It is time for Europe’s politicians to overrule the bureaucrats and re-create a flexible, democratic EU capable of responding to its citizens and adapting to a changing world. Most British voters would be happy to remain in that kind of Europe.
...the world population of billionaires nearly doubled to more than 1,800. More than 70 of them live in London – one of the highest concentrations in the world – making the British capital a ripe target for class resentments....
Since 1980 the number of countries with a shrinking population of working age people has risen from 2 to 38.
A smarter grid is also virtually a prerequisite for large-scale power generation from renewable sources such as solar and wind, which are often located in remote locations and have highly variable generation rates depending on time of day or weather conditions.
SMALL BUSINESS LENDING
According to a Harvard Business School case study, small businesses
have created two-thirds of US jobs since 1995. Even so, these enterprises
have become increasingly shut out by traditional banks. To apply for
a loan, the average small or medium enterprise (SME) must fill out 25
hours of paperwork which in turn takes several weeks to process before
a credit decision is made. This low velocity of money wastes critical time
in which a small business may have urgent need for funds. Many of these
companies have both poor accounting and record-keeping. Furthermore,
the idiosyncrasies of small companies makes finding comps difficult if
not impossible. For banks, this makes the transaction costs of lending
$100,000 equal to lending $1,000,000. ...
...
for sme lending....OnDeck (NYSE: ONDK) and Kabbage offer more traditional lines
of credit, but are able to avoid mountains of paperwork by employing
data imported from tax software such as Intuit (NAS: INTU), as well as
social media (e.g. from Foursquare which can track foot traffic)....
...
UK-based Funding Circle—backed by Index Ventures, Accel Partners,
Blackrock, USV and others—offers term loans to small businesses in the UK and US and just expanded to the Netherlands, Germany and Spain
by acquiring German lender Zencap. The company originally offered
loans through an online auction process, but has since transitioned to
a proprietary model to assess credit risk and price loans. The company
resells loans to individual and institutional investors under the guise of
earning a high return...
...
SoFi has already expanded from student loan refinancing
for the most creditworthy borrowers graduating from elite programs
to mortgages for similarly “elite” borrowers, including interest-only
options with faster underwriting and less restrictive liquid net worth
requirements than traditional lenders....
...
According to a 2015 Goldman Sachs report on the rise of shadowbanks, traditional lenders stand to lose $209 billion in unsecured
personal lending and $177 billion in small business lending to online
upstarts. In order for these platforms to justify lofty valuations, they
will need to not only realize their potential in current verticals, but also
tap into much larger markets such as the US mortgage industry, which
originates $1.2 trillion annually.1 ...
...
Prosper’s 2008 class
action lawsuit ... obliged the platform and fellow lender Lending Club
to register with the SEC. The costs of SEC registrationincrease the
barriers to entry for peer-to-peer lenders and thus put a constraint on
new platforms. ...Prosper, the only peer-to-peer lender
to weather both the financial crisis and the settlement of an early class
action lawsuit from investors, announced in May that it would lay off over
28% of its staff due to declining loan volume....
...
Securitization of online-originated loans remains another essential piece
to the puzzle for these lenders to attract long-term, low-cost capital. Through 2Q 2016, cumulative securitization issuance has reached $10.3
billion according to PeerIQ, ...Marketplace lender securitizations
are similar to ABS (asset-backed securities) in other consumer credit
classes; they have similar WALs (weighted average life—the average
amount of time until a dollar of principal is repaid), offering prices and
subordinations, yet are rated lower than comparable securities. ...
...
the long-run knock on effect from underwriting
underperforming loans in an efficient marketplace platform are worse
than the short-term losses from charge-offs....
...
There may be increased opportunity for borrowers to commit fraud due
to lax controls on the use of funds for their intended purposes....
...
Since the start of 2011, online
lending has attracted $12.6 billion in capital across 463 completed
deals....
...
We’ll
likely begin to see platforms cut costs and soon accept down rounds,
as the increased regulatory scrutiny of the industry comes with higher
compliance costs. In order to accommodate hot money, some platforms
dropped lending standards. ...
...
London has
accounted for 10.4% of capital invested and 8.5% of transactions....
...
, the influx of capital into online loans is only made possible with heightened transparency and sophisticated tools to help analyze both
single and packaged loan products....
... The happiest hours of mankind are recorded on the blank pages of history.
The pages of history are not very blank right now. We live in interesting times.
