Wednesday, May 18, 2022

Alain Bertaud on Building new cities

An excellent Alain Bertaud interview where he discusses the idea of creating new cities. 

He does not in general agree with creation of new cities,

New city projects often start by highlighting their nice infrastructure, like Neom in Saudi Arabia. But nobody will move to a city with a good sewer system but no jobs. Historically, infrastructure follows the market, not the other way around. This is why, for example, the Greeks founded my home city of Marseilles: It exported local wine and cork and imported olive oil. During Roman times it became a portal for shipping grain from North Africa to Gaul. Then there’s the issue of cash flow. When you build a new city, you have negative cash flow for a long time. Essential early infrastructure like roads and airports aren’t cheap, and it takes time for land sales and tax revenue to start coming in. This might work for new capital cities like Canberra or Chandigarh, which had the financial backing of millions of taxpayers, but it won’t work for most new cities.

On successful examples of new city formation,

True new cities start with something that attracts a lot of people and go from there. This is the story of Orlando, one of the fastest-growing cities in the U.S. Disney created a lot of jobs there in the 1970s, and thanks to tourism, you quickly get a major international airport. Before you know it, you have a diversified city... Often, new international trade routes are the draw. For example, expect to see new cities emerge in Central Asia as China’s Belt and Road initiative creates a lot of new hubs. This is the story of Atlanta, by the way: It built an economy around being a rail junction. Or we might see new cities in the Arctic, as climate change opens up new Arctic shipping lanes. This is the story of Vancouver — a connection to the Pacific Ocean.

On what he thinks is necessary requirements if we are to establish new cities - the need to marry planning with bottom-up market-based evolution,

The first thing you need to do is clearly demarcate the public and private realms... These are design problems that need to be done all at once and in a top-down way before a healthy city can start to grow. Second, you need to set up some way to finance infrastructure... If you set it up correctly, new development should incrementally pay for itself... Beyond these two considerations, don’t overthink it. The key is to lay the groundwork for a land market that will reveal the right way to allocate land uses and densities. This is partly what went wrong with Brasília — planners thought they could plan out every little detail about the city, right down to how many shops each neighborhood should have, and the results have been less than ideal. Compare Brasília to Hong Kong, arguably one of the most successful new cities in modern history. Instead of micromanaging everything, the government focused on stewarding the public realm and providing quality public services. Otherwise, they mostly let markets design the built form of the city in a spontaneous and evolutionary way.

This nuance is missing in the likes of Paul Romer's Charter Cities.  

I am not convinced by the idea of building new cities, especially in developing countries. They are too grandiose as projects to be structured to a reasonable degree of satisfaction through planning and enabling regulations in the messy political economy and weak state capacity environments. However, what's possible is that once new communities start to emerge from housing developments, governments can step in with enabling regulations and investments to support their growth as future small towns. 

Monday, May 16, 2022

Winners and losers from the Ukraine invasion

It's coming to nearly three months since Russia invaded Ukraine. The war is now a stalemate and it appears set to continue for some time. As the fog clears, it may be time to look at who have been the winners and losers from this invasion.

It's easy enough to argue that the biggest loser is Russia. Vladimir Putin's decision to invade Ukraine must rank among the worst miscalculations by any major leader in history. It's surely the biggest strategic blunder by any leader since the war. Over the space of three months, Russia's economic prospects have been pushed back decades. More than the freezing of Russian foreign finances and other sanctions themselves, the actions of western countries have shaped expectations among businesses and investors that are deeply detrimental to Russia's long-term prospects. Besides the economic damage and prospect of extended period of economic and political isolation portend bleak future. This is just a long list of companies which have paused or exited Russia. 

Economically too Russia loses its massive captive market for natural gas, coal, and other commodities. While it'll eventually find other buyers, it will come at a steep cost and with all the uncertainties. Politically, instead of deterring the expansion of NATO, the invasion looks set to expand the boundaries of NATO. It has succeeded in convincing Finland to abandon its 75 years of neutrality and apply to join NATO

For decades in Finland’s case and centuries in Sweden’s, the thought of joining a military alliance was all but impossible. Now, in the 81 days since Russia launched its full-scale war against Ukraine, the situation has changed so dramatically that Sweden and Finland are rushing into Nato with large majorities in both their parliaments and populations backing them.

In one stroke Putin has upended decades and even centuries long beliefs and trends, materialising exactly the same scenario that he has sought to eliminate! Talk about self-goals...

It's difficult to imagine Russia being seen as anything other than a rogue state as long as Vladimir Putin remains in power. There are also no signs of his hold on power slipping because of the debacle. And even if Putin leaves after a few years, the damage done to the Russian psyche by NATO encirclement and political and economic isolation would be such that it would harden Russian nationalism and prevent a genuine rapprochement. 

The other big loser is China. In fact, in the final analysis, the Russian invasion and the Chinese actions around it coupled with the latest Covid lockdowns, may have hastened the decline in China's fortunes which (as this blog has held) started with President Xi Jinping's authoritarian turn. The internal and external aggressions of recent years, bullying and wolf warrior diplomacy, and the worsening economic relations with US had already sown the seeds for China's economic slowdown. I blogged here.

