in their sample (16 of 60) have or recently (in 2018) had populist governments, as compared to only 14% in the 1930’s. Typically, populism is associated with weaker growth or economic volatility – an occurrence that makes sense if we think of the weakness of the Turkish lira, unrest in South Africa and in general, the consistently poor handling of the coronavirus crisis by populist leaders. The German researchers also show that most populist leaders suffer an ‘irregular’ political exit, and will no doubt be adding the events of January 6th in Washington to their database.
The ‘populism peak’ is important in many respects, not least for the way in which populists feed off and exacerbate the issues of the day – the ambivalence of some Tory politicians over racist acts against English football players is one example.
My hunch is that inflation is about to become the latest populist focus. Recent data show that in the US and increasingly in Europe, inflation is awakening after a long slumber. Indeed, many professional economists and investors have never experienced high inflation. In the USA, some inflation measures and price components are the highest that they have been since the 1980’s. The consensus and official view on rising inflation is that it is ‘transitory’ – driven by a burst of coronavirus recovery spending. The risk, across many fronts is that it proves more enduring and thus can cause financial, economic and political pain.
This is where inflation becomes interesting to populists – anything that causes economic pain and social discomfort is populist ammunition. Indeed, there is plenty of evidence to show that inflation is often the offshoot of populist economic policies as the economic history of Latin America shows.
Inflation, if it is here to stay, will become a political issue in at least three ways. The first is housing where the OECD’s housing affordability gauge has gone vertical (i.e. housing is extremely unaffordable), easily surpassing the levels of 2008 (recall the housing crisis). In some countries like Ireland there is a persistent and acute housing crisis, the debate around which is becoming populist – though it should be said that there has been a broad failure to manage this issue from a policy point of view.
The second way in which inflation becomes an issue is where rising real living costs are not matched by wage rises (we may see this in about six months’ time as economic activity and policy normalizes) and ‘the price of things’ becomes a topic of political debate and increasingly, agitation. In the past, and particularly in emerging economies where households spend a large amount of disposable income on food, price rises can lead to unrest (i.e. the Arab Spring).
Third, rising inflation brings the prospect of rising interest rates which will not only make life more complicated for mortgage holders but will ignite a debate on indebtedness, its consequences and remedies. Lurking behind this is the fact that central banks by declaring inflation ‘transitory’ and not yet giving any sense that they are worried about asset price inflation nor the consequences of asset purchases, find themselves snookered. As we have seen with the tussles between Donald Trump and Fed Chair Jay Powell, central banks make easy targets for populists and can be forced into bad policy decisions by them.
So, inflation if and when it materializes, may be political fodder for populists and if it does, this will complicate the policy and political outlook. Populism is difficult to counteract, and often the best remedy for it is the incompetence of populists themselves. What might be the best solution for inflation – I propose that it is populism. As the study I mentioned earlier shows, populists tend to depress growth, and therefore inflation.
There were three events that occurred last week, two of which mirror each other, and that are logically tied up in the third.
The first is the decision of the Chinese internet regulator to suppress the use of the Didi (effectively a Chinese version of Uber or indeed Uber is a Western version of Didi) web application based on concerns over the way it collected personal data and the related potential governance and disclosure shortcomings in the Didi initial public offering.
The second was the decision by US Department of Defence to reopen its JEDI Cloud contract process (note to all arms dealers if you want to convince a government to buy a weapon or weapons system, it needs to have an appropriately convincing name).
The two events are united by a key sentence in President Biden’s midweek speech on the withdrawal of forces from Afghanistan where he stated ‘we will be more formidable to our adversaries and competitors over the long run if we fight the battles of the next 20 years, not the last 20 years’. China and Russia have the same idea, and the battles of the next twenty years will be ‘total’ in that they will encompass cyber security, finance, social media, and trade as well as military aspects, and they will have a strong competitive (as opposed to outright conflictual) aspect.
As a result, the broad topic of security will be all encompassing – stock markets and cloud computing are just two elements that will be drawn into this vortex. This reminds me of the comment of another President Ike Eisenhower, one of only three Presidents to hold a high military rank (after Washington and Grant) who warned ‘we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military–industrial complex. The potential for the disastrous rise of misplaced power exists and will persist. We must never let the weight of this combination endanger our liberties or democratic process’.