Keep a Cool Head
I think the first step is to acknowledge that these are not normal financial conditions. Far from it.
Normal financial conditions are when interest rates are at 6%, you can reasonably save for the future in a bank account, stocks are neither rich nor cheap, bonds aren’t trading at 160 or 180 or 200 cents on the dollar, and dozens if not hundreds of startup companies aren’t valued at more than a billion dollars.
rapidly becoming the biggest building in the world: Tesla's battery Gigafactory. When complete, the three-story building will be about the size of New York's Central Park.
l...“The more the structural headwinds, the less effective central banks’ stimulus is. It’s ironic, but this is a recognition that is now spreading within the Fed.”...
“The U.S. is having as much structural problems as it is cyclical problems,” said El-Erian,
...Through algorithms driven by machine learning processes, business leaders are matched to the right expert for their project within minutes of uploading an RFP. The platform then stores project information to increase knowledge sharing across the business, minimizing project duplication and optimizing operational efficiency....
I am in my late fifties, and I worry that our generation in the advanced world will be remembered – to our shame and chagrin – as the one that lost the economic plot.
In the run-up to the 2008 global financial crisis, we feasted on leverage, feeling increasingly entitled to use credit to live beyond our means and to assume too much speculative financial risk. We stopped investing in genuine engines of growth, letting our infrastructure decay, our education system lag, and our worker training and retooling programs erode.
We allowed the budget to be taken hostage by special interests, which has resulted in a fragmentation of the tax system that, no surprise, has imparted yet another unfair anti-growth bias to the economic system. And we witnessed a dramatic worsening in inequality, not just of income and wealth, but also of opportunity.
The 2008 crisis should have been our economic wake-up call. It wasn’t. Rather than using the crisis to catalyze change, we essentially rolled over and went back to doing more of the same.
Specifically, we simply exchanged private factories of credit and leverage for public ones. We swapped an over-leveraged banking system for experimental liquidity injections by hyperactive monetary authorities. In the process, we overburdened central banks, risking their credibility and political autonomy, as well as future financial stability....
...
We let inequality worsen, and stood by as too many young people in Europe languished in joblessness, risking a scary transition from unemployment to unemployability....
...
Growing restrictions on companies such as Airbnb and Uber hit the young particularly hard, both as producers and as consumers....
...
Sadly, young people have been overly complacent when it comes to political participation, notably on matters that directly affect their wellbeing and that of their children. Yes, almost three-quarters of young voters backed the UK’s “Remain” campaign. But only a third of them turned out. In contrast, the participation rate for those over 65 was more than 80%.
For instance, more and more affluent people are leaving California because of the taxes and other high costs. Dennis Gartman wrote this note:
According to the always interesting and strong proponent of free markets and small government, the Mercatus Center at the George Mason University, California now owes a stunning $118.2 billion. However, when we add to this sum the pension fund shortfalls and other major concerns, California actually owes $757 billion. On a population of 38.8 million, that's a stunning $19.5 thousand per citizen... Children included!
California's problem is that the state is adding nearly $15 billion annually to its deficits, and as those deficits rise the state’s ability to add to its roads, its universities, its hospitals, its bridges, its all-important water supplies et al are falling rapidly.
California, according to the Investor's Business Daily, is a “massive welfare state.” According to the IBD, one/third of all US welfare recipients live in California, which, with its generous welfare benefits, has become a magnet for impoverished immigrants from around the world. A quarter of the population lives near the poverty line.
And the news from California just gets worse. This from Reason magazine:
Another year, another mess with California’s public employee pensions. The California Public Employees’ Retirement System (CalPERS) announced this week that the rate of return for its investments for the fiscal year ending on June 30 was less than one percent. It was .61 percent. As the Los Angeles Times notes, this is the worst returns it has logged since 2009, when the housing bubble burst and hit California particularly hard.
That’s a far cry from the 7½% CalPERS assumes it will get. And the newly passed $15 minimum wage in California will add almost $4 billion of annual cost for government employees as well as increase the state’s required pension payments. ...
....
