My article, summing up the key lessons from the Global Financial Crisis that investors should review before the next crisis hits is now available via Manning Financial newsletter: http://issuu.com/publicationire/docs/mf_winter_2017?e=16572344/55685136.
Friday, November 24, 2017
My article, summing up the key lessons from the Global Financial Crisis that investors should review before the next crisis hits is now available via Manning Financial newsletter: http://issuu.com/publicationire/docs/mf_winter_2017?e=16572344/55685136.
Tuesday, November 21, 2017
Holger Zschaepitz @Schuldensuehner posted earlier today the latest data on ECB’s balance sheet. Despite focusing its attention on unwinding the QE in the medium term future, Frankfurt continues to ramp up its purchases of euro area debt. Amidst booming euro area economic growth, total assets held by the ECB rose by another €24.1 billion in October, hitting a fresh life-time high of €4.4119 trillion.
Thus, currently, ECB balance sheet amounts to 40.9% of Eurozone GDP. The ‘market economy’ of neoliberal euro area is now increasingly looking more and more like some sort of a corporatist paradise. On top of ECB holdings, euro area government expenditures this year are running at around 47.47% of GDP, accord to the IMF, while Government debt levels are at 87.37% of GDP. General government net borrowing stands at 1.276% of GDP, while, thanks to the ECB buying up government debt, primary net balance is in surplus of 0.589% of GDP.
Meanwhile, based on UBS analysis, the ECB is increasingly resorting to buying up ‘bad’ corporate debt. So far, the ECB has swallowed some 255 issues of BB-rated and non-rated corporate bonds, with Frankfurt’s largest corporate debt exposures rated at BBB+. AA to A-rated bonds count 339 issues, with mode at A- (148 issues).
It would be interesting to see the breakdown by volume and issuer names, as ECB’s corporate debt purchasing programme is hardly a very transparent undertaking.
All in, there is absolutely no doubt that Frankfurt is heavily subsidising both sovereign and corporate debt markets in Europe, largely irrespective of risks and adverse incentives such subsidies may carry.
The folks at Brown University have carried out the most detailed assessment of the disastrous costs of the U.S. wars fought since 9/11. The details can be found here: http://watson.brown.edu/costsofwar/. These are a must read! While Russia stands accused by the U.S. of triggering the humanitarian crisis through its intervention in Syria (the civil war that started with the U.S. support and blessing), here is Brown University's conclusion about the real refugees crisis:
Not to say that one wrong (U.S.) makes another wrong right (Russia), but 10.1 million estimated refugees caused by the U.S. wars? This got to stand out, folks.
The U.S. has spent estimated USD5.6 trillion from 9/11 through fiscal year 2018 according to the study.
Enough to buy healthcare for every American, or to pay all outstanding student debt. Hell, in fact, it would have allowed for both.
And the above costs and impacts do not account for Libya, Egypt, Yemen and other direct and indirect 'minor' conflicts the U.S. has been involved in. The statistics do not include Syria.
In a recent post, I mused about the asymmetric warfare and the fact that, seemingly, outspending the entire world in terms of defense expenditures, the U.S. appears incapable of achieving its core objectives (see the post here: http://trueeconomics.blogspot.com/2017/09/12917-asymmetric-conflicts-and-us.html).
There appears to be no learning curve from the past 16 years - neither in the public minds (who support increasing expenditure on military industrial complex) and in the mind of the Washington politicians (see http://www.tomdispatch.com/post/176335/tomgram%3A_andrew_bacevich%2C_how_we_learned_not_to_care_about_america%27s_wars/#more).
And there is neither an increase in transparency in the American policies post-9/11, nor an increase in scrutiny of choices made (see http://watson.brown.edu/costsofwar/files/cow/imce/papers/2017/Linda%20J%20Bilmes%20_Credit%20Card%20Wars%20FINAL.pdf):
As folks from Brown University project conclude: "The wars have been accompanied by violations of human rights and civil liberties, in the US and abroad. The wars did not result in inclusive, transparent, and democratic governments in Iraq or Afghanistan... The human and economic costs of these wars will continue for decades with some costs, such as the financial costs of US veterans’ care, not peaking until mid-century. US government funding of reconstruction efforts in Iraq and Afghanistan has totaled over $170 billion. Most of those funds have gone towards arming security forces in both countries. Much of the money allocated to humanitarian relief and rebuilding civil society has been lost to fraud, waste, and abuse."
