Weekend reading links

1. Animal spirits have real effects on the economy

In a recent working paper, Joel Flynn of Yale University and Karthik Sastry of Princeton University try to isolate the effect of pure optimism on hiring decisions in America, and find evidence that it is real. They analyse the wording of US end-of-year reports to measure narratives, and split firms into the optimistic and the pessimistic. Optimistic companies increased their workforce by about 3.6 percentage points more than pessimistic ones over the following year. They also found that optimistic firms did not go on to be any more productive than pessimistic ones, and in fact tended to be less profitable in future. Company hiring is influenced by both positive and negative stories, not just good news.

The paper is here.  

2. Taylor Swift is having real effects and raking in the moolah

Swift will soon conclude the US leg of her Eras tour with a six-night run in Los Angeles. Hundreds of thousands of her fans have flown into cities, filling hotels and restaurants and spending an average of $1,300: the Federal Reserve Bank of Philadelphia credited her for May being the best month for the city’s hotels since the pandemic. She is estimated to have grossed $13.6mn per concert, each attended by an average of nearly 54,000 people. Swift is not finished: she will now move to the global leg, ending in London next summer, for which millions of “Swifties” have tried to buy tickets online. Eras could become the first $1bn music tour, surpassing Elton John’s $939mn Farewell Yellow Brick Road shows... Air New Zealand has added flights to Australia for Swifties to reach her shows there in February.

3.  Starlink's dominance of low earth orbit satellites that provide internet services in war and disaster zones and for strategic purposes is posing serious concerns. Elon Musk's ownership makes it even more so. 

This market needs to be regulated. If weapons sales by US defence contractors to other countries are regulated by the US governments, there's a case for doing the same with Starlink access. 

There's also a need to regulate this service. The first mover advantage has been reaped and the market is catalysed. There are now 4500 Starlink satellites and another 38000 are planned by Starlink and similar by others. There are questions of spectrum usage, orbital space ownership etc that needs to be regulated. 

This is an earlier blogpost on Starlink. 

4. FT has a long read on China's salami-slicing approach of pressuring and enveloping Taiwan's airspace. The Chinese have sharply increased incursions into Taiwan's contiguous space, a buffer zone just 12 nautical miles outside its sovereign airspace. 

The Chinese military is waging what defence experts call a grey zone campaign: it is increasing its presence closer to Taiwan one step at a time, yet all the while remaining below the threshold of what could be considered an act of war. For all the global attention there has been on the prospect of a Chinese attack on Taiwan, the country’s military planners also fear a very different, more gradual threat. They worry that the so-called salami-slicing tactics that Beijing is employing right now are slowly changing the status quo, one small step at a time, and could eventually deprive Taiwan of the ability to defend itself... 

Since September 2020, when Taiwan first started publishing data on Chinese military activity in its air defence identification zone, the number of monthly incursions into Taiwan’s ADIZ by the PLA has ballooned from 69 to 139 this July. An ADIZ is a self-declared buffer zone in international airspace in which countries monitor flight movements for potential security threats. But as the airspace above the contiguous zone is outside Taiwan’s jurisdiction, the PLA’s behaviour does not violate international law...

Over the past three years, Beijing has gone from occasional flights into Taiwan’s ADIZ by one or two military reconnaissance or transport aircraft to almost daily incursions by often large groups of planes including bombers, fighters, electronic warfare aircraft, aerial refuelling planes and various kinds of drones. According to Taiwan defence ministry statistics, the PLA has already flown 60 per cent more aircraft into Taiwan’s ADIZ since January 1 than during the same period last year. In addition, the PLA has expanded its area of operations from mainly the south-western corner of Taiwan’s ADIZ, the crossroads between the shallow Taiwan Strait, the South China Sea and the Bashi Channel which connects both to the open Pacific, to the airspace and waters all around Taiwan.

This kind of creeping engagement is a gauntlet thrown by Beijing at the US and others,

Some officials draw a parallel to the South China Sea, where Beijing is enforcing its claim over almost the entire area against several neighbours with similar salami-slicing tactics. Over the past decade, China has wrested control of some land features from rival claimants and built military installations step by step. But it has always kept its activities below the threshold of open conflict — a process which some analysts argue could have been prevented if the US had stepped in early on... At the root of Taipei’s feeling that too little is being done to deter China’s grey zone operations is disagreement over where the PLA’s tactics are leading — whether they are a prelude to conflict or a form of pressure.

5. Luxshare emerges from the shadows of Foxconn as one of Apple's most trusted contract manufacturing partners, perhaps its preferred choice in China in the years ahead.

When Foxconn started out in China with the opening of a new factory in Shenzhen in 1988, 21-year-old Grace Wang was one of the first migrant workers to be employed on its production lines. Wang displayed enough ingenuity and skills to earn a quick promotion to manager, as her employer began a decades-long dominance over the making of tech gadgets. Thirty-five years on, the factory girl is now chair of her own contract electronics maker, after co-founding and building up Luxshare to be Foxconn’s most serious challenger. Working its way up from being a subcontractor supplying connectors in 1999, Luxshare grew to become a public company, listing in the southern city of Shenzhen in 2010 and selling directly to Apple from 2011. Revenues have surged from Rmb2.5bn ($350mn) in 2011 to Rmb214bn last year...