I’ve been having this conversation with my friend Ed Easterling. He pointed out that the crunch I am expecting could come in a very different way. Let me quote a paragraph from a recent email he sent me:
Lots of folks [he left the “like you” unstated] have been worrying about a looming financial catastrophe following policies that have included Fed QE, ZIRP, etc., and near-trillion-dollar stimulus programs. Maybe, just maybe, we’ll look back in five or ten years, after no catastrophe, and applaud that such “good” actions saved the economy without negative consequences. When, in reality, the “catastrophe” will have been the loss of 20%, 30%, or more in our standards of living and wage growth. The anecdote of the Frog-In-Boiling-Water may again prove to be a truism of life….
Sentiment: What strikes me the most is the lack of enthusiasm for equities. I was reminded of this by a Bankrate.com poll (see chart below). A quarter of all respondents said the best way to invest money they wouldn't need to touch for a decade or more was real estate. Next was cash or equivalent investments (23 percent). Stocks came in third, tied with gold and precious metals (16 percent). Back in 2013, four years after the bear market had bottomed, a similar Bankrate.comsurvey found that just 14 percent of Americans believed that stocks were the best long-term investment.
...
...Unlike in politics, whererepeating false statements over and over can be a winning strategy, markets have a more objective measure of reality: either your analysis makes you money or it does not. It is the ultimate adjudicator.
Whereas high-quality jobs once made up more than 45 percent of total U.S. employment less than three decades ago, they've since fallen to less than 44 percent. Low-quality work, meanwhile, has risen from less than 37 percent to now account for more 41 percent.
...outgoing Prime Minister David Cameron’s cabinet called for cutting the top corporate tax rate to 15 percent from 20 percent. Cameron’s successor, Theresa May, hasn’t embraced that proposal since taking office on July 13. But with some pro-Brexit members of Parliament calling for the corporate tax to be scrapped altogether,...
steep tax cuts are usually cost-effective for small countries with relatively undeveloped business sectors. In those countries, the loss in tax revenue is more than offset by new investment. Not so for Britain, ...
...By leaving the EU, Britain will be free to change some taxes affecting the sector. But if Britain’s cuts are viewed as unfair to other countries, the EU could exact a high price by restricting access to its markets, ..
Lackland believes his model of revenue-based finance can help companies that:
are likely to generate growth, but not at the scale a VC would be comfortable with;
want to increase valuations before pitching to VCs in order to hold more bargaining chips in the negotiation;
need to raise money quickly and want to be able to count on follow-on capital.
As with anything, benefits come with drawbacks:
Companies are forced to invest revenue into paying back loans immediately. This money can often be used elsewhere.
The need to pay back loans can put a founder in a position where he/she needs to prioritize short-term revenue over other growth metrics.
Investor incentives are aligned with fostering growth but not generating home-runs. Because the investors returns are essentially capped at the investment multiple, risk-averse slow growth is more advantageous than a potentially aggressive flame-out.
...Indigo's first product is aimed at improving water use efficiency of cotton crops, with the company arguing that its application can increase yields by between 5% and 20%. What's particularly important about that claim is that Indigo, unlike other microbial providers, doesn't charge farmers up-front. Instead, the company itself pays to have a farmer's seed coated, and then only receives payment once yield increases are realized in the fields (by using a small untreated crop as a control group)....
....I put the next-gen Wi-Fi gear to the test in two homes that are diabolically difficult to network: a three-story vertical Victorian, and a long, skinny railroad apartment. Aside from awkward shapes, these houses include a laundry list of obstacles like pre-War walls lined with chicken wire, competition from neighbors’ networks and signal-blocking human bodies....
Perhaps Japan could authorize the BOJ to issue very-low-interest perpetual bonds to take on a significant portion of the Japanese debt. That option has certainly been a topic of discussion. It’s not exactly clear how you get people to give up their current debt when they don’t want to, or maybe the BOJ just forces them to swap out their old bonds for the new perpetual bonds, which would be on the balance sheet of the Bank of Japan and not counted as government debt. That’s one way to get rid of your debt problem.
...The same kind of decline in institutional buyers was a dramatic harbinger of the last downturn as more seasoned stakeholders headed for the sidelines.
"Their analytics are telling them it's not a good time to buy — that's definitely another red flag that they're pulling back at the same time as the less savvy investors are ramping up," he said.
And while investors at foreclosure auctions could rely on about a 40 percent discount from the previous sales price in the early years of the expansion, this year they're only garnering about a 30 percent markdown, Blomquist said....
...While everyone was talking about Brexit for the last month, the Bank for International Settlements released its 86thannual report. Based in Basel, Switzerland, the BIS functions as a master hub for all the world’s central banks. ...