His words ring true today, more so in the light of data and cyber security. They should also alert us to the fact that the military-industrial-financial-data complex (MIFD) will be an expensive affair. In the USA at least, military spending is vast, and often wasteful. Bear in mind that one of George W. Bush’s economic advisers Larry Lindsay, effectively lost his job for estimating the cost of the Iraq War at between USD 100-200bn (it was multiples of this).
Also bear in mind failed spending projects such as the Future Combat Systems Program (USD 46bn), the Crusader gun, a new Bradley tank, the Commanche helicopter (again pay attention to the project names). Also, set all of this against the early warning from the US Defence Intelligence Agency in November 2019 of an emerging pandemic in China and the subsequent government failure to spend on preventative measures, we get the sense that military hardware led investment is overly prioritised.
To give the military a break, all this raises two finance related questions. One is whether the geopolitical contest between the US and China will skew government spending, and the other relates to the combination of military research and innovation.
In the past, warring states have pushed themselves to the brink of bankruptcy – the Napoleonic Wars, the gigantic expense of the German and British navies in the 1910’s and nuclear weapons spending in the cold War. The risk here, and as with the comparison of military and COVID-health spending, is that there is a great, ultimately value destroying wave of investment spending in cloud computing, cyber and data security and drone technology.
The risk also is that the increasingly fashionable idea of industrial strategy in the US (again another example of America becoming more like France) becomes led by the MIF’D. Brian Deese, President Biden’s National Economic Council adviser is already pointing towards developing strategic industries such as semiconductors and telecoms, but the risk is that this strategy becomes skewed by the geopolitical side of the debate rather than the necessarily important focus on productivity.
My final thought is on innovation, where despite inefficiencies in the way military procurement is handled, the underappreciated side of military related spending is innovation. Israel, somewhat controversially I should say, proves this point. A great many of its leading technology firms have been developed as follow throughs from its soldiers and some of its battlefield technologies (Iron Dome, and its drone and robotic battlefield programs) have spawned successful commercial applications and reflect a thriving public-private innovation partnership. Indeed, Israel is cited as a case by Mariana Mazzucato in her thesis that states have a key role to play in driving innovation.
However, beyond extreme data points like Israel, the reality is that the countries that are best at innovating, do not have MIFD complexes, but rather good education systems, progressive incentive structures and state support (rather than control). In that respect, the biggest obstacle to innovation in the US is that it becomes the plaything of geo-politics, and increasingly of a small community of investors who it seems increasingly view innovation as something to trade rather than to nurture.
Have a great week ahead,
This year Independence Day falls on a Sunday so the associated bank holiday in the US will be held on Monday (5th). This is not wholly unusual. Benjamin Franklin celebrated the first Independence Day with a dinner for close friends (including John Adams) in Paris. Franklin’s dinners were part of his diplomacy as America’s man in Paris, and the American Club in Paris has continued this tradition (as I am on the topic of Paris, visitors and residents alike should visit the superb, newly restored Hotel de la Marine which will give a taste of the magnificence of the ‘Franklin era’ in Paris).
Franklin is a good example of a political figure who is associated with food, Churchill being an obvious one (Cita Selzer’s book ‘Dinner with Churchill’ is good) and I suspect nearly all the French Presidents (see Jean d’Ormesson star in ‘Les Saveurs du Palais’ for example). By comparison, the post Brexit squabble over sausages is banal.
Franklin, one of my favourite historical figures, also reminds us of many other things, the first of which is that we will rarely see his like again – he was a writer/publisher, physicist, diplomat and politician, amongst many other accomplishments and hugely influential in setting the values and codes that shaped America.
Politics is now such a cruel and demanding ‘sport’ that it is unlikely that someone of Franklin’s many talents (the same is true for the other Founding Fathers) would or could rise to the top (note that the positive trend of rising female participation in top level politics is accompanied by the fact that relatively few European leaders have children illustrating that it is difficult to have a family life in politics).
The other aspect of Franklin’s great life that is worth commentating relates to his time in Paris and the very close ties between America and France. It is very likely that few of those who stride up and down Lafayette Avenue in lower Manhattan know of the contribution of the Marquis de Lafayette and also of the writer Beaumarchais to American history. France and America entered the 18th century as the lynchpins of the democratic world and together with England, Ireland and a host of other European and Asian nations, are still its flag bearers.