The large captive western markets and free access to western multinationals and their technologies already look like things of the past. We are already well on the way to a near total freezing out of China from access to strategically important sectors and technologies. The Covid lockdowns and manufacturing supply chain disruptions have highlighted the need for diversification away from China. Economically too, it was inevitable that the debt-fuelled growth reach its limits. The latest developments may be the final blow. 

The biggest winner appears to be the western democracies. As I have blogged here, the speed with which they mobilised together and the resolve with which they sanctioned Russia puts to rest conversations about the steep decline of United States as a global superpower and the imminent demise of the western alliance.  The Russia-China axis has restored the "enemy" which had gone missing after the collapse of the Soviet Union. 

But the gains go beyond the political realm. The Chinese threat had already started to spur transatlantic cooperation in technology sectors and the Russian invasion will only strengthen the trends. A Trans-Atlantic Technology Council (TTC) has been established to respond "to efforts by the likes of China and Russia to build an autocratic digital world and bring the physical supply chains that underpin it under their control". It has the potential to become the platform for US and EU to co-ordinate digital policies. 

The two sides have created ten working groups, ranging from “technology standards” and “secure supply chains” to “investment screening” and “climate and clean tech”. The structure of the TTC allows the relevant agencies and experts in Brussels and Washington to develop working relationships that go beyond ad hoc encounters that have long dominated transatlantic policymaking. It is a practical forum in which they can resolve their digital differences. Officials once barely knew who was in charge of a given topic on the other side of the Atlantic. Now they can just jump on a video call... The TTC has already helped move negotiations along in several areas, particularly with regard to a new version of “Privacy Shield”, an agreement to create a clear legal basis for flows of personal data across the Atlantic... Another project that has benefited from the TTC is the “Declaration for the Future of the Internet”, which was announced on April 28th and signed by more than 60 countries.

The combination of shocks from the Russian invasion and the supply chain disruptions due to Chinese Covid lockdowns and worsening relations with China, means that supply chain re-alignments and reshoring will be hastened. It's no longer a matter of whether such re-alignments will happen, but what will be the degree of re-alignment and diversification away from China. 

Reshoring will revive manufacturing in the west and create jobs. It'll certainly bring back several parts of the manufacturing supply chain. The Cold War will make the western economies refocus on control over critical technologies. All this spur domestic R&D and investments. It's already in motion in several areas, semiconductors being only the most prominent of them. 

Then there is the energy recalibration away from Russia. This has the potential to foster innovation, spur investments, and create jobs across Europe and the US. There will be greater investments in green energy technologies to substitute away from Russian coal and large expansion LNG terminals across Europe. 

Fundamentally, such reshoring and diversification will also mean companies shift away from efficiency maximisation at all costs towards a strategy that combines the pursuit of efficiency with resilience. The result will be higher costs, lower profits, and higher prices for western businesses and consumers. Interestingly, this pain has the promise of laying the foundations for a revival of economic dynamism and more equitable and sustainable economic growth in the western economies. 

Sunday, May 15, 2022

Weekend reading links

1. A stand out winner from the Russian invasion of Ukraine is Qatar. With its massive gas reserves, it has become the most important source of incremental gas supplies for Europe. 

Europe’s clamoring for liquefied natural gas, or LNG, comes after Qatar started a $30 billion project to boost its exports by 60% by 2027. The extra demand means more competition among buyers for long-term supply contracts and, most likely, better terms for Qatar. Before the outbreak of the Ukrainian war, some analysts doubted there’d be enough business to justify the expansion plan. Now, Qatar is sounding out customers about an even bigger enlargement... Qatar is reaping benefits already. The $200 billion economy is set to grow 4.4% this year, the most since 2015, according to Citigroup. Gross domestic product per person will soar to almost $80,000, back up toward levels in places like the Cayman Islands and Switzerland. The start of what could be a gas “supercycle” comes just as the World Cup construction boom that powered the economy in recent years comes to an end, according to Ziad Daoud, chief emerging markets economist at Bloomberg Economics. “The timing is fortunate for Qatar, which could see a new driver of growth for this decade,” he said.

2. India's cereal exports have been rising.

But the abrupt decision to temporarily ban wheat exports should come as a dampener. 

3. Global economic prospects weaken, financial markets get seized by uncertainty, the US Dollar rises, and EM's suffer sudden stop and capital flow reversal. This is a constant feature and is happening now too

March alone saw the sixth consecutive month of FPI outflows, which was the most severe since March 2020 (after the pandemic scare) on the back of continued geopolitical risks, elevated inflation led by supply side issues, rising commodity costs... Apart from India, other emerging markets, including Taiwan, Korea and the Philippines also saw massive outflows so far this fiscal. The record fall was mainly due to the massive outflows of USD 5.4 billion in March and a whopping USD 15.7 billion in FY22. Such a massive pullout came after they pumped in USD 23 billion in 2020 and USD 3.7 billion in 2021.