This is genuinely frightening!
In a recent post, I wrote about the AI breaching the key dimension of 'intelligence' - the ability to self-acquire information and self-replicate knowledge (see http://trueeconomics.blogspot.com/2017/10/221017-robot-builders-future-its-all.html). And now, Chinese AI developers have created a robot that is capable of excelling at (not just passing) a medical certification exams: https://futurism.com/first-time-robot-passed-medical-licensing-exam/.
Years ago, working for IBM's think tank, IBV, I recall discussions about the future potential applications for Watson. Aside from the obvious analytics involved in finance (my area), we considered the most feasible application for AI and language-based software in... err... that's right: medicine. More precisely, as family doctors replacement. For now, Watson is toiling primarily in the family doctors' support function, but truth is, there is absolutely no reason why AI cannot currently replace 90% of the family doctors' practices.
And, while we are on the subject of AI, here is an interesting article on how China is beating the U.S. (and by extension the rest of the world) in the AI R&D game: https://futurism.com/china-could-soon-overtake-the-us-in-ai-development-former-google-ceo-says/ and https://futurism.com/china-has-overtaken-the-u-s-in-ai-research/.
Still scratching your heads, Stanford folks?..
There is a much-discussed in the crypto-sphere chart making rounds these days, plotting Bitcoin price dynamics against the historical bubbles of the past:
The chart is striking. Albeit simplistic. See Note 1 below for a technical argument on the chart timing.
On price dynamics alone, Bitcoin looks like a sure bubble - a disaster waiting to happen. But Bitcoin dynamics are basically not suited for any empirical analysis of any significant accuracy.
As noted by some commentators, Bitcoin had numerous 80-90% and larger drawdowns in the past (given its immense volatility). It keeps coming back from these. Some claim this to be the evidence that Bitcoin it not a bubble. Which is neither here nor there: bubbles are generated by exuberant expectations of investors, not by actual parameters of price processes. Causality does not flow from dynamics to bubbles, but the other way around. So to identify a bubble, one needs to identify exuberance. See Note 2 below for more on 80% drawdowns.
In the case of Bitcoin fans, there is clearly such.
No investor or serious analyst has been able to provide a fundamentals-based valuation model for Bitcoin.
A disclosure in order here: myself and a graduate student of mine have looked at the fundamental modelling for Bitcoin over the summer. We found no tangible relationship between any economic or financial parameters tested and Bitcoin price dynamics. In another piece of research, myself and two co-authors are currently looking at empirical dynamic and fractal properties of Bitcoin. Again, we finding nothing consistent with a behaviour of an asset with fundamentals-derived valuations.
Absence of evidence is not the same as evidence of absence. But, taken together with the general lack of credible fundamentals-linked modelling of the crypto-currency, this means that, at this point in time, Bitcoin price can be potentially driven solely by… err… expectations held by its enthusiasts, plus the incentives by the predominantly China-based investors to avoid extreme risks of capital controls and expropriations. If so, both drivers would make it a speculative bubble.
The only quasi-fundamentals-linked argument for Bitcoin has been the blockchain one - the promise of Bitcoin serving as a key tool for data aggregation, recording and transmission. This argument, however, no longer holds. Blockchain technology has migrated from public blockchains, like Bitcoin, to either open blockchains, like Ethereum or, increasingly more frequently, private blockchains. It is the latter that currently hold the promise to serve as viable platforms for data economy.
As a libertarian, I should like a private currency system that supports anonymity of transactions. As an economist, I should like the innovative nature of Bitcoin. And, put simply, I do. Both.