What is worrying however is that democracy and much of what Independence Day represents is under steady attack. Some years ago, the American political scientist Larry Diamond wrote of the global ‘democratic recession’ and in recent years think tanks like Freedom House and the Economist Intelligence Unit have remarked on a broad based decline in both the number of democracies and in the quality of democracy.
Almost 70% of countries covered by the EIU’s Democracy Index recorded a decline in their overall democracy score, while the global average score fell to its lowest level since the index began in 2006. The EIU’s database shows that the leading democracies of the world are largely small advanced countries, which contributes to a sense of the vulnerability of democracy vis a vis larger countries, while some of the ‘freedom’ maps from Freedom House show how (geographically) polarised democracy is across the world.
If asked ‘what worries you most about the world’, my response is that democracy withers away and with it the rule of law and the role of credible institutions. We can see the effects of this in countries like Brazil, Hungary and Turkey but we could just as easily dismiss these as emerging markets.
That’s wrong on two fronts – what will shape the world in the 21st century is the form of governance that populous fast growing countries like Bangladesh, Nigeria, Rwanda and Vietnam. Second, in countries like the UK that were hitherto regarded as bastions of democracy, the quality of government is visibly deteriorating.
Moreover, to return to Larry Diamond, he has recently written in Foreign Affairs magazine that the world may face the prospect that American democracy would die out, leaving the international political economy directionless and shapeless. To that end, the politics of states like Georgia may be more meaningful than what happens in domestic politics across India.
The worry is that ‘fake news’, voting restrictions and a radicalised Republican Party lead the US further away from democracy and in the absence of a unifying figure of the mantle of Hamilton (beyond President Biden it is not clear who the obvious next candidate will be given the poor performance of the Vice President) there is a leadership vacuum.
It may be, unfortunately, that such a threat is required to bring forth the next Benjamin Franklin. Happy 4th of July.
One of the memorable moments in the 1967 film ‘The Graduate’ is where the main character 21-year-old Benjamin Braddock is taken aside by a Mr. Maguire, who says ‘One word Ben ‘plastics’, there is a great future in plastics!’
If the film was remade today, it is hard to know what might replace ‘plastics’ because there is such a mind boggling array of new technologies and technological applications bursting through. For example, a recent report by McKinsey on top technology trends flagged areas like ‘the future of programming’, ‘the bio revolution’ and ‘applied AI’ as the trends to watch.
I could add many more, but the point is that one characteristic of the post COVID economy is a bewildering array of new sub-industries, ESG related norms and consumer areas, that bring the future to our doorsteps almost to the point of exaggeration (e.g driverless flying taxis).
This wave of innovation is accompanied by a surge in entrepreneurship, and a noticeable improvement in the formation of entrepreneurs (one example is the entrepreneur incubator Entrepreneurs First). An important question for large companies is how to think about this array of innovation, how to gain exposure to it and relatedly how to defend business models against its disruptive effects.
One interesting schematic on disruption was recently published in the Harvard Business Review by three management consultants and looks at the vulnerability of different industries to ‘disruption’. More traditional industries like ‘plastics’ (diversified chemicals and rubber) are less prone to disruption, and in many cases tend to buy up brand innovators before they become disruptive (the beer industry is a case in point).
According the HBR schema, industries that are vulnerable to disruption are utilities, energy trading, consumer technologies and banking (investment and asset management). My personal view is that incumbent European banks have, with a few exceptions, failed to innovate and continue to be hampered by poor corporate governance and incentive structures, and unambitious governments and regulators. In some respects the best that can happen is that government and regulators aid the rise of digital banking, though again I am not optimistic that this will happen.
The case of fintech and the rise of digital money, banking and asset management illustrates the nexus between states, corporations and regulators, and helps to show why large corporations need to pay great attention to not only new trends in technology, but also new frameworks and ecosystems (see my May note).
The task of looking into and plotting the future, may be just a little too much for many CEO’s. In recent years the debate on the role of the corporation in socio-economic life has been re-ignited, and there is a consensus that corporations need to play a greater socially responsible role.
A good number are true to this – in the US social causes have been pioneered by progressive corporate leaders, though in Europe company heads are far more shy. While there is a very strong case to be made for corporates that have a more balanced contribution to their social, physical and financial environments there is also a sense that CEO’s now have multiple demands on their attention.
Still, apart from avoiding disruption there are good reasons for corporations to become ‘more involved’ in the future, if I can put it like that.