More sanguine observers note that because it is relatively free from political considerations, the BIS can speak about economic issues more candidly than its member central banks can.... Today, we find BIS using calm, qualified, central bank language to say, “We think things are likely to come off the rails!”
... this letter we’ll dig into the BIS annual report, parse how their views differ from everyone else’s, and discuss why we are all feeling considerable angst about the future.
...The report’s first chapter has a provocative title: “When the Future Becomes Today.”
Risky Trinity
... Bill White speak. He is a former BIS chief economist and now chairs the OECD Economic Development and Review Committee. ...Bill told us last year that the world’s central banks were making a mistake with their single-minded focus on monetary policy. He noted, correctly, that monetary solutions have not helped, and he stated emphatically that more of the same won’t help, either.
...Bill White is my favorite central banker. Central bank models, he told us, are artificial machines. His best quote was, “The basic problem with central banks: they think they know how the economy works.” Their models are built to be gamed and always assume a return to equilibrium. But there is no equilibrium – you are where you are. The problem with equilibrium models is that they don’t reflect reality.
... like a forest ecosystem, not a machine. We are on a very bad path – debt is unsustainable. Notice the environment since the 2008 crisis: the Eurozone crisis is a limited variant on a global crisis; fiscal and regulatory restraint is not helpful; and monetary policy is the only game in town and is not effective.
... central banks ..., having pushed rates negative in Japan and throughout Europe. I don’t know whether they are following their models or not, because I can’t imagine what model would lead them to the places they have taken us. Nonetheless, here we are.
.... central bankers ... As Winston Churchill said, “However beautiful the strategy, you should occasionally look at the results.”
.l.. negative rates in Europe have been disastrous for banks and insurance companies, not to mention pensions and fixed-income investors. The single-minded focus of current economic thinking is that the driver of the economy is consumption and/or the artificial replacement of private consumption by government debt, which will create desirable inflation. This tenet, trumpeted most famously by Paul Krugman, is going to bite us all ... And that is the essential message of the new BIS report.
The BIS report doesn’t say that the global economy is in a terrible place. Growth is disappointing, sure, but it could be much worse. Unemployment is still too high but is getting better. Inflation isn’t a problem in most places.
What worries BIS, though, are the long-term consequences of what they call a “risky trinity” of unusually low productivity growth, stubbornly high debt levels, and little room for policy maneuvers. That combination is responsible for persistently low interest rates. This is an important point. Ultra-low, zero, or even negative interest rates are not themselves the problem; instead, they are symptoms of the “risky trinity” syndrome. We can (and must) treat the symptoms, but doing so won’t cure the disease.
Interest rates aren’t simply the cost of borrowing liquid capital. They are ultimately the price of money, the single most important price-signaling mechanism in the economy. Rates tell us a lot about confidence among both lenders and borrowers, not to mention consumers.
Right now they tell us nothing good. As BIS puts it:
The contrast between global growth that is not far from historical averages and interest rates that are so low is particularly stark. That contrast is also reflected in signs of fragility in financial markets and of tensions in foreign exchange markets.
The following chart from the BIS report is already wrong, by the way. Last week Swiss interest rates went negative for the entire yield curve, all the way out to 50 years. (In the graph below, CH is the international abbreviation for Switzerland. It’s Latin for Confoederatio Helvetica or Swiss Confederation.)
Addictive Behavior
One thing we don’t have to wonder about is the impact of rising debt. The world is just as addicted to debt today as it used to be addicted to OPEC oil. You might think the pace at which we leverage ourselves would be slowing as regulators crack down post-crisis. Not so. Total debt in all categories (except households, whose debt has shrunk only a very little in the advanced economies since 2010) is still growing at a steady clip relative to GDP.
The right-hand chart above shows global debt growing. Pretty much everyone is in hock to someone. Pay down private debt, and government debt goes up. Reduce government debt, and household debt rises. This is what addictive behavior looks like. Forget heroin and OxyContin; debt is the world’s favorite drug by far.
Periodically, addicts concerned about outcomes try to get clean. The results are never pretty at first. Our politicians, unwilling or unable to go through the painful detox process, always go back for another fix. Dealers are always happy to provide. The dealers, in this context, are banks – and central banks more than private ones.
