Issue 116

Regulating crypto

Delivered on 14 June 2021 by Justin Pyvis. About a 3 min read.

The Basel Committee on Banking Supervision is gearing up to regulate banks that hold cryptocurrency, as "the growth of crypto assets and related services has the potential to raise financial stability concerns and increase risks faced by banks". Unfortunately its proposed regulations completely miss the mark. According to the FT:

All other [non-stablecoin] crypto assets, including bitcoin and ethereum, would go into the new, more strenuous regime. The Basel committee proposed a risk weight of 1,250 per cent, in line with the toughest standards for banks' exposures on riskier assets.

That would mean banks would in effect have to hold capital equal to the exposure they face, and be prepared if the value of the asset were worthless. A $100 exposure in bitcoin would result in a minimum capital requirement of $100, Basel said.

The standards would apply to assets created for decentralised finance (DeFi) and non-fungible tokens (NFTs), but potential central bank digital currencies were outside the scope of the consultation, it added.

I get that the regulator is concerned about stability, but the effect of these capital requirements will be to kick crypto to the curb – including the very promising DeFi – where it will be embraced by non-bank entities.

We've seen how excessive regulation can lead to growth in problematic shadow banking – well soon we may see a growing shadow crypto sector. A far better approach would be to update the rules to incorporate crypto, rather than kneecap it to the point that the only place it can thrive is outside of the traditional banking system.

There is a legitimate need to develop a proper, global regulatory framework that would allow institutions to access new DeFi services through the banking system. It really shouldn't be that difficult – most cryptocurrencies are actually more traceable than cash, given that they provide an open, immutable record of all transactions.

Then again, if the five Big Tech-busting bills released for review in the US last week are any indication (see below), perhaps proper regulation of crypto is indeed impossible.

Those five antitrust bills

US House Democrats on Friday unveiled five separate bills aimed at breaking up Big Tech. If you were to put several politicians in a room who knew nothing about technology and asked them to devise some new regulations... well this is close to what you would get:

  • American Choice and Innovation Online Act, to prohibit discriminatory conduct by dominant platforms, including a ban on self-preferencing and picking winners and losers online.
  • Platform Competition and Opportunity Act, to prohibit acquisitions of competitive threats by dominant platforms, as well acquisitions that expand or entrench the market power of online platforms.
  • Ending Platform Monopolies Act, to eliminate the ability of dominant platforms to leverage their control over across multiple business lines to self-preference and disadvantage competitors in ways that undermine free and fair competition.
  • Augmenting Compatibility and Competition by Enabling Service Switching Act, to promote competition online by lowering barriers to entry and switching costs for businesses and consumers through interoperability and data portability requirements.
  • Merger Filing Fee Modernization Act, to update filing fees for mergers for the first time in two decades to ensure that Department of Justice and Federal Trade Commission have the resources they need to aggressively enforce the antitrust laws.

At least we finally get a definition out of this. Big Tech (i.e. companies covered by these Acts) are defined as those with 50 million US-based monthly active users, 100,000 US-based monthly active business users, or possessing a market capitalisation of more than $US600 billion. Right now that would include Google, Facebook, Microsoft, Alphabet (the parent company of Google), Amazon, Apple, Netflix and maybe even Snapchat (which has close to 50 million US-based monthly active users). None of the metrics are indexed to population or inflation, meaning over a sufficient period of time they could become all-encompassing.

One important variable that isn't defined is "data", which will be provided "6 months after the date of enactment". So these Acts will go into force, require Big Tech to ensure things such as "all data must be portable", and "enable the secure transfer of data to a user", but not provide a definition of data?!

Not to mention that mandating data portability generally requires an assumption that the current way of doing things is the only way: will some future Facebook competitor be required to ensure its data are portable and interoperable with whatever today's regulators come up with? Surely not, but that's what will happen. The effect will be to lock-in some kind of standard and force every future entrant to comply accordingly, which would likely have the opposite effect to the stated goal: it would help Big Tech maintain its dominance and stymie innovation.

Then there's the effective prohibition on all mergers and acquisitions, with M&A disallowed for any Big Tech company that might "compete with the covered platform... constitute nascent or potential competition to the covered platform... enhance or increase the covered platform operator's market position... or maintain its market position". Really?

There's plenty more nastiness inside each, feel free to read them all here. But essentially a handful of US companies will be regulated differently to every other business – without evidence of consumer harm – in a process that, if passed, will probably destroy many products consumers actually enjoy. 🙄👏

Issue 115

A big success

Delivered on 08 June 2021 by Justin Pyvis. About a 3 min read.

The Australian government's attack dog has given itself a big pat on the back for successfully shaking down Google and Facebook with its News Media and Digital Platforms Mandatory Bargaining Code:

Rod Sims, chair of the Australian Competition and Consumer Commission, told the Financial Times on Tuesday that the country's world-first news media bargaining code had forced big technology platforms to the negotiating table to agree deals with publishers.