4. Striking numbers about the Mathew Effect in school education in UK

All fee-paying (private) schools... collectively educate about 6% of the British school-age population. They also make up a disproportionate share of the student body at top universities (40% at Oxford, 35% at Cambridge, 32% at the London School of Economics) and of elite British professions (65% of senior judges, 29% of members of Parliament, 43% of journalists... Adjusted for inflation [at the time this was written in March 2020], British private schooling has become three times more expensive since 1980. The rise owes in part to a facilities arms race that ran unimpeded until the financial crash of 2008, as schools once synonymous with character-forming privation became increasingly luxe.

The article describes how England's private schools are increasingly establishing their franchises abroad, especially in Eastern Europe, East Asia, and Middle East.

As fee escalation put private schools beyond the reach of their traditional demographics, they started admitting more students from overseas, but the gambit had limits. Bringing in too many foreign students risked diluting the Harry Potteresque cachet that had attracted their parents in the first place. “They don’t want to have lots of internationals. They want lots of British kids,” says Lorna Clayton, whose company Academic Families places foreign students in U.K. schools. So the schools came up with franchising, which would bring in money and spread tradition without altering the original product, while also providing overseas parents with a more affordable way for their children to attend internationally reputable schools.

5. India middle class fact of the day

India’s movie-loving, value-conscious customers have already humbled streaming godfather Netflix, which initially priced too high and had to shelve plans for India that included building a wholly owned post-production facility. It had to ratchet back ambitions to sign up 100mn subscribers — according to Media Partners Asia, they ended last year with fewer than 6mn.

If India did indeed have a middle class in the 250 million range, then the number of Netflix connections should have been several multiples of the lowly 6 million!

6. From the same article above, Amazon is trying to get its business model right in India.

Unlike other countries, where Amazon Prime subscribers mostly sign up to get faster deliveries, India’s Amazon Prime subscribers are primarily paying to watch movies and TV. “In developed markets, Prime service is sold primarily on the back of privileged delivery,” Shah said. “In India it’s the other way round, more people subscribe for video than for delivery benefits.” The big difference between Amazon and Netflix or Disney Plus Hotstar is that Amazon has many other things to sell you besides light comedies and cricket. If the company can convert watchers into customers in one of the world’s fastest growing ecommerce markets, then it will have hit the jackpot. “Amazon clearly sees video as a way to monetise India’s ecommerce opportunity,” Shah added.

I'm not sure that the video subscribers will buy much through Amazon.

7. A reflection of the fragmented nature of the natural gas market comes from the relative prices in Europe and US.

8. While we observe the markets roiled over inflation and interest rates, it's important to put the bond markets in perspective.
9. More on the great resignation in the US labour market,
More than 40 million people left their jobs last year, many in retail and hospitality. It was called the Great Resignation, and then a rush of other names: the Great Renegotiation, the Great Reshuffle, the Great Rethink. But people weren’t leaving work altogether... What workers realized, though, is that they could find better ways to earn a living. Higher pay. Stable hours. Flexibility. They expected more from their employers, and appeared to be getting it... Many of last year’s job quitters are actually job swappers, according to data from the Bureau of Labor Statistics and the census, which shows a nearly one-to-one correlation between the rate of quitting and swapping. Those job switchers have tended to be in leisure, hospitality and retail. In leisure and hospitality, the rate of workers quitting rose to nearly 6 percent from 4 since the pandemic began; in retail it jumped to nearly 5 percent from 3.5. White collar employers still struggled to hire, but they saw far fewer resignations... When workers switched jobs, they often increased their pay. Wages grew nearly 10 percent in leisure and hospitality over the last year, and more than 7 percent in retail. Workers were also able to increase their shift hours, as rates of those working part-time involuntarily declined. A slim share of people left the work force entirely, though for the most part that was driven by older men retiring before age 65 — and some of them are now coming back to work.

10. US stock market ownership fact of the day,

According to an analysis by the New York University economics Professor Edward Wolff, the top 5 percent of American wealth holders own 72 percent of all stocks.

11. On the possibility of imported inflation from China for US consumers,

Goods made (in whole or in part) in China made up less than 2% of American personal consumer spending in 2017, according to economists at the Federal Reserve Bank of San Francisco. China’s covid-related bottlenecks could have larger ripple effects, say by allowing rival manufacturers to raise their prices. Most American inflation, however, is made in America.

12. India's cash transfer system fact of the day,

India has also found a workaround to redistribute more to ordinary folk who vote but rarely see immediate gains from economic reforms: a direct, real-time, digital welfare system that in 36 months has paid $200bn to about 950m people.

13. The Economist has a rare bullish story on India,

As the pandemic recedes, four pillars are clearly visible that will support growth in the next decade: the forging of a single national market; an expansion of industry owing to the renewable-energy shift and a move in supply chains away from China; continued pre-eminence in it; and a high-tech welfare safety-net for the hundreds of millions left behind by all this.