But as an investor, I do not have the stomach for Bitcoin’s valuations and volatility, as well as for its higher moments behaviour (in particular worrying are kurtosis, co-skews and co-kurtosis, which severely complicate empirical dynamics analysis, see Note 3 below). And I have even less enthusiasm for the crypto market that is sustained increasingly by undertakings, like BitMEX - a purely speculative platform trading some $35 billion in Bitcoin derivatives with leverage up to x100 to the amateur speculators who, put frankly, have zero idea what they are buying and at what price. The vast majority of Bitcoin investors have no clue what a butterfly option looks like and how it can be valued. And the vast majority of financial markets analysts and professionals won’t be able to price a butterfly strategy for Bitcoin, given its painfully twisted moments. Yet, within a month of starting trading, BitMEX reached 1/3 of the market capitalisation of Bitcoin. This is not just a shoe-shine-boy moment, folks. It is white-powder-under-the-nose-and--empty-bottles-of-vodka-on-the-floor hour for high school dropouts with cash to burn.
Another worrying issue with Bitcoin is the argumentation of its main supporters.
This ranges from the cognitively biased “you don’t know anything about the Bitcoin” to “Bitcoin is scarce & limited in supply” to “Bitcoin is a promise of liberating the masses from the oppression of the Central Bankers”.
The first sort of argument exhibits not just Jurassic ignorance of logic, but also a gargantuan dose of arrogance. Repeated sufficiently enough, it signifies the absurd degree of exuberance of investors’ expectations.
The second argument is patently false. Bitcoin has undergone splits, and engendered dozens of other cryptos, with unlimited supply of such into the future. Bitcoin itself is divisible ad infinitum and, with forks, its supply is potentially unlimited. Worse, Bitcoin rests on man-made mathematical foundations. Which means it has no physical bound or constraint. Anything man-made (and even more so, anything mathematically derived) is, by definition, fungible and axiomatic. Just because to-date no one cracked the code to alter Bitcoin mid-stream or drain blockchain-held information does not mean that in the future such a code cannot be written. So hold your horses: gold is physically limited in quantity (even though in the Universe, it is not as scarce as it is on Earth, which makes long term supply constraint on gold potentially non-binding). Bitcoin is limited by our capacity to alter the underlying code defining it. Anyone thinking of an algorithm as a 'law' needs to go back to Godel's mathematics.
Worse, anyone claiming that Bitcoin is a hedge against inflation fails to understand how modern markets work. Again, to increase in value, Bitcoin requires higher rates of adoption. Higher rates of adoption bring about higher rates of asset instrumentation (see above for BitMIX). Higher rates of instrumentation and adoption, taken together, imply higher holdings of Bitcoin by institutional and diversified portfolio investors. So far so good? Right, now the kicker: these holdings imply greater, not lower, positive correlations between Bitcoin and other asset classes in shock-experiencing markets. That's right, dodos: Goldman holdings of Bitcoin are correlated to liquidity supply in general markets, because if such liquidity starts evaporating, Goldman will sell Bitcoin to plug holes in other instruments. Sell-off in the markets can trigger sell-off in Bitcoin. Now, another kicker: Bitcoin is currently less liquid than any major asset class (see extreme volatility of pricing across various Bitcoin exchanges). Which means that smart folks at Goldman will be dumping Bitcoin before they dump gold and other assets. Hipsters hugging their laptops will be the last to wake up to this momentum (behavioural evidence suggests, they might actually buy into falling Bitcoin in hope of speculatively gaining on a bounce, which, incidentally, can explain why large drawdowns in Bitcoin can turn so fast into upward trends).
The tricky bit about Bitcoin is that its enthusiasts need to learn to live in the real world first. Until they do, Bitcoin will continue its upward path, and this process can go one for quite a while, depending on the supply of cash in the markets for Bitcoin. Once they are taught a sufficient lesson, however, the rest of us will be learning the long term fundamentals valuations of Bitcoin. I, for now, have no idea what these valuations might be.
So Bitcoin, then. A bubble or not? If you ignore the arguments that attempt to justify its valuations, it looks like one, albeit with dynamics that are very hard to interpret. If you listen to them, it looks that way even more, with more confidence in the arguments bogus nature. Draw your own final conclusions.