One is that the institutions, laws and frameworks that will marshall new areas like cyber security, climate damage and digital money will not only involve governments in their construction but other players from corporations, large cities, citizens assemblies and universities. Notably, some of the most interesting thinking I have seen on how to best police cyber security comes from corporates like Microsoft.
Another reason is that, as emphasized here, many of the new technologies that are mentioned in reports like that of McKinsey, have acquired a strategic value and in reality will be developed by tandem relationships of states and corporates – this will be the case with digital currencies, cyber security and artificial intelligence. Plastics never had this problem.
A third and perhaps yet underappreciated reason for corporates to think very hard about issues like the future of democracy, institutions and society is that changes in trust and how we capture identity are undergoing huge shifts. First of all, trust in democracy, politics and institutions in the Western world is falling and to a certain extent is being replaced by new forms of money, corporate brands and radical. This trend places a premium on companies that can build trust with consumers, and on the responsiveness of companies to events that threaten this trust.
The second element here is identity, specifically digital identity. Soon, a combination of cyber security, digital money and data protection will usher in the arrival of secure digital identities or passports. Theoretically this should contribute to more secure e-commerce and banking and potentially better online behaviour through reduced anonymity, but it also means that the channels through which companies interact with consumers will be more formalized and potentially better policed.
Few companies are ready for this.
Have a great week ahead,
I have thankfully gotten my ‘two jabs’ and theoretically at least should be free to roam the world. Before I do that, a quick detour to John Prescott, once the UK’s Deputy Prime Minister from 1997 to 2007, who being attacked (an egg was thrown) whilst on an election canvas, responded with his fists against his assailant. As a result he was nicknamed ‘Two Jabs Prescott’. Prescott came to mind when I read of the physical attack on French President Emmanuel Macron.
What was noteworthy was not the stupidity of the attacker but Macron’s response afterwards – he stated that his role was to get out and meet people, hear their concerns and rebuild trust with them. With that, he has put his finger on one of the essential political issues of our time – that people no longer trust their governments and the institutions that rule over them. In France there is speculation (misplaced I think) that Marine Le Pen will sweep to power, and in the UK and beyond a growing realization that Boris Johnson individually is untrustworthy.
More broadly, a few surveys sketch a worrying picture. The PEW Centre in the US shows that trust in government is very low – only 24% of Americans trust their government (the low point was 17% during the Trump administration), compared to 50% after 9/11 and 77% during the Kennedy era.
The OECD Trust in Government project shows a similar picture – globally only 45% of people trust their governments and have a much higher level of trust in education and healthcare systems (in the USA healthcare and military personnel are amongst the most trusted professions – with politicians, banker and journalists at the low end of the trust spectrum).
Across societies, an interesting picture emerges. The World Values Survey shows that in smaller advanced economies – the Nordics and Switzerland for instance – people have a high (60%) level of trust in each other (this may be due to country size, culture and proximity of populations), but in many emerging countries with weak institutions and rule of law (i.e Colombia, Brazil, Ecuador and Peru), trust across societies is far lower (10%). What is striking is that trust levels in China are high, underlying a cohesive society and one where the ‘contract’ between the government and its people is still intact, something that is vastly underappreciated in the West.
Still, this generalized lack of trust in government and high variance in trust across societies has many implications for politics and commerce. The PEW Centre also report that in the US, France and the UK, a majority of people desire a major change in their political system (with citizens assemblies and referendums amongst the solutions proposed here, a la Ireland and Switzerland).
It suggests that in the democratic world (which according to many surveys such as one by the EIU, is shrinking), governments need to invest more in transparency, and in new ways of giving voice to their citizens – either at a local level or for example using social media to gather feedback.
At an institutional level, many institutions are not at all well understood by the people they oversee, central banks being prime amongst them. One example I often flag is the EU, whose leaders now speak of ‘European values’ but who at the same time have not thought out what this means in a tangible sense to the diverse nationalities that make up the Union, and how in a pragmatic way, it might bring them closer together.
Moreover, with respect to the new institutions of the 21st century, be they the guardians of the climate or cyber activity or bodies that will marshal new forms of money, public trust will be one of the most important criteria that drives their construction.
In commerce, there are two trends worth keeping an eye on.