"We are on track for deals all around. It's been a big success," Sims said in an interview. "We are just about there and the media companies are happy — and that's the key point."

The word "deal" is a generous use of the English language, which defines it as "an arrangement for mutual advantage". These deals are only mutually advantageous to the extent that the legislation allows Australia's Treasurer to arbitrarily "designate a digital platform as being under the news media bargaining code", unless a deal is struck resulting in "no need for designation under the code".

In other words, the costs being "designated" by the Code are so significant that it's in Google and Facebook's interest to agree to a completely one-sided deal to avoid having to "bargain" in the ACCC's kangaroo court. There's a serious lack of transparency: no details of any of the "deals" have been made public, although they're each rumoured to be in the tens of millions.

Essentially Facebook and Google have to pay a secret 'protection fee' to Australia's archaic, highly concentrated media companies or the government will beat them down with a big stick known as the News Media and Digital Platforms Mandatory Bargaining Code. The public is completely in the dark, the media companies are unaccountable to the taxpayer and any potential entrant must now compete against these dinosaurs plus the extra tens of millions of dollars with which they're now being subsidised.

No doubt a lucrative advisory gig at one of the legacy media companies awaits ACCC chair Rod Sims when his term expires in July 2022.

Solar policy and unintended consequences

A few days ago Bloomberg published a good piece summarising the demise of the US solar industry. It's a warning for fans of so-called industrial policy, with good intentions ruined by unintended but entirely predictable consequences.

The [solar] industry failed to take root in the U.S. despite billions of dollars in government incentives and nearly two decades of pledges from presidents, starting with George W. Bush, that the nation would be a clean-energy superpower.

In the early 2000's China was emerging as a major solar competitor to the US. So successive Presidents – before the 'Tariff Man' Donald Trump even came to power – whacked them with tariffs, with Obama raising them "as high as 249%", which... "spurred retaliation instead of a manufacturing renaissance":

Manufacturers responded by moving operations out of China, but they didn't head to the U.S. Instead, large manufacturers skirted the U.S. tariffs by building facilities to assemble solar cells and modules across Southeast Asia.

But it gets better:

Making matters worse, China retaliated by imposing its own duties of up to 57% on imports of U.S.-made polysilicon -- tariffs that crippled U.S. producers of the conductive material used in solar panels.

Instead of affordable, Chinese-taxpayer subsidised solar panels that made "solar as cheap as coal", the US raised the domestic price of solar, did not save the industry, and accidentally managed to kill off its thriving polysilicon industry, going "from making 50% of the world's polysilicon in 2007 to less than 5% today".

Unintended consequences from poorly conceived policy strike again. What's the saying about good intentions again?

Issue 114

Facebook's data problem

Delivered on 31 May 2021 by Justin Pyvis. About a 2 min read.

Facebook is a data leviathan, gobbling up anything and everything it can on its users and non-users alike. It does that for a reason – Facebook is not a social network but an advertising company. It needs as much data as it can get because it's competing with the likes of Google, Amazon and even traditional media for a limited number of advertising dollars.

Facebook has to prove that its adverts are better targetted than the competition – that its adverts are "useful and relevant", i.e. properly directed at the desired audience, generating more useful clicks. It has done a pretty good job of that over the past decade:

Over 97% of Facebook's revenue comes from advertising.
Over 97% of Facebook's revenue comes from advertising.

But recently the tide has started to turn and Facebook finds itself with a data problem.

The first blow was the immense backlash to Facebook's attempt to capture even more data from its messaging subsidiary, WhatsApp, which it acquired for around $US16 billion in 2014 but hasn't been able to monetise. That forced the company into two backflips: it delayed the planned February change to 15 May, then last week it announced that "we will not limit the functionality of how WhatsApp works for those who have not yet accepted the update".

In other words, WhatsApp users will still have to opt-in for Facebook to have access to their WhatsApp images and metadata (WhatsApp is likely end-to-end encrypted so the messages themselves are useless), limiting the number of users it can data mine.

The second blow was Apple's IOS 14.5 update, which starting rolling out to users in late April:

Since the update went live last month iPhone owners have been opting out of data tracking in their droves. According to Flurry Analytics, 85 per cent of worldwide users clicked 'ask app not to track' when prompted, with the proportion rising to 94 per cent in the US.

Now to be clear, Apple is no saint. It has been accused of using forced labour in Xinjiang and has been more than willing to sell its Chinese users down the river:

Mr. Cook [Apple CEO] often talks about Apple's commitment to civil liberties and privacy. But to stay on the right side of Chinese regulators, his company has put the data of its Chinese customers at risk and has aided government censorship in the Chinese version of its App Store. After Chinese employees complained, it even dropped the "Designed by Apple in California" slogan from the backs of iPhones.