There is a dilemma lurking behind the industrial growth story - reconciling the need for large scale private investments and the threat of business concentration

Saurabh Mukherjea of Marcellus, an asset manager, calculates that India’s top 20 firms earn 50% of corporate India’s cashflows. They are making money fast enough to take risks with their earnings instead of having to borrow to excess. The ambitious giants include conglomerates—Adani (energy, transport), Reliance Industries (telecoms, chemicals, energy, retail), Tata (it, retail, energy, cars)—and more focused giants such as JSW (mainly steel). Those four firms alone plan to invest more than $250bn over the next five to eight years in infrastructure and emerging industries; in doing so they intend to develop local supply chains, which fits with government goals. Mukesh Ambani of Reliance says he will cut the price of green hydrogen to $1 per kilogram by 2030, for instance, from about $5 today. Tata is rolling out battery plants, electric vehicles and semiconductors. These are huge, risky bets that few other firms would dare take.

Finally, some figures on the national social safety net

In the year to March, payments reached $81bn, or 3% of GDP, up from 1% four years earlier. Payments have totalled $270bn since 2017. Roughly 950m people have benefited, at an average of $86 per person per year. That makes a difference to struggling households: India’s extreme poverty line is about $250 per person per year at market exchange rates. Mr Modi has not managed to initiate a national jobs boom, but he has created a national safety-net of sorts.

Wednesday, May 11, 2022

Corporate India's scorecard from last three decades

This post shines light on corporate India's disturbing failure to deliver world-class products and services even after three decades of liberalisation and global market integration. 

In a recent article FT's Gillian Tett argued that far from reversing, globalisation may only have taken a different course, this time without America at the centre. In the article she points to this,
But Squid Game is a made-in-Korea product, backed by Netflix, which has become the most viewed show in 90 countries around the world this year. Indeed, polls suggest that one in four Americans has watched it, while Spanish, Brazilian and French offerings produced for a global audience now litter the Netflix site. The globalisation of media, in other words, is no longer about Hollywood; digitisation has made it a multipolar affair. 

The absence of any Indian soaps and movies in the landscape of chart toppers in Netflix is especially interesting given the enormous volume of movies and serials that are produced in India. This reminds me one of the most intriguing economic trend - the absence of Indian companies and brands in the global economic landscape. What explains the remarkable lack of any meaningful Indian global brands or globally leading Indian companies?  

I have blogged here about narratives which endure despite limited evidence or even evidence to the contrary. One of these is the narrative that pins the blame for India's economic failings on the government, by glossing over the equally disappointing performance of its private sector. This post will seek to surface the latter by sharing an illustrative factual scorecard of India's private sector of the last three decades.

Here goes an illustrative list:
  1. All major private banks are foreign majority owned; 
  2. apart from the founders capital, almost all the remaining capital in the major startups are foreign owned (if not addressed, it's only matter of time before they all become majority foreign owned too, if not already - flipping); 
  3. the sectors which were deregulated and private enterprise allowed to play out are in a mess - telecoms, airlines etc; 
  4. not one noteworthy enterprise or consumer focused software solution/product by the Big Four Indian tech companies in 40 years of existence (TCS, Infosys, Wipro, CTS) and hardly any presence in any of the cutting-edge areas like cloud computing, AI, IoT, Blockchains etc; 
  5. not one world-class e-governance solution nor globally competitive government software prime contracting proficiency despite numerous opportunities that the big three (TCS, Infy, Wipro) have had from central and state government contracts for two decades; 
  6. not one original and cutting-edge technology provider among the nearly 150 unicorns (mostly copy cat providers of solutions/ideas which are already being used in developed markets), no globally used product/solution (either B2B or B2C or C2C) by any of them; 
  7. apart from a couple like Voltas, Godrej etc, the overwhelming majority of consumer durable brands are foreign; 
  8. not one Indian mobile phone brand in the largest and fastest growing consumer durable segment (with a global market); 
  9. apart from ITC, Marico, Dabur etc, the vast majority of FMCG brands in globally relevant market segments are foreign; 
  10. the entire four-wheeler and above markets has negligible Indian brand presence (it's a moot point  whether Maruti is Indian or Japanese, given that Suzuki still provides its engines); 
  11. India is the second or third largest solar generation market, but with an almost completely import dependent value chain and no major local polysilicon or wafer or cell manufacturer of note;
  12. no world-class large domestic contract manufacturer in textiles, footwear etc; 
  13. despite nearly 50 years of experience, no Pharma company in the higher end areas of non-generic drugs or formulations, biosimilars etc;
  14. no Indian global brand of note in any major global mass market segment...
One could go on. Alright, we can quibble on some of the details. But on the broader thrust of the point being made?

This is no one-off observation. I have blogged hereherehere, and here highlighting corporate India's persistent failures to produce world class entprereneurship, create global brands, and innovate and expand technology frontiers. I have blogged herehereherehere, and here about the failure of the country's startup eco-system to generate innovators and innovations which have had a significant impact on the country's development or push the frontiers of innovation. I have also blogged here and here about India's deficit of high quality entrepreneurship which leads to scale, this and this about its persistent corporate governance problems, this about how while market participants game the regulations bureaucracy responds with more regulations. I also blogged here that even Indian capitalists appear to avoid making risk capital investments in India.