Note 1: In defence of the chart above, without validating its implied conclusions: the chart plots Bitcoin evolution from 3 years ago through today. This starting point makes sense. Until mid-2014, Bitcoin was extremely obscure, hype-only investor vehicle, with volatility so off the charts, any analysis of its dynamics was futile (I know, I did such analysis and presented the results in my talk at Bloomberg two years ago). Those us who do research in finance generally and routinely disregard the first 3-4 years of existence of Bitcoin for exactly that reason.
Note 3: Interesting Elliott Wave analysis of Bitcoin dynamics here: https://atozforex.com/news/29-september-bitcoin-elliott-wave-analysis/ and here https://www.cnbc.com/2017/07/20/bitcoin-bubble-dwarfs-tulip-mania-from-400-years-ago-elliott-wave.html, although I am not convinced Bitcoin price trends are established enough for this technique to work.
Monday, November 20, 2017
An interesting view of the Russian economy (as usual) from Leonid Bershidsky: https://www.bloomberg.com/view/articles/2017-11-14/russia-s-economy-is-growing-with-borrowed-money
Credit, is not a sustainable source for growth in Russia, especially as the Russian households’ leverage capacity (underpinned by expected future wages) is not exactly in rude health. A recent study from the Russian government's own Analytical Center found that roughly 17% of the working population, or about 12.1 million Russians, can be classified as the working poor - those earning less than enough to cover the minimum purchases required to sustain a family. The study also found that majority of the working poor in Russia rely on microcredit, short term payday loans and/or traditional bank or credit card borrowing to meet daily necessary expenditure.
Low wages, rising credit
Rosstat data confirms the findings. Roughly 7% of all wage-earners are paid wages below the monthly subsistence minimum. Over 17% of people working in the education sector or various municipal services earn below-subsistence wages.
Moscow has set a target of 2019 for raising wages to the legally required subsistence minimum level, with minimum wages hiked in 2016 and mid-2017. Current minimum wage is set at Rub 7,000 per month (roughly EUR115) which is only about 60% of the average subsistence minimum levels and close to 20% of the average monthly wage, according to BOFIT report. This is about half the level (of 40%) ratio of the minimum wage to the average wage across the OECD countries.
Accumulation of household debt, therefore, is hardly the good news for the economy in the long run, as debt affordability is only sustained today by the falling interest rates (cost of carry), and is not consistent with the wages dynamics, and wages levels, especially at the lower end of earnings.
Meanwhile, the latest data on economic growth came in at a disappointing print. Russian GDP growth fell from 2.5% y/y in 2Q 2017 to 1.8% in 3Q 2016, driven down by slower expansion in both exports and domestic investment. Over the period from January through September, Russian economy grew by roughly 1.6% y/y - well below the official forecasts and analysts consensus expectations. Oil output fell, despite the rise in global oil prices, as Russia continued to implement OPEC-agreed production cuts.
On external trade, exports of oil and related products were up in 3Q 2017 in line with oil prices, rising 26% y/y. Exports of metals and other primary materials were down sharply. In January-September, exports of goods were also up 26% y/y with the share of oil and gas in total goods exports up sharply to 60%.
Notably, the value of exports of goods and services (at USD250 billion) over the first nine months of 2017 has robustly exceeded the value of imports (at USD 170 billion).
Russian growth slowdown is structural, as I wrote on numerous occasions before. The structural nature of the slowdown is reflected in subdued private investment growth and lack of dynamism in all private enterprise-led sectors, with exception, perhaps of the cyclical agriculture. Even food production sector - which should have benefited from record crops (over 2014-2017) and trade sanctions (import substitution) is lagging. Capital deepening and technological innovation are far behind where these should have been after roughly 19 years of post-default recovery in the economy.
The structural decline in the private sectors activities is contrasted by expansion of the state sector.