This addiction to debt is one reason we keep having market tantrums. Last year people got concerned about China. Before that it was Greece. Now China is off the radar (even as its currency drops more than it did during our tantrum last summer); and we’re obsessed with the UK, Germany, and Italy. BIS says the results of this oscillating calm and turbulence are troubled equity markets, wider credit spreads, a stronger dollar, and lower long-term interest rates.
Mixed Debt Signals
I noted above that interest rates have an important signaling function. What happens when the signals are wrong? People make bad decisions, of course. And, for at least the last six years (perhaps more), the signals have been very wrong indeed. Distorted signals spurred an epidemic of unwise choices. Worse, many of those bad choices were made by central banks, which, by virtue of their size and position, can spread the infection far and wide. What we have seen is the financialization of business markets, as businesses are incentivized to buy their competitorsrather than competing or to buy their own stock with cheap money rather than invest in new productive processes. Neither of those options boosts employment or labor productivity, which is why you see a slowing economy.
Truly “free” markets exist only in theory. Maybe interest rates would find a real equilibrium in a free market, but we can’t know this because our markets aren’t free. What we actually have is a muddled mixture of market forces, political decisions, and human folly.
The BIS report notes the problem with interest rates and suggests that it is at the core of our present predicament. Here’s what they say. (Bold emphasis is mine.)
Importantly, all estimates of long-run equilibrium interest rates, be they short or long rates, are inevitably based on some implicit view about how the economy works. Simple historical averages assume that over the relevant period the prevailing interest rate is the “right” one. Those based on inflation assume that it is inflation that provides the key signal; those based on financial cycle indicators – as ours largely are – posit that it is financial variables that matter. The methodologies may differ in terms of the balance between allowing the data to drive the results and using a priori restrictions – weaker restrictions may provide more confidence. But invariably the resulting uncertainty is very high.
This uncertainty suggests that it might be imprudent to rely heavily on market signals as the basis for judgments about equilibrium and sustainability. There is no guarantee that over any period of time the joint behaviour of central banks, governments and market participants will result in market interest rates that are set at the right level, i.e. that are consistent with sustainable good economic performance (Chapter II). After all, given the huge uncertainty involved, how confident can we be that the long-term outcome will be the desirable one? Might not interest rates, just like any other asset price, be misaligned for very long periods? Only time and events will tell.
For what it’s worth, I think there is no question that interest rates have been misaligned for quite some time now. When 12 people or 27 people sit around a table and decide what the price of the most important commodity in the world is (that would be the interest rates for money), how can they possibly get it right? The evidence is that, more often than not, they don’t.
But what would happen if the central banks didn’t set rates? Oh dear gods, market participants intone, we would have unrestrained volatility and uncertainty. That is true, but central bank misjudgments about economic trends, translated into interest rates, eventually lead to crashes and result in markets far more volatile than we would experience with lesser, more numerous adjustments that didn’t involve control of rates.
Let’s draw an analogy between monetary policy and forest management. We have learned that by preventing small forest fires we actually create the conditions for large, disastrous fires that are extremely difficult to bring under control. We have found out that we should actually allow the smaller fires in order to avoid the big ones. Unfortunately, the more enlightened approach comes too late for a large portion of our nation’s forests, which in many places have become overgrown tinderboxes. Central bank monetary policy likewise suppresses the smaller corrections that prevent economic conflagrations
I know it is difficult to admit this, but think about it. Can’t stock prices go irrationally low or high? Of course they can. Do they then adjust? Of course they do. We’ve all seen them do it and can point to many examples in market history. So why should interest rates be any different?
We have, all of us, built an economic and political system that encourages and subsidizes debt. Is it any surprise that we have created an excess supply of it? Of course not. There is a great irony here, in that more and more countries are penalizing income and savings – and then we worry about incomes not growing enough. By now, it should be a well-understood concept that if you subsidize and set the price for a commodity (like debt) below its actual market price, you’re going to get too much of it.
Debt is future consumption brought forward. Once debt is incurred, consumption that might have happened in the future won’t happen, and it should come as absolutely no theoretical surprise that at a certain level of debt, growth and income begin to diminish. That is exactly what we are seeing in the real world, even if those who espouse the reigning economic paradigm (Keynesianism) are still in love with their beautiful theory.
There are basically two categories of debt: debt used to purchase or create productive activities (like tools for a carpenter or a new factory for a business) and debt used to consume.