Reinforcing the point, a recent article in the Business Standard wrote on the dismal fortunes of Indian mobile phone manufacturers.
According to industry estimates based on excise and Custom duty trends, the value share of Indian brands (across smartphones and feature phones, operator phone sales — which is mostly Jio phones — and the value of phones smuggled into the country) has dropped to a mere 1.2 per cent in January-October 2021 compared to 25.4 per cent in the calendar year 2015... a similar trend can be seen in the latest volume sales figures in smart phones. Techarc, which tracks the market share of Indian vs Chinese brands (other foreign brands like Samsung have been kept out of the analysis), says that the share of Indian brands has now fallen from 68 per cent in 2015 to a mere 1 per cent in 2021.
In the context of this discussion, a Business Standard analysis of the R&D spending among 2893 listed Indian companies provides a partial answer. Consider these - R&D spending as a share of net sales was just 0.38% in 2020-21 and has remained stuck in that range; around 82.3% of companies did not report any R&D spending; automobile and Pharma companies apart, R&D spending is minimal; the top 10 companies accounted for 54.99% of the total spending etc. Further, private businesses accounted for just 37% of national R&D spending compared to 68% for other large economies.

To be clear, the point I am making is that corporate India's failure to produce anything of note which is world class and in globally relevant sectors in the last 30 years - despite economic liberalisation; the country's fairly diverse and strong industrial base (compared to its today's EM peers); global tailwinds from trade liberalisation, globalisation and commercial innovations in the ICT; large population and market; and a well-educated entrepreneurial elite class - is remarkable and should be a matter of deepest concern and trigger introspection. 

The real issue is what (other than the government-regulations-are-responsible line) explains this shockingly poor performance for a continental economy? What ails the higher tiers of India's corporate and entrepreneurial ecosystem? This is also a surprisingly barren area of academic research.

Monday, May 9, 2022

The difference between the theory and practice of free trade - face masks edition

Free trade and comparative advantage have been articles of faith in Econ 101. 

Joe Nocera has an article about the fate of mask manufacturers in the US. The short story is that in the aftermath of the pandemic, several small businesses responded to the demand and calls for local manufacturing by establishing mask manufacturing facilities in the US. They flourished during the pandemic. Once the pandemic eased and prices fell, the Chinese competition returned and now threaten to drive them out of the market. 

This story repeated with Swine flu in 2009 and Covid 19 in 2020-21. 

Just weeks into the Covid-19 pandemic in 2020, the supply chain for protective equipment had broken down, creating severe shortages that cost lives. A black market emerged, full of con men and get-rich-quick schemers. A handful of U.S. entrepreneurs decided they would do their part by manufacturing masks... At first, customers who could no longer obtain masks through their normal supply channels were beating down their doors. The same was true during the Delta and Omicron waves, when masks were also scarce. But as soon as the waves crested, and Chinese companies, determined to regain their market share, began exporting masks below cost, the customers disappeared. “All the hospitals and government agencies and retailers that had been begging for American products suddenly said, ‘We’re good,’” said Mr. Hickey.

One important way to address this problem is by leveraging public procurement,

The government’s answer to this pattern is its own buying power. During his State of the Union address on Tuesday night, President Biden promised that the government would begin to rigorously enforce provisions in the law that call for the federal agencies to buy American-made goods whenever possible... resilience — that is, creating extra manufacturing capacity that can get the country through an emergency — is what the small mask makers say is their value to the country. Sure, they argue, a globalized, just-in-time supply chain for low-cost protective equipment is fine in ordinary times. But we’ve learned these past two years that the country needs domestic manufacturers if we hope to avoid terrible shortages during the next pandemic, and the one after that. But how do you create that resilience? The federal government spent $682 billion buying goods and services from contractors in 2020, according to Bloomberg Government. That’s the sum the Biden administration wants to use to buy American products.
This approach would stand in contradiction to the principles of Econ 101. 
The mask manufacturers are a microcosm of a larger problem. Today, there are shortages that go well beyond personal protective equipment. Things as diverse as semiconductors and garage doors are in short supply — all products whose manufacturing was offshored during the past decades as American companies embraced just-in-time supply chains and inexpensive foreign labor. Economists and corporate executives ignored resilience, and now the country doesn’t have a clear idea how to create it, even as its necessity has become obvious.

The idea and associated narrative around free trade endures despite very little evidence to support it. 

Some observations:

1. The theory of comparative advantage suggests that each country specialise in those goods and services in which they are best placed (compared to other things in the global consumption basket). But in reality, absolute advantage is what matters. A few countries are better placed than others in absolute terms to produce most goods better and cheaper. So these countries end up dominating the global production of most goods. 

2. In the globally integrated market, where the pool of consumption class is expanding continuously and will do so for a long time, the economies of scale just keep rising. This means that once a country entrenches itself in a few products it develops the backward and forward linkages to expand production and supply of the same goods and services as well as similar products at a far cheaper marginal price than any new entrant.

3. Such concentration of production trades-off against resilience and risk diversification, a point that became egregiously manifest during the Covid 19 pandemic. Overlooking all other factors, purely on resilience grounds alone, there is a strong case for ensuring at least a certain share of local production on many things. At the least, there should be an effort to diversify production across multiple locations. 

4. Amplifying all these trends is the dynamic of capitalism, which elevates profit maximisation above all else. Similarly, for the median (and vast majority of) consumers, price considerations trump all else. 