Luxshare has also been steadily expanding its business with Apple, becoming an important partner and alternative supplier of services. While revenues and profits remain far below Foxconn’s level, its high-growth profile led to its market capitalisation overtaking its rival’s at one point in early 2021. Apple’s high opinion of its capabilities can be measured by the level of difficulty in the assignments awarded — from setting up factories outside China as geopolitical tensions increase to producing higher-end phones.

It's today the sole manufacturer of Apple's Vision Pro mixed-reality handset. 

6. Uber declares operating profits for the first time after racking up $31.5 bn in losses since 2014 when it first started declaring results. 

7. China's manufacturing output declined in July and exports of most goods contracted in the first six months. 

8. FT long read on how South Korean companies have been diversifying away from China.

Korean companies’ dependence on China was waning long before recent Sino-US tensions over technology. In the late 2000s, rising costs encouraged them to start moving production out of China, while competition from Chinese rivals intensified in sectors ranging from smartphones to shipbuilding. Beijing’s industrial policies were also a factor... US overtook China as a destination for Korean investment as long ago as 2011... Samsung’s... the world’s largest smartphone manufacturer but its market share in China is a mere 1 per cent. Samsung started moving production from China to Vietnam in 2008 and by 2019 had closed its last Chinese smartphone plant...

“What Samsung showed is that you don’t need to manufacture in China, and you don’t even need to rely on the Chinese consumer — as long as you’re prepared to diversify,” says Yeo. Similarly, Hyundai Motor’s Chinese revenues dropped by 76 per cent between 2016 and 2022, according to Seoul-based market research firm CEO score. The automaker is selling two of its four remaining plants in China as it moves production to Indonesia and US, where strong demand powered it to a record second-quarter operating profit this year. Excluding the chips and batteries sectors, the revenue generated by Korean companies’ operations in China declined by 37.3 per cent between 2016 and 2022, says CEO score.

9. US spends more on defence than all the next ten countries combined.

10. Some statistics on the South Vs North divide in India,

According to NSSO education survey (2018), English is the medium of teaching till Class 12 in a high percentage of schools in south India — 63 per cent in Telangana, 60.7 per cent in Kerala, 59 per cent in Andhra Pradesh, 44 per cent in Tamil Nadu and 35 per cent in Karnataka. This figure for Bihar, in contrast, is 6 per cent and for UP, it is 14 per cent. In western India, Maharashtra tilts towards the southern way of educating children (29 per cent prefer the English medium), while Gujarat (12.8 per cent) follows the northern states... Three-fourths of the 27,682 public libraries in India are located in the southern states... 

Today, an average person in Karnataka earns almost 5.5 times more than an average person in Bihar. The per capita incomes of Andhra Pradesh (Rs. 1,14,324), Karnataka (1,54,123), Maharashtra (1,33,356), Kerala (1,34,878) and Tamil Nadu (1,45,528) are way above the per capita incomes of Bihar (28,127), Chhattisgarh (72,236), Madhya Pradesh (58,334), Rajasthan (74,009) and Uttar Pradesh (39,371)... The share of the southern states in India’s population has drastically come down from 24.8 per cent in 1971 to 19.9 per cent in 2021 while for UP and Bihar it has gone up from 23 per cent to 26 per cent.

11. Robin Wigglesworth has an essay in FT on how bonds have eclipsed banks to emerge as the back-bone of the global financial system. 

While the bond market has become larger and more powerful, the importance of banks — historically the workhorses of the capitalist system — is subtly fading. The global bond market was worth about $141tn at the end of 2022. That is, for now, smaller than the $183tn that the Financial Stability Board estimates banks hold globally, but much of the latter is actually invested in bonds — a fact that some US banks have recently rued. Three decades ago, James Carville, the American political adviser, quipped about wanting to be resurrected as the bond market because “you can intimidate everyone”. Since then, the market has grown fivefold. Tighter regulations on traditional lenders resulting from the recent rash of bank failures in the US will force even more borrowers towards bonds...

“Shadow banking” is what some academics call the part of the financial system that resembles, but falls outside traditional banking. Policymakers prefer the less malevolent-sounding — but almost comically obtuse — term “non-bank financial institutions”. At $240tn, this system is now far bigger than its conventional counterpart. The bond market is its main component, taking money from investors who can mostly yank it away at short notice and funnel it into long-term investments. The question of how to tame shadow banking is one of the thorniest topics in finance today.

The essay describes the roles played by Mike Milken at the investment bank Drexel Burnham Lambert in the 1980s in the emergence of the junk bond market and by Lewis "Lew" Ranieri at Salomon Brothers in the emergence of the mortgage securitisation market (especially the tranched mortgage bonds with different interest rates, tenors, and riskiness). 