The first is the rise of blockchain, and blockchain enabled means of exchange such as bitcoin. The theory behind blockchain is that its protocol works to bind two parties in a technologically trustworthy transaction or contract. More particularly, the idea of decentralized finance is that it operates outside the ambit of governments and central banks – bodies that are increasingly less trusted. We might even interpret the decision of Ecuador – a country where trust and institutional quality are very low – to adopt bitcoin as a money, as an affirmation of the above.
If you draw a graph of the decline in trust in government and the market value of crypto currencies there is good (inverse) fit, albeit with only eight years of data. So, a provocative way for governments to curb the use of bitcoin might be to boost the credibility of their own actions!
Relatedly, banking systems – which are in many cases too battered or too ill formed to be trusted – are being replaced by other more trustworthy brands. In Kenya for example, the mobile payments system MPensa is widely used and trusted, in part because it is operated by a brand (Vodafone) that is (anecdotally) trusted by Kenyans.
The idea of trust in the economy is a vast and complicated issue, my own preference is that we have governments and institutions we can trust and admire, but the reality is that there is little innovation and dynamism in today’s institutions. I suspect that instead, the next ten years will see a wave of entrepreneurship in money and democracy, some of it ugly and I hope, the sum of it constructive.
Have a great week ahead,
In his book ‘On China’ Henry Kissinger states that “What distinguishes Sun Tzu from Western writers on strategy is the emphasis on the psychological and political elements over the purely military.”
In that context, President Biden’s commissioning of a report on the origins of the coronavirus is more than just a fact finding project, with respected scientists like Francis Collins of the National Institutes of health as well as partisan politicians such as Sen. Tom Cotton calling for an inquiry into the possibility that the virus was generated in a laboratory. In recent days Anthony Fauci the NIAID Director has added to these calls.
There are plenty of reasons to consider the possibility that the coronavirus could have emanated from bio-experiments, not least the hitherto inability of researchers to decisively pinpoint its precise natural origins. What is striking however, is the lack of cooperation shown by the Chinese authorities in such investigations – either by the World Health Organisation or other bodies (notably calls by Australia for an inquiry have been met with an aggressive reaction from China).
It is this lack of transparency that may condition China’s relations with the rest of the world in coming years, and upon which the USA may choose to focus the ‘psychological and political elements’ of its Asia geopolitical strategy.
As a starting point on transparency, the ‘West’ is not sufficiently curious nor well informed about China, its workings and not sufficiently recognisant of the fact that China has its own deeply rooted political economy. At the same time, China is not ‘open’ to Westerners in the sense that there are linguistic, cultural and strong political barriers to Westerners living in China.
For instance, there are close to 174,000 registered foreigners living in Shanghai (a city of 26 million), compared to the fact that there are at least 5 million Chinese living in the USA. Another perspective is to consider students – in 2018 there were over 120,000 Chinese studying in the UK alone, but only 20000 Americans and 10000 French (the two biggest groups of Westerners in China) studying in China. To my mind this lack of proper two way flow in people between China and the West is one of a number of factors that severely curtail globalization.
So, China is something of a mystery to outsiders, and to a degree to its own citizens (the Tiananmen Square massacre never happened and now any consideration of it in Hong Kong is off limits). China’s economic data is also a case in point. The official line is that Chinese GDP trips along at a rate of 6-7%, though a recent paper from the Brookings Institution suggests that trend GDP is close to 2% lower than official figures, and equally the rate of investment is 7% lower.
Despite a manifest rebound in growth across the world, the health of China’s economy will come into sharper focus in coming months. There are growing signs that credit growth is beginning to slow, and many of the underlying indicators of its economy – industrial production, services activity, economic surprise indicators, car sales, freight activity and electricity generation, land activity and cement production are dropping from recent highs. This comes at a time when inflation in China is rising.
What is most interesting is that the Chinese authorities’ response to this mixed economic data is uncharacteristically (compared to the West) sensible. China is actively trying to prune back excesses in its banking and property sectors, trim crypto activity and halt the rise in its currency. In that respect it is a model for others to follow.
Diplomatically this is not the case – most of China’s neighbours tire of its needling, be it border skirmishes with India, air space incursions over Taiwan, Japan and South Korea, or trade pressure on Australia.
Against this background, the Biden administration may have a greater aim – ‘transparency’ based diplomatic pressure. By seeking to – controversially through Wuhan – shine a light on the lack of openness and transparency in Chinese politics the US may diminish any soft power China has, sow doubt in its intentions and potentially turn the economic screw against China. There are two ways it which this could happen.