The net result of all this is an inexorable dynamic where the first mover who captures the market ends up keeping the market for a long time (till something unexpected happens and something shifts). 

Sunday, May 8, 2022

Weekend reading links

1. China holds more than $1.5 trillion of US securities.

2. The Japanese yen falls to touch a 20 year low against the dollar.

Leo Lewis in FT points to two advantages from the depreciation,
The first relates to Japan’s increasingly important “not China” status in a less certain and deglobalising world... As global industry begins to re-engineer itself away from efficiency and towards security, Japan’s position as a reliable partner, manufacturing hub or supply chain link for US and European businesses has been significantly enhanced. The weak yen, say the bankers, is already tipping investment decisions in favour of Japan, with that trend likely to accelerate. But the second effect of the yen’s sharp fall this year has been to vindicate the continued commitment of Japan’s Government Pension Investment Fund to its big overseas investment weighting... the GPIF’s roughly 50 per cent portfolio weighting in overseas bonds and stocks now generates what one analyst calculates is a 2-3 per cent performance windfall for a 10 per cent move in the dollar-yen rate.

3. Fascinating snippets from The Economist's Technology Quarterly which focuses on wearable devices and health tracking. This graphic of technology diffusion is interesting

This on the smartwatch industry,

In 2019, Apple sold more watches than the entire Swiss watch industry. Some 400m devices a year (of all brands) are expected to be sold globally by 2026, up from 200m in 2020.

This about the wearables market,

What a wearable device can measure depends on its sensors and its software. Lower level algorithms turn the noisy output of photodetectors and the like into heartbeats. Higher level programs combine, say, heart rate, temperature and movement into measures of the duration, and quality, of sleep. Sensors and algorithms combine to help wearable devices measure step counts, calories burned, oxygen levels and more. Artificial intelligence gives extra oomph to the algorithms. Technology advancements in the past five years have made it possible to pack wearable devices with more sophisticated sensors and more computing power... In a recent review iqvia, a research firm, found 384 wearable devices marketed to consumers. They include wrist-worn fitness trackers, sports watches, smartwatches, smart jewellery like the Oura ring and sensor-bearing headsets, patches, straps, clip-ons and even clothes (such as smart socks that measure the vitals of babies). Just over half of the devices analysed by iqvia monitor activity. The rest are devices that measure a wide array of health variables, including sleep, temperature, breathing, blood pressure, oxygen saturation, blood sugar and electrical activity of the heart.

4. Vladimir Putin's invasion of Ukraine is perhaps the mother of all misadventures and blunders. Ian Bremmer has a nice summary of all the costs,

Mr Putin has cost his country the lives of thousands of young soldiers, some of them conscripts. He claims that Russians and Ukrainians are “one people,” but his war has given Ukraine a stronger sense of national identity than it’s ever had before and transformed it into Russia’s bitter enemy. He has shown the world that his army is ineffectual, and that billions of dollars spent on modernising Russia’s military has been wasted. He has given NATO a sense of unity and purpose it hasn’t had in decades and non-members like Finland and Sweden new reasons to join. His actions have driven members including Germany to boost defence spending. Others have dispatched troops close to Russia’s border. Mr Putin has convinced Europe that it must stop buying Russia’s most valuable exports. He has brought sanctions and export controls on his country that will inflict generational damage. For Europe and America he has crossed the Rubicon. Most grievously, he failed to prepare the Russian public for the true human, financial and material costs of his “special military operation.”

5. Financial market concentration fact of the day,

The past decade has seen a concentration of voting power among managers of large index funds. Three asset managers—BlackRock, State Street and Vanguard—together own over a fifth of the average company in the s&p 500, but wield even greater clout, because only 30% of retail investors bother to vote their shares.

6. The manner in which the stories around the electric two-wheelers catching fire have been handled by the startups firms indicates that poor corporate governance is not exclusively confined to the old economy companies. Sample this,

There is no official count of EV fires because the government and industry bodies don’t collect such data... Ola Electric, Okinawa, Pure EV and Boom Motors made around 7,000 recalls after incidents of flaming vehicles emerged since last September, and after transport minister Nitin Gadkari warned of penalties... One of the problems is the lack of standardisation. As a result, companies send a good model for certification but subsequent batches may have inferior units... With over 400 EV models in the market, there’s a need to standardise batteries for safety and performance... More so in India’s fragmented EV market, where big manufacturers jostle with minions and traders for a slice of the $200 billion opportunity by 2030. Most treat E2W manufacture like a kid assembling a Lego game — import cells and components from China, pack, and arrange them in a shell. There are no penalties if something goes wrong... Ola Electric acquired Amsterdam-based Etergo, an E2W scooter OEM in 2020, and opened bookings last year. It now faces fires, irate customers cribbing over performance and range anxieties, and allegations of a Twitter-led customer service.

This is a Mint investigation which found that "a network of seemingly co-ordinated Twitter handles appears to be working to drown out criticism of Ola Electric on social media and build a positive narrative for the brand online". These handles attack people who post stories of their experience with Ola electric's safety. 