It also describes the increasing riskiness of the shadow banking system, and how the massive purchases of the US Treasuries during the pandemic prevented a collapse of the bond markets. It was definitive signal about the importance of the bond markets - during the GFC, the US Treasury bailed out the banks, whereas now it was the bond market that was being bailed out.  

This is a fascinating snippet

Ian Fleming chose the name Bond for his spy because he thought it was “the dullest name I’ve ever heard”

Interpreting Keynes - restoring market confidence

The 'neo-classical synthesis' of Keynesianism and classical microeconomics holds that the economy is Keynesian in the short-run because wages and prices are "sticky" (as initially interepreted by John Hicks in England and Alvin Hansen in the US), while it is classical in the long-run when prices have found their right level. It implies that, to restore full employment, we simply need to realign nominal prices with nominal demand, either with monetary policy to stimulate private spending or with fiscal policy to replace private spending with public spending. Opponents of the Keynesian fiscal policy to stimulate aggregate demand, led by the likes of Robert Barro and Eugene Fama, invoke Ricardian equivalence to argue that government spending will crowd out private expenditure.

UCLA Professor Roger Farmer, in a series of recent working papers and articles, while conceding the usefulness of fiscal policy he argues that the fiscal stimulus induced government spending multiplier is smaller than claimed and presents an alternative approach to address such deep economic crisis. He argues that orthodox Keynesian interpretations of the General Theory misses the story and offers an alternative reconciliation of Keynes with microeconomics that does not rely on sticky prices.

About the problem with fiscal policy, he writes,

Keynes said three things in the General Theory. First: the labour market is not cleared by demand and supply and, as a consequence, very high unemployment can persist forever. Second: the beliefs of market participants independently influence the unemployment rate. Third: It is the responsibility of government to maintain full employment. He was right on all three counts. But he was wrong about something else.

Keynes thought that consumption depends on income... Consumption, and this is two thirds of the economy, depends not on income but on wealth... the theory of the (government spending) multiplier and the implication that fiscal policy can get us out of the current crisis rests on exactly this point... but if income depends on wealth then fiscal policy may be less effective than the Keynesians claim... fiscal policy cannot provide a permanent fix to the problem of high unemployment.

Prof Farmer raises doubts on the Ricardian equivalence claim since its logic "requires that rational forward looking households fully internalize the future tax burden of current fiscal profligacy", an unlikely fact since human "lives are short and not everyone cares for their descendents".

In the first paper, Prof Farmer claims that the equilibrium business cycle theory is flawed and presents an "alternative paradigm that retains the main message of Keynes’ General Theory and which reconciles that message with Walrasian economics". He argues that unemployment will remain trapped at a high level due to two labor market failures - arising from a lemons problem and an externality. The aforementioned two market failures makes it difficult and costly to match unemployed workers with vacant jobs, by not providing "the necessary price signals to ensure that a given number of jobs is filled in the right way". This results in economically and socially inefficient multiple "equilibria in which the unemployment rate is determined by the self-fulfilling beliefs of stock market participants". He writes,

"Firms decide how many workers to hire based on the demand for the goods that they produce. The demand for goods depends on wealth. Every different equilibrium unemployment rate is associated with a different set of prices for factories and machines and the value of these physical assets depends on what market participants think they will be worth in the future. The world economy is currently headed rapidly towards a high unemployment, low wealth equilibrium which was triggered by a loss of confidence in the value of assets, backed by mortgages in the US subprime mortgage market. The inability to value these assets has since led to an amplification of the crisis as panic hit the global financial markets. Even though the US stock market is appropriately valued based on historical price earnings ratios — investors are worried that the value of stocks could fall further... (any further) drop may prove to be self-fulfilling...".

In another working paper, he draws attention to a less costly and more effective alternative to fiscal policy. He feels that the "current financial crisis is an example of a shift to a high unemployment equilibrium, induced by the self-fulfilling beliefs of market participants about asset prices". His arguement is summed up as - "informational asymmetries cause missing markets, missing markets lead to the existence of multiple equilibria, and psychology, in the form of self-fulfilling prophecies, becomes an additional fundamental that selects an equilibrium".

Under such circumstances, a better "alternative might be for the Fed to intervene in the asset markets through purchases and sales of a broad index fund of stocks". He writes, "We need a new approach that directly attacks a lack of confidence in the asset markets by putting a floor and a ceiling on the value of the stock market through direct central bank intervention".

Bankers and animal spirits

"Incompetence is certainty in the absence of expertise. Overconfidence is certainty in the presence of expertise".

Malcom Gladwell in his analysis of the role of bankers in causing the financial crisis. He feels that bankers were "mis-calibrated" in the "overestimation of their ability to make predictions and control the somewhat random environments surrounding them". The "confidence" trait is one of the five dimensions of animal spirits, outlined by George Akerlof and Robert Shiller, in their recent book by the same name.