The first obvious one is by undermining the broad Belt and Road initiative, whose momentum has slowed badly and is increasingly contested in Europe and parts of Africa. Another, second approach is to set the rules of global corporate governance. By raising the bar on corporate governance globally, the US may make it more onerous for Chinese companies to grow more aggressively and expand overseas, not to mention to limit their access to international capital markets. A global corporate tax agreement could be followed by further measures to improve disclosures on accounting and their enforcement, effectively beefing up governance and oversight. In casting the Chinese economy and its corporates as untransparent the US could impose a capital market penalty on China.
If that is the plan, what then should President Biden do about Tesla, AMC and other market darlings?
Have a great week ahead,
The most startling comment from Dominic Cummings, formerly chief adviser to Boris Johnson, in his parliamentary committee testimony on his previous boss was ‘In any sensible rational government, it is completely crazy that I should have been in such a senior position”. This and the swathe of Cumming’s performance underlines the attractions of British politics as the very best (blood) sport in international political economy. The ‘Brexit’ series has only heightened this sense of entertainment and stupefaction.
It also emphasises that many governments face fiercest opposition from within, and the degree of disorder and degradation that have beset the workings of Downing Street. Boris Johnson’s poor response to the outbreak of COVID (he was apparently writing a book on Shakespeare) is masked by chaos elsewhere, and the absence of both decisive international leadership, and a coordinated global response to the crisis. As I write, two of the major news items refer to the lack of a coordinated global roll-out of vaccines, and to President Biden’s commissioning of a report into the origins of the virus.
To put it mildly, this is not a great way to embark on the road towards a ‘new world order’ as many politicians now term it, or the building of the post COVID economy. The success, productivity and durability of that new world order will depend very much on the kind of ‘rules of the game’ and institutions that marshal it. As the recent cyber-attacks on an oil pipeline in the USA and on the Irish health system show, we do not yet have frameworks in place to deal with the negative outcomes of new technologies.
Democracy, the mechanics of government and institutions need massive investment.
In the ‘new order’ we will need institutions that can bring order to issues such as ‘the future of money (digital currencies, crypto)’, ‘cyber warfare and cyber crime’, policing climate damage’, ‘the incorporation of mental health into healthcare systems internationally’ and genetic editing, to name a few of the challenges looming on the horizon. In this context the crucial question, given the context of a multipolar world driven by very different values, is how to realise the institutions of the 21st century. Here, I can think of maybe four options.
‘Crash and crisis’ – the first option follows the thread of recent history, in particular the policy responses to the global financial crisis and the euro-zone crisis where apparently obvious risks and imbalances caught policymakers off guard, and where they then scrambled inelegantly to put in place rules so that a debt crisis could ‘never happen again’ (I give it three years).
I worry that a major and catastrophic (in terms of resulting human fatalities) cyber-attack could be the catalyst that, following a direct military response, forces the introduction of ‘rules of the game’ for cyber.
‘East versus West’. It is worth remembering that the current international institutional order (i.e. UN) has its origins in the desire of the prospective victors of the second world war to shape the post war world order, and the location of institutions like the UN, IMF and WHO is testament to that balance of power. More recently as the economic centre of gravity in the world shifts, we are beginning to see China both infuse itself into the bureaucracy of the UN (it controls a number of committees) and cultivate Asia centric institutions such as the Asian Development Bank. A world where we have ‘Western’ and ‘Eastern’ multilateral institutions would be a truly divided one, though there is the hope that these institutions could speak to each other, and that this dialogue might be facilitated by smaller nations from Switzerland to the UAE.
Multiple Actors – Two cojoined elements of the ‘new world order’ that are striking are the facts that the challenges posed by innovation and technology (genetics, data, cyber) are closely tied to the corporate and financial worlds and those corporations are of such a size that they are now important global actors in their own right (25% of US stock market capitalisation is made up of the top five technology companies). Under this approach, the institutional solutions to climate damage are collaborations between disparate actors – mayors of large cities, large strategic corporations (i.e. Microsoft), governments, activists and some universities.
‘Santa Fe’ – a variant on the above approach is that it is driven by experts, from very different fields and who bring both a specific expertise and an appreciation of the interlinking causes of many of the challenges the world faces. I term this approach the ‘Santa Fe’ one after the Santa Fe institute which is likely the exemplar in applying a cross disciplinary approach to complex problems and systems. In many ways this is the most enlightened approach to building the institutions of the future, though a somewhat less democratic one.