According to the Rosstat figures, over recent years some 11-12% of total earnings in the Russian economy was generated by the larger state-owned or part-state-owned enterprises. This figure excludes direct Government spending. In other words, state spending and state-owned companies revenues now account for close to 40% of the Russian GDP. As reported by BOFIT, state-owned enterprises “revenues are highly concentrated. Surveys by the Russian Presidential Academy of National Economy and Public Administration (RANEPA) show that just 54 large state-owned enterprises (SOEs) account for 8% of revenues [half of that accrues to only two companies: Gazprom and Rosneft]. When 20 indirectly state-owned firms are added the share rises to 12%.” This is in line with the figure of 11% reported by Expert.ru based on their list of 400 biggest companies in Russia.
Outright direct Government (local, regional and federal) expenditure amounts to slightly above 13% of GDP, based on Rosstat figures. This means that, raising the larger enterprises share to account for smaller and medium sized state-owned companies, the total state-owned enterprises and Government share of the economy can be around 38% mark, slightly above the 2010 estimate of 35%, provided by the ENRD. Interestingly, the above imbalances in the structure of the Russian economy do not seem to reflect too poorly on the country rankings in the World Bank Doing Business report. Out last week, the rankings put Russia in 35th place globally, our of 190 countries, placing it just below Japan and well ahead of China (78th).
In summary, Russian economy will not be able to get onto a higher growth path (from the current 1-1.5 percent range) until there is a significant shift in growth drivers toward capital deepening (necessary both to offset adverse demographics and the chronic under-investment in new capital over the recent years), and technological deepening (required to modernise industrial and services sectors). To effectively trigger these processes, Russia needs to hit, simultaneously. three policy targets:
- Improve overall relationship with Europe, while continuing to build on positive trade and investment momentum with Asia-Pacific region;
- Increase the share of private enterprise activity in the economy, by reducing the state share of the economy to below 35% of GDP; and
- Focus on reforming institutional frameworks that currently hold Russian investors from investing in the domestic production, including closing gaps on product/services certification between Russia and Europe, and effectively (not pro-forma) reforming legal frameworks.
In the context of the ongoing Chinese debt bubble crisis (yet to explode into a full crisis, but the timer is ticking ominously), the ZeroHedge presented the following chart:
The dire state of the global economy post-QE waves of 2008-2017 is reflected in the vast asset bubbles building up across the main markets, with Canada, China, Australia leading the surge, while the U.S. residential property prices are now also at historical peak (previous peak reading was at 184.62 against current at 195.05):
New Zealand is not far off from its neighbour, Australia:
In short, things are getting beyond the pre-2007 bubble levels and the risks of a blowout in global property markets are rising. All we need is a catalyst for breach, which is likely to be either a ramp up in credit costs in the advanced economies or a tightening of credit in China, or both.
S&P Global article on the fate of tracker mortgages scandals in Irish banks (with comments of mine): https://marketintelligence.spglobal.com/our-thinking/news/irish-banks-face-higher-provisions-as-storm-over-tracker-mortgages-grows.
Sunday, November 19, 2017
Behavioral biases come in all shapes and forms. Many of these, however, relate to the issue of imperfect information (e.g. asymmetric information, instances of costly information gathering and processing that can distort decision-making, incomplete information, etc).
A recent Quartz article on the balance of threats/risks arising from the 'fake news' phenomenon (the distortion of facts presented, sometimes, by alternative and mainstream media alike) and another informational asymmetry, namely selectivity biases (which apply to our propensity to select information either due to its proximity to us - e.g. referencing bias, or due to its ideological value to us - e.g. confirmation bias, etc). Note: Quartz article is available here: https://qz.com/1130094/todays-biggest-threat-to-democracy-isnt-fake-news-its-selective-facts/.
According to the article: "News sources aim to cover—in the words of the editor in chief of Reuters—the “facts [we] need to make good decisions.”" But, "As readers, we also suffer from what’s called confirmation bias: We tend to seek out news organizations and social media posts that confirm our views. Selective facts occur precisely for this reason." In other words, confirmation bias is a part of our use and understanding of information. The author concludes that "Selective facts are worse than outright fake news because they’re pervasive and harder to question than clearly false statements."
So far so good. except for one thing. The article does not go in detail into why selective facts are, all of a sudden, prevalent in today's world. Why does confirmation bias (and, unmentioned by the author, proximity heuristic) matter today more than they mattered yesterday?