7. Scott Galloway writes about the attention economy,

The element fueling economic growth is not a rare earth metal, processing power, or NFTs: It’s attention. The average American spends 11 hours per day consuming media, 65% of their waking life. Roughly 40% of that time is spent on a mobile device. Billions of dollars and millions of person-years are spent capturing and monetizing that attention. The more attention, the more data, the more money, the more relevant offering(s), the more attention … and so on and so on.

8.  Economics explains politics. The US enthusiasm for oil and gas embargo on Russia is explained by the graphic below - its limited dependence on Russian imports!

9. Manu Joseph has a nice read on the ways in which India's price consciousness plays itself out. The context is the use of air-conditioners in public facilities and utilities. 
The average Indian has low standards for life—for beautiful spaces, time, hygiene and comfort. He is willing to wake up at dawn and commute two hours in heat and dust, and return late at night. He plays no sport, does not date and spends very little on fun, even if he is a drinker. He overspends only if there is a sacrificial quality to it—like his child’s education or sister’s wedding.

10. Conventional wisdom has it that anxiety is bad and something to be avoided. So it can come as counterintuitive to argue in favour of anxiety. Tracy Dennis-Tiwary, a clinical psychologist, writes,

We’ve convinced people that anxiety is a dangerous affliction and that the solution is to eliminate it, as we do with other diseases. But feeling anxious isn’t the problem. The problem is that we don’t understand how to respond constructively to anxiety... This “bad” feeling isn’t a malfunction or failure of mental health. It’s a triumph of human evolution, a response that emerged along with one of our greatest attributes: the ability to think about the uncertain future and prepare for it. Anxiety places us in the “future tense” (pun intended)—a state in which we are motivated not only to survive but to thrive, by being more persistent, hopeful and innovative. It was the father of evolutionary theory, Charles Darwin, and his intellectual heirs, such as psychologists Nico Frijda and Joseph Campos, who saw that unpleasant emotions like anxiety confer a profound evolutionary advantage. Emotions provide key information about our well-being and prepare us to act. Fear, for example, signals that you may be in danger—from a predator, bully or speeding car—and readies your body and mind to fight or take flight. Anxiety, by contrast, has nothing to do with present threats. Instead, it turns you into a mental time traveler, drawing your attention to what lies ahead. Will you succeed or fail in that interview for a job you desperately want? Anxiety prompts your mind and body into action. Your worries impel you to prepare meticulously for the interview, while your heart races and pumps blood to your brain so that you stay sharp and focused, primed to pursue your goals.

The article points to research that confirms the presence of higher levels of dopamine (the hormone whose levels spikes when we have pleasurable experiences and in expectations of reward) when we are anxious, thereby raising the possibility that the elevation makes us do the same thing that we do when we experience joy and expect reward - prepare for the same. 

She writes about the problems with trying to eliminate anxiety,

We have come to believe that the best way to cope is to treat anxiety like Covid-19 or cancer by trying to eradicate it. But treating anxiety like a disease is a recipe for its spiraling out of control; it prevents us from distinguishing between ordinary anxiety and anxiety disorders, which occur when our ways of coping with anxiety serve to amplify it in ways that are out of proportion to the situation and keep us from functioning in our professional and personal lives. When we say anxiety is a public health crisis, what we really mean is that the way we cope with anxiety is a public health crisis. We need to develop a new mind-set about this misunderstood emotion. Reframing and reclaiming anxiety as an advantage and a valued part of being human isn’t easy or just a matter of willpower. It takes practice and time, and it doesn’t mean that anxiety becomes enjoyable. Anxiety can’t do its job unless it makes us uncomfortable, forcing us to sit up and pay attention. We don’t need to like anxiety—just to use it in the right way.

Instead the way forward

Today we too often treat anxiety as a malfunction to repair, but anxiety doesn’t need fixing. What needs fixing is our disease model of dealing with it, which is meant to increase stability and destigmatize psychological struggle but is not succeeding and may even be causing harm. Once we rescue anxiety from this mindset, we’ll be in a better position to rescue ourselves.

The article points to this study and its findings about the benefits of ikigai

Beginning in 1938, the Harvard Study of Adult Development, one of the longest-running and most comprehensive longitudinal studies ever conducted, asked a fundamental question: What leads to a healthy and happy life? Following over 1,300 people from all walks of life over decades, the study has found that one of the best predictors—better than social class, IQ and genetic factors—is having a sense of purpose.

Thursday, May 5, 2022

Markets sell the forward guidance and buy the informal gossip, and asymmetrically too!

The stock market reaction to the US Federal Reserve's 50 basis points repo rate hike announcement on Wednesday is a teachable moment in the psychology of the markets. I have blogged here earlier. 

The US markets  reacted by registering its largest one day gain since May 2020 in response to the FOMC decision. This is surprising since the 50 basis points hike is the first in more than 20 years and the Fed also announced two more such hikes before the year end. In particular, the markets appear to have been relieved that a 75 basis points hike is not under consideration as of now. 