I suspect that this last option is the least likely. World wars spurred the creation of the League of Nations and the United Nations, let’s hope we don’t need the world to get worse so that it can get better.
Have a great week ahead,
On February 25th the Zuger Woche newspaper popped through the letterbox with the front page headline, ‘Bitcoin – was ist das?’ (German is so alike English that readers need no translation). I was sufficiently struck by the headline that I took a photograph (now posted on social media), the reason being that Zug is known as the epicentre of Europe’s ‘Crypto Valley’, with growing concentration of crypto currency firms establishing there. While it’s not quite the same as Le Monde asking, ‘What is the Mona Lisa’ the headline does illustrate the disconnect between new areas in finance and technology and the ‘real world’.
Having written about crypto last week I had little intention of returning to the topic this week, though the collapse in the crypto complex is worth a few words (Ethereum halved in value in about four days). The extreme volatility confirms that bitcoin and most of the other crypto currencies are not money, and likely have no economic role (blockchain, tokens may be different) and as an asset class could best be described as a ‘bauble’ – a tacky trinket of an asset. Even tacky trinkets have their place, but in the case of finance they lie somewhere on the asset spectrum between art and race horses.
Having rubbished bitcoin, there are two other more important points to make. The first is to reiterate last week’s note which is to restate that there is a storm brewing between centralized finance and decentralized finance. Last week’s crypto volatility was spurred by China curbing financial institutions’ use of crypto currencies (twice announced), and by the US Treasury’s move to draw cryptocurrency holdings into the remit of the taxation system. Note also that this summer the Federal Reserve will launch a discussion on digital currencies.
Bitcoin, whose coding incorporates a news item regarding the global financial crisis, is an affront to the staid world of central banking and a threat to governments’ taxation programmes, and indeed to the probity of financial systems. As such, the crypto world should continue to expect attacks from finance officials. The exception may be the likes of Switzerland, where, in the case of Zug the authorities have set out the technological and regulatory backdrop for a new eco-system to grow (Zug allows taxes and train fares to be paid in bitcoin).
The second point to garner is that despite a number of policy moves, the crypto complex is still standing. I am not sure if this can be attributed to the workings of the decentralized finance system (I don’t know enough about it), or its lack of liquidity and more simply to the risk appetite and deep pockets of those who invest in crypto.
I wont dwell any more on crypto. Back to the Zuger Woche, whose editors have reinforced a trading strategy – my rule is that newspaper, and magazine covers are often a good, contra indicators of market and economic trends.
In a previous note I have highlighted how magazine covers can often offer the best guide to the future – though upside down. I am thinking of the famous BusinessWeek cover of August 1979 that proclaimed ‘The Death of Equities’ before the beginning of the 1980’s bull market, the 2014 Time magazine cover with the headline ‘Can anyone stop Hilary ?’, or the Economist cover ‘Brazil takes off’ in November 2009 just before its markets collapsed, and then ‘Has Brazil blown it ?’ in September 2013 as the country was about to boom.
The staff at the Zuger Woche just about got it right, on February 25th bitcoin traded at 55,000 and pretty much stayed close to that high level until the recent stumble. I will keep an eye out for any Zuger headlines that worry about the bitcoin collapse as a sign to jump into bitcoin.
Another related trading signal is the IPO (initial public offering) as a sign that a trend has peaked. It was the case with the mining sector and Glencore (a Zug company!) in 2011, and the recent market listing of crypto trading firm Coinbase (its down nearly 40% since).
In both cases – newspapers and IPO’s – the common factor is that the public are the last to discover financial innovations. Robinhood’s IPO is next week. Buyer beware!
Have a great week ahead,
When the euro was introduced just over twenty years ago, there were tales of people around Europe refusing to exchange their national currency notes for the single currency, on the basis that the euro ‘will never catch on’. When the hacking group Darkside ransomed the dataset controlling the Colonial pipeline last week, the ransom was paid in a cryptocurrency.
These two, different tales from opposite ends of the ‘money’ spectrum tell us much about how finance, and money in particular is evolving. At one end, we see the development of a new, traditional money (euro) and the centralised financial and capital markets (to an unsatisfyingly incomplete degree), that go with it. At the other end of the spectrum is decentralised crypto finance, that exists on a largely anonymous, unregulated way beyond the ‘old’ global financial system.