The answer to this, at least in part, has to be the continued polarization of the mainstream media (and, following it, non-traditional media).
Here is a PewResearch study from 2014 on ideological polarization in the mainstream media and social media: http://www.journalism.org/2014/10/21/political-polarization-media-habits/. Two charts from this:
Not enough to drive home the point? Ok, here is from Forbes article covering the topic (source: https://www.forbes.com/sites/brettedkins/2017/06/27/u-s-media-among-most-polarized-in-the-world-study-finds/#1ee9a3242546):
"The Reuters Institute recently released its 2017 Digital News Report, analyzing surveys from 70,000 people across 36 countries and providing a comprehensive comparative analysis of modern news consumption. The report reveals several important media trends, including rising polarization in the United States. While 51% of left-leaning Americans trust the news, only 20% of conservatives say the same. Right-leaning Americans are far more likely to say they avoid the news because “I can’t rely on news to be true.""
- Tuning Out or Tuning Elsewhere? Partisanship, Polarization, and Media Migration from 1998 to 2006 by Barry A. Hollander (2008), Journalism & Mass Communication Quarterly, Volume 85, Issue 1, which posits a view that polarization of the mass media has been driving moderate voters away from news and toward entertainment. Which, of course, effectively hollows out the 'centre' of media ideological spectrum.
- "This article examines if the emergence of more partisan media has contributed to political polarization and led Americans to support more partisan policies and candidates," according to "Media and Political Polarization" published in Annual Review of Political Science Vol. 16:101-127 (May 2013) by Markus Prior.
- And economics of media polarization in "Political polarization and the electoral effects of media bias" by Dan Bernhardt, Stefan Krasa, and Mattias Polborn, published in Journal of Public Economics, Volume 92, Issues 5–6, June 2008, Pages 1092-1104
These are just three examples, but there are plenty more (hundreds, in fact) of research papers looking into twin, causally interlinked, effects of media polarization and the rise of the polarized voter preferences.
Which brings us to the Quartz's observation: "While social media and partisan news has allowed more voices to be heard, it also means we are now surrounded by more people manipulating what facts make it to our newsfeeds. We’d draw a different conclusion—or even just a more nuanced picture—if we were given all the information on an issue, not just the parts that best benefit a particular viewpoint."
It may be true, indeed, that current markets for supply of alt-news are enabling greater confirmation bias prevalence in voter attitudes. But it is at best just a fraction of the complete diagnosis. In fact, the polarized, or put differently - biased, nature of the mainstream news is at least as responsible for the evolution of these biases, as it is responsible for the growth in alt-news. That is correct: fake information is finding are more accepting audiences today, in part, because the CNN and FoxNews have decided to cultivate ideologically polarized market differentiation for their platforms in the past.
It was my pleasure, recently, to record a podcast with excellent Tony Groves @Trickstersworld . The link to the podcast is here: http://www.broadsheet.ie/2017/11/14/the-road-ahead/. Enjoy!
My column for Cayman Financial Review on how the stage has been now set for the next Global Financial Crisis is available at http://www.caymanfinancialreview.com/2017/10/20/the-stage-has-been-set-for-the-next-global-financial-crisis/.
Sweden, the tough-fighting 'socialist' haven of capitalism is cutting its corporate tax rates. Again.
Yes, that is right. Sweden used to have a decisively 'socialist' rate of corporate income tax (irony implied) of 28% until 2008. In 2009 this rate dropped to a relatively convincing 'socialist' rate of 26.3%, before falling to a sort-of-'socialist' softy 22%. It now plans a cut to 20%.
Tax optimization, folks, just went mainstream in Europe and the U.S. Which is a good thing for transparency (reducing the disparity between the effective rates and the headline rates). But a bad news for personal income taxes. To offset the declines in corporate tax revenues that BEPS changes will inevitably engender, Governments from Sweden to Italy, from Canada to the U.S. will have to either cut spending or increase personal income tax rates. No medals for guessing what they will opt for.