We forget that debt used for consumption doesn’t create new supply; it simply pulls supply forward in time. The problem is that debt can’t do this forever. Pulling your consumption forward to the present means you will consume less later. The BIS says these “intertemporal trade-offs” eventually constrain our options. And when they say “eventually,” what they really mean is “now.” Thus the title of their current report: “The Future Will Soon Be Today.”
Is the Fed Shooting Blanks?
As noted above, the BIS is in the unique position of serving global economic stability in general and central banks in particular. It can criticize central banks more freely than politicians, bankers, or business leaders can. The BIS is usually gently critical in public documents, but I’ve always wondered what happens behind closed doors. I am told by reliable sources that the conversations can get rather blunt, especially in the monthly meetings of global central bankers. The current report ratchets up the public level of the BIS’s concerns.
Right now the problem is that monetary policy is carrying a load it was not designed to bear. Strong central bank action during the crisis was necessary and appropriate, says the BIS report, but the extended wind-down hasn’t served the desired goals. This protracted reliance on extraordinary monetary policy carries the risk of causing the rest of us to lose faith in the policymakers. The BIS has an ominous note on this:
Financial markets have grown increasingly dependent on central banks’ support, and the room for policy maneuver has narrowed. Should this situation be stretched to the point of shaking public confidence in policy making, the consequences for financial markets and the economy could be serious. Worryingly, we saw the first real signs of this happening during the market turbulence in February.
In other words, what happens when banks, investors, and the public lose trust in the Fed, the ECB, the Bank of England, and the Bank of Japan? The BIS isn’t talking about the sort of routine grousing we all engage in. Everyone gripes about the Fed in good times or bad. But beneath our chronic irritation, we still maintain a fundamental trust that the Fed will step in to prevent any cataclysmic event. What if that’s not true? What if the Fed really is out of bullets? If you ask almost anyone associated with the Fed, they will tell you they still have choices and ammunition.
The problem I worry about is, do they actually have any more live bullets? I’m quite concerned that in the future they will be “shooting blanks,” and the expected economic responses will simply not happen. The irony is that, like actors in a grade B action movie, they will keep pulling the trigger and shooting those blanks. Somehow, they seem to think the “editing” process will make their economic movie seem more real.
We all hope not to learn the answer to my question. The BIS drops a pretty loud hint, though. With its “Worryingly” sentence, the BIS confirms that we are right to wonder about the continued efficacy of central bank action.
Having worried us about policy making, the BIS goes on to offer some policy suggestions. They group their ideas into three sections: prudential, fiscal, and monetary.
By “prudential” policy, the BIS means bank regulation and capital requirements. Much has changed on that front since the last crisis. The Basel III framework is forcing banks to hold more capital to cover the risks they take. This requirement is having the effect, according to many traders, of drastically reducing bond market liquidity.
The BIS concedes the point but responds with an argument I haven’t seen anywhere else. Before the last crisis, they say, liquidity was actually underpriced. Liquidity providers, having not been fully rewarded for the value they provide, then disappeared when everyone really needed them. Central banks and governments had to step in and take their place.
To avoid this dynamic in the future, BIS suggests we should be happy to pay more for liquidity than we are accustomed to doing. We should pay market-makers well in good times so they will be there for us when a storm hits.
The best structural safeguard against fair-weather liquidity and its damaging power is to avoid the illusion of permanent market liquidity and to improve the resilience of financial institutions. Stronger capital and liquidity standards are not part of the problem but an essential part of the solution. Stronger market-makers mean more robust market liquidity.
I deeply suspect this language is really a veiled criticism of high-frequency algorithmic trading. High-frequency trading (HFT) creates an illusion of liquidity. Depending on whom you choose to believe and how you measure it, HFT may be 70% or more of total market volume. This trading will immediately disappear if we actually need liquidity. It is simply a canard foisted on the public by exchanges and funds that use HFT to say that these entities are providers of liquidity. HFT is precisely what the BIS is talking about when they use the term illusion of market liquidity.
It makes me wonder if we are going to miss the “specialist” role the NYSE has traditionally had for the trading of most listed stocks. The exchange has nearly done away with all that and thought it could make up for the lost fairness and market equilibrium with volume. I’m not sure it has worked out that way.
In the fiscal policy area, the BIS says we should rethink how we evaluate sovereign risk. Because governments – or at least the ones that have their own currency – can always “print money,” investors assume their credit risk is low or nonexistent. That’s clearly not the case. Ask someone who invested in Argentine government bonds a few years ago, and they will explain.