These two worlds are soon set to collide. Regulators, witnessing the speedy rise of cryptocurrencies, the lurid ways in which they are traded (e.g. dogecoin) and the threat they present to the incumbent financial system, will I suspect soon take a heavier hand in overseeing the architecture around crypto currencies like bitcoin which currently can’t be regulated, though the infrastructure or architecture that trades it can be overseen.
For context, these two approaches criss-cross many other related debates – the rise of sophisticated organised crime, the future of the dollar as the world’s reserve currency and the need to build emerging market financial systems that can curb corruption.
A potentially decisive development is the acceleration in the rollout of central bank digital currencies (CBDC). Central banks are set to issue digital versions of their currencies to accompany outstanding reserves and bank deposits. Theoretically, central banks will give each of us a retail account, and households can exchange money directly with them (as opposed to going through the banking and economic systems). The logistical and communication aspects of this project will be fiendishly complex to the extent that ‘it will never catch on’ echoes through my head.
It is however, catching on. Nearly twenty million Chinese are hooked up to an experimental digital yuan run by the People’s Bank, whose intention is that the 2022 Winter Olympics in China will serve as a showcase event for the digital yuan. Small, advanced economies – notably Switzerland and Singapore (not forgetting the Bahamas’ Sand dollar) are to the forefront in planning digital currencies as is the Bank of England, which egged on by the strategic urgency created by Brexit, may be the first large central bank to roll out a digital currency (the Fed and ECB also have blueprints).
It strikes me that the ingredients necessary for this sort of manoeuvre are a well banked and financially literate population, one that is well penetrated technologically, and a central bank with a very good policy and regulatory brains trust. (I attach a link below to a good overview from the BIS)
Digital central bank currencies can achieve a range of aims – from making the transmission of money a cheaper and faster process (though I am not at all sure that this is good for payment companies and banks), a potentially more secure banking system, and the possibility to rebuild decrepit banking systems (stablecoins – that are linked to an underlying asset/currency – can play a role here). Two other factors are prominent.
One is the ability of central banks to better tailor monetary policy. As it stands, quantitative easing is delivered through financial markets. With a digital central bank currency where households have retail ‘accounts’ at the central bank, it can drop money directly into household accounts, with even a bias towards certain types of households. For example, if the central bank decides that families with two children tend to have a particularly strong impact on the economy then it can funnel relatively more money to them.
The other aspect of the CBDC that deserves greater attention is the enhanced power that it will give central banks. In opening up accounts with the public and businesses there is the risk that central banks assume a Leviathan level of control over financial systems, and to a very large extent subsume them. In China where the government aggressively policies social media content, it may seem automatic that an institution like the central bank can have immense power over people finances, and to an extent act like a fiscal authority as well.
So, if central bank independence and their outsized role in the political economy will be called into question, the counterveiling argument, for the larger central banks at least, is the geopolitical value in rolling out digital central bank currencies. Indeed, China’s announcement that it was advancing its digital currency project has prompted the Fed and the ECB to flag their own programs.
This trend raises many questions, the most prominent of which is the long term role of the dollar. What is perhaps more pertinent is to think how the architecture of central bank digital currencies will evolve – to what extent will central banks have power over household finances and economic behaviour, and to what extent will digital currencies change banking systems (I half suspect that the Chinese authorities’ attempts to rein in Alibaba is conditioned on its plans for the digital yuan).
Two of the important structural issues are outstanding. One relates to emerging countries, whose currencies and relatedly central banks are not as liquid as the ‘old’ monies – will they try to launch their own digital currencies or will we see competing waves of dollarization, euroifciation and yuanificiation across countries like Argentina, Serbia and Malaysia? What is promising here is that countries like Colombia and Uruguay are already active in terms of either mobile payments systems or digital currencies, and in Africa Kenya’s MPESA is a notable digital success story.
The second issue relates to the way in which ‘centralised’ digital currencies will interact with decentralised finance (cryptocurrencies and stablecoins). There is a vision of how these systems can join harmoniously together (see Giles’ excellent DigitalEconomist post on this below). The concern is that by definition the evolution of the crypto world is happening at such a rate, and in such a disorganised way that it presents a threat to the established financial order, and that the two systems grow in parallel, competing ways. It is an exciting and potentially very messy clash, though ultimately CBDC’s might just catch on.
Have a great week ahead,