The US central bank on Wednesday announced its first 0.5 percentage point interest rate rise in more than 20 years, but the move was widely expected and investors instead focused on Powell’s comments at a subsequent press conference. Powell signalled that the Fed’s policymaking committee expected to implement 0.5 percentage point increases at its next two meetings, but was not “actively considering” a more aggressive 0.75 percentage point increase. He added, however, that the “if higher rates are required, then we won’t hesitate to deliver them”. The yield on the two-year Treasury note, which is particularly sensitive to central bank policy, dropped 0.13 percentage points after the press conference, to 2.64 per cent. Yields fall when prices rise. The yield on the benchmark 10-year Treasury dipped 0.04 percentage points, to 2.92 per cent, having climbed in the run-up to the announcement. Wall Street’s benchmark S&P 500 closed 3 per cent higher, its largest one-day gain since May 2020. The Nasdaq Composite, which was in negative territory shortly before the press conference started, ended up 3.2 per cent. Michael de Pass, head of linear rates at Citadel Securities, said the response reflected the fact that investors had priced in most of the Fed’s plans. “It was still hawkish overall, but there was a fair amount priced in . . . it’s not as if Powell did a complete 180, but the most hawkish scenario has been taken off the table for now — they’ve said ‘it will be 50 basis points for the next two meetings, and then we’ll reassess’.”
The market's response to the Fed hikes reveal an interesting this about it that I blogged here. It's now relieved that 75 basis points hike is off the table and there are only three 50 basis points hike for the year, and therefore it zooms over 3% in a day! If we recollect, even less than two months back, it was alarmed about the possibility of even one 50 basis points hike and I don't think any credible news source was even discussing a 75 basis points hike! In a few weeks, even as the fundamentals have worsened (in terms of more news about the impending economic downturn), the markets appear to have seen something else that merits continuation of its trend even with the guidance on two more 50 basis points hikes in the coming three months. 

In the circumstances, it's hard not to see that forward guidance itself may be becoming a distortion. Fundamentally, market participants are disciplined by the uncertainties of the market. As Bengt Holmstorm and others have written, "asymmetric ignorance" (also here) is a virtue in the financial markets. The market participants should be more ignorant than the regulators. There's a disciplining force with such uncertainty. 

The regulators should not be trying to reduce this disciplining force of "market uncertainty" when we are in the midst of the longest bull market in history. The market participants should remain exposed to the full force of the market uncertainty, also especially when the regulators themselves are not sure about their own forward guidance. This is furthermore so given the well-known trend of the markets reacting more positively to good news than it reacts negatively to equivalent bad news, assuming both come at uncertain times. 

There is another reason. Markets gradually price in the formal guidance. Simultaneously informal gossip raises the possibility of more/greater increases. A new anchor emerges for monetary policy uncertainty, which has little basis except that the old anchor has been dissolved by the guidance. When the decision already priced in by the forward guidance is announced, the markets react euphorically, relieved that the gossip has not materialised. It's almost like the markets collectively decide to set up a straw man scenario to keep the party going. 

Since the market response to the guidance is longer drawn, they generally tend to undershoot in their response to the guidance. In contrast, the sudden relief ends up overshooting on the gossip not materialising. In the net, the gossip, triggered only by the forward guidance, ends up boosting the market more than the guidance would have wanted. The markets end up selling on the guidance and buying on the gossip. And since the latter is generally larger in effect than the former, the net result is that the markets end up moving further ahead. Monetary tightening ends up being effectively a loosening, or at least not a tightening. 

Accordingly, far from tightening, the Fed's transparency in communicating that it's not considering a 75 basis points hike, appears to have shaped market expectations that are likely to end up effectively loosening market conditions, or atleast not tightening to the extent that would otherwise have been possible. As a counterfactual, if the Fed had not communicated this, it would have left the markets on their toes and the uncertainty would have forced greater risk mitigation measures and greater caution among participants. Now the Fed communication has effectively ended up distorting the market response. The asymmetric ignorance on the extent of future rate hike possibilities would have induced greater caution and have had a market disciplining impact.   

There are also two asymmetricities here in the market's response to different kinds of news. The first is regarding the market's response to bad and good news, and the second is with respect to the materialising of formal guidance and informal gossip. In both cases, the markets overshoot on the upside news (good and gossip) more than on its undershoots on the downside news (bad and guidance).

This is also a good example of how academic research built on ideal markets and divorced off understanding of market psychology can worsen the problem. When Michael Woodford et al came up with their forward guidance theory in the aftermath of the global financial crisis, little did they realise the damage they would be doing over the coming decade. This is the latest example of expert opinion turning out to have worsened the problem.

In The Rise of Finance, co-authored with Dr V Ananthanageswaran, we had written about the near complete capture of regulators and central banks by the financial market interests. For all talk of central banks now breaking that stranglehold on the face of the rising inflation, the ideological and institutional capture is such that it'll be some time, if at all, before they can break free on their own. 

I think the RBI did a clever thing by intervening just before the FOMC and that too with the 40 basis points hike. The 40 basis points (and not 50) also perhaps reveals that the RBI is not yet fully convinced that it's behind the curve big time. It did some catching up, though much remains to be done. In fact, it's telling that of the 22 countries that have raised rates in recent days, 15 have done by 50 basis points or more, and RBI is among the seven in the minority.