Whatever governments deliver in reduced credit risk usually gets offset by higher inflation and interest-rate or market risks. We need to think about risk as a liquid substance. We can move it from one bottle to another, split it among multiple bottles, or put it in the deep freeze, but we can’t make it disappear. Even pouring it down the drain just transfers it to someone else.
If prudential and fiscal policies were properly organized, we would not need to rely on central banks so much. But that doesn’t mean central banks should be inactive. The BIS does explicitly argue for a strong monetary policy role. However, they think that role should look different than it does today.
One big change they suggest is to rely less on inflation targeting. Stubbornly low inflation is what has kept policy accommodative ever since the 2008 crisis. In hindsight, it may have been better to tighten interest rates back toward “normal” (whatever that is) long before inflation rose back to “normal” (whatever that is)..
It’s hard to say how this approach would have worked in practice. Looking back, by 2011 the US was out of recession and stocks were doing well, but unemployment was still stubbornly high. Unable to drop rates any further, the Fed launched quantitative easing instead. The ECB is now doing something similar but even more aggressively.
For three or four years, the Federal Reserve used the excuse that unemployment was unacceptably high; and then when unemployment got close to the “normal” range, they simply refused to pull the rate-hike trigger. They worry about stock markets more than they worry about the imbalances they are creating. They are in danger of losing their credibility, which would be damaging to all of us.
One way or another, says the BIS, “We badly need policies that we will not once again regret when the future becomes today.”
Losing the Narrative
My friend Ben Hunt writes one of the more thoughtful letters I read. I’m going to summarize what I believe to be his views – perhaps because they reinforce my own.
Ben talks about the power of the Common Narrative, the things that we all know and believe. Much of this is what we learned growing up about our countries or religions. These narratives (and there are more than a few of them) shape our prejudices and our actions. This is not necessarily bad, as more often than not these narratives can encourage socially beneficial behavior.
More specifically, Ben talks about the narrative surrounding the central banks. We tend to imagine that they have a great deal of power to drive markets, especially with quantitative easing and their ability to raise and lower rates. We have come to the point that we actually think that the Fed creates value, apart from the income generated by businesses. In fact, it is increasingly a problem (a problem in my mind, at least) that investors are relying more and more heavily on central banks to continually stoke the market, rather than valuing and investing in the market in an old-fashioned Graham-Dodd way. And as long as enough of us believe in that narrative, it becomes a self-fulfilling prophecy. Says Ben,
What I care deeply about, however, is how the Narrative around these events is being shaped and reshaped, because that Narrative will determine the path and outcome of every election and every market on Earth. And what I can tell you is that I am shocked by the diminishing half-life of status quo protecting Narratives, by the inability of Big Institutions and Big Money and Big Media and Big War and Big Academia to lock down an effective story that protects the State, even when their competition is primarily comprised of clowns... There’s a … tiredness … to the status quo Narratives, a Marie Antoinette-ish world weariness that sighs and pouts about those darn peasants all the way to the guillotine….
Why are the status quo protecting Narratives faltering so badly? I think it’s because status quo political and economic institutions – particularly Central Banks – have failed to protect incomes and have pushed income and wealth inequality past a political breaking point. They made a big bet: we’re going to bail-out/paper-over the banks to prevent massive losses in the financial sector, we’re going to inflate the stock market so that the household sector feels wealthier, and we’re going to make vast sums of money available for the corporate and government sectors to borrow really cheaply….
The result, or so the thinking went, of all this pump-priming or bridge-building or whatever metaphor you please would be for all four basic sectors of the global economy – households, corporations, governments, and financial institutions – to consume more and invest more and fail never, which would in turn create a virtuous, self-sustaining cycle of risk taking, real growth, and real wealth creation.
We all know what happened when the narrative surrounding the price of housing and subprime debt collapsed in 2008. You don’t have to be much of a historian to come up with many examples of collapsing narratives. War in Europe is impossible, we were told as late as 1913. And more recently, the British wouldn’t actually vote to leave the EU.
Central banks around the world have pushed the limits of what their credibility can actually deliver. I truly worry what will happen when we enter the next recession and everybody realizes that the Federal Reserve, the ECB, the BOE, and the BOJ are shooting blanks and the emperor has no clothes. Given the mood in countries all over the world and the frustration of the Unprotected class with the seemingly impervious Protected class (which will be compounded if we have another protracted income recession), the level of uncertainty regarding future events is at least as high as it has been at any time in my life.
The next recession, whenever it comes, will result in a completely different type of global crisis than we have seen in the experience of those alive today. Oh, there will certainly be some things that rhyme with history, but I think we would have to go back to the ’30s to find a period roiled with this much social upheaval.
Investors are going to require a different type of portfolio management and structure. You really need to rethink your commitment to a long-only portfolio, especially if you are over 50 years old. I know that’s difficult to contemplate, because the Federal Reserve and the ECB have made normal fixed-income investing impotent. But moving out the risk curve today is fraught with peril.
...
I know I complain about absurdly low interest rates, and they do affect all of us who would prefer to have more fixed income in our portfolios; but many of us also benefit from low rates. Two years ago I actually bought a home (technically an apartment in a high-rise) for the first time in 20 years, benefiting from low rates. There was actually a bidding war for my mortgage business. Who knew that banks actually got into a bidding situation over a mortgage? That was my first clue that things had changed. The next clue came a few months ago when my banker at Capital One bank, Clinton Coe, who was one of the losers in the last bidding war, called and asked me if I would like to refinance my mortgage for no points at ¼% lower.
I would have been silly not to, so I told him to go ahead and get the paperwork done. I had originally done a 5-year, 30-year amortization, ARM (adjustable-rate mortgage) at 2.75%, expecting that there would be another recession within five years and that I would get to refinance my mortgage at what would probably be a lifetime, if not generational, low, at which point I would tell them to back up the truck and give me as much money as they could for as long as they could.
...Capital One.,,, the world of bank lending has truly changed. It has truly turned upside down. Oh, the final rate? 2.375% for five years. Clinton tells me they are doing the mortgage for their own “book,” which leads me to wonder what kind of return on capital banks are actually trying to procure these days. I shake my head.
So how can AR/VR startups survive when long-term AR/VR business models won’t have the scale they
need to thrive for 18-24 months? You just need to know where to look. So let’s
look.
pretty standard for
the games industry, and is already helping AR/VR games studios build their
businesses via development
Own a vertical
zSpace’s a complete screen
VR solution for education. “We use a subscription model, where hospitals get
our hardware for free and pay for neuro-healthcare exercise/games content and
analytics. We also have a subscription-based home product for compliance and
training.”
Have wealthy parents
strategic high ground requires
serious piles of cash to make it work
Sell picks and shovels
serves “almost a
quarter of a million developers, and over 25,000 apps.” making money from
app development, customized AR engine licensing and AR engine sales …. fill the
gap left from when Metaio was
bought by Apple.”
Get sponsored
on brand-funded
content. Brands can rationalize this in a marketing budget and get early mover
visibility for whatever they’re trying to promote
Enable advertisers
turn static media into
AR interactive content, …monetize with platform access fees and
performance-based pricing.”.
Sell to enterprises
to enterprises and
governments value-added reseller network today.
the company’s $60,000 OZO 360-degree camera
from “sports, music, news, entertainment and advertising sectors. Our pilot
projects could lead to large enterprise deployments in the next one to two
years.”
Sell to users
build marketplaces and
tools that help people share content, and collect fees on those marketplaces.
retail sales,
Be lean
It’s worth keeping in mind that AR/VR is
still a very early-stage market.
Sequoia Partner Matt
Huang describes this approach eloquently. “If you’re a startup in a market with
uncertain timing like AR/VR, breaking into a curve is safer than accelerating.””
Innovate
business model
innovation in the next 18-24 months, rather than legacy monetization models
. It is not the strongest
that survives. But the species that survives is the one that is able to adapt
to and to adjust best to the changing environment in which it finds itself.”
The immediate effects on startups have been incredibly personal. Bewilderment is the word you hear most. ...
....
The day after the referendum I was contacted by three separate startups to say their venture capital funding had been cancelled because they were being financially backed from the UK and were in the EU, or in the UK and backed by EU-based investors. Several more have come to me since with similar news. Uncertainty has left the normally upbeat tech sector reeling.
And we’ve been coldly reminded of the complexity of the modern international startup, once seen as a strength, but, post-Brexit, could now become a huge headache. One UK-based founder contacted me: “My entire budget is now completely invalid as we have employees in 3 different EU countries, and in the USA. We are deeply affected by the currency devaluation issue.