Apple's attack on Facebook via the data tracking opt-out is not an act of benevolence but a strategic move designed to cripple a major competitor. If Facebook can't track Apple iPhone users (over 1 billion in use worldwide), it can't sell targeted adverts to them as easily. How can Facebook continue to pump development dollars into the likes of WhatsApp if they can't be monetised?

The short answer is it can't, which is why Facebook has a data problem. In an effort to offset Apple's move, Facebook recently increased the number of internal commerce products it offers, such as Facebook Shops and Instagram Shops ('other' revenue in the chart above). It has also been begging Apple users to "show you ads that are more personalised", to "keep Facebook free of charge".

But would anyone actually pay for Facebook? 🤔

Issue 113

Bubble risks

Delivered on 24 May 2021 by Justin Pyvis. About a 3 min read.

Bloomberg published an article on Sunday looking at asset bubbles in China:

Home prices are soaring, prompting officials to revive the idea of a national property tax. A surge in raw material prices spurred pledges to increase domestic supply, toughen market oversight, and crack down on speculation and hoarding.

The rapid gains are challenging the central bank's ability to restrain inflation without hiking borrowing costs or making a sharp turn in monetary policy – something the People's Bank of China has said it will avoid. The risk is the government's attempts to curb price increases won’t be enough, forcing the central bank's hand at a vulnerable time for domestic consumption.

Bubbles – particularly in assets – are blowing up everywhere, not just in China. Demand surged on the back of record-low interest rates and gargantuan fiscal stimulus in response to the coronavirus pandemic, despite the fact that it was a supply shock, not a deep demand shock (as after, say, a financial crisis).

There is a reasonable risk that the observed asset price inflation eventually flows through to consumer price inflation, forcing rate hikes and a destruction of company valuations. It's already showing up in China's producer prices – the price of raw materials and goods leaving its factories – which will squeeze the margins of consumer goods vendors, unless they also start to raise prices.

China's bond market isn't concerned about inflation.
Source: Bloomberg

While China's financial markets are "pricing in a relatively benign scenario", and the "10-year government bond yield has fallen to the lowest level in eight months", it's important to remember that bond markets have never actually predicted future inflation but instead move concurrently with inflation, sometimes even with a lag.

There is no evidence to suggest that bond markets are good predictors of inflation.
Source: Peterson Institute for International Economics

We made a prediction of sorts back in December 2020:

Central bankers have been very vocal about suppressing interest rates for, in some cases, up to three years. Whether they'll be able to achieve that stated goal is another question, but you can be sure they'll try for far longer than they should.

But the sheer amount of demand stimulus being injected into the global economy can't go on forever and when it turns, it'll turn quickly. As Hemingway wrote in The Sun Also Rises, you go bankrupt in two ways: "Gradually, then suddenly." That's probably how the latest global debt adventure will also unfold: first with asset price inflation, then with the wealth effect pushing up consumer price inflation, then finally with a sudden crisis as markets, central bankers and governments eventually realise their errors (far too late).

Unfortunately, the madness may continue for much longer than you expect (such is the nature of credit booms).

Asset price inflation, check. We're now starting to see some consumer price inflation – which central banks are claiming is "transitory" – but there's still pressure to come given that the savings rate remains elevated and growth in bank deposits only started to decelerate in mid-March.

However, supply chains are already under pressure from COVID-restrictions and the swathe of order cancellations last year and subsequent investment and production cuts mean prices could respond relatively quickly to additional consumer demand.

Google searches for inflation are back where they were during the global financial crisis.
Source: Google Trends

We don't pretend to know when the music will stop but the recent volatility in equity, commodity and crypto markets, along with rising web searches for inflation, suggests we're not alone in worrying about bubble risks.

Issue 112


Delivered on 10 May 2021 by Justin Pyvis. About a 5 min read.

The ABC (an Australian government news organisation) ran an article 'explaining' the global microchip shortage, titled What does chipageddon have to do with climate change?

As you might have guessed by the title, the authors attribute the global chip shortage – chipageddon – to a drought in Taiwan (its worst for 56 years, according to the BBC), which they say "is happening in the context of a changed climate, particularly the extremes". At first glance, that makes sense – chip production requires a lot of water and the ABC cites a 2012 journal article that concludes climate change will lead to "a rise in drought frequencies" in Taiwan (as well as increased floods).

There are two major problems with the ABC's article. First, the paper cited only modelled the years 2080 - 2099. It's a bit of a stretch to say the current drought "is happening in the context of a changed climate", then citing a paper that supports that argument by modelling climate change 59 - 78 years into the future.

But the biggest problem with the article is there's no evidence a lack of water has actually affected Taiwan's chip production.

Due to the drought, the government has been transporting water from less affected regions for use in technology parks (where most microchip factories operate). So while agricultural crop yields might be damaged due to the lack of typhoons in 2020 (around 70% of water usage in Taiwan is for relatively lower value agricultural use), microchip manufacturing has so far been spared.

Don't get me wrong: climate change is something Taiwan's chip producers will have to manage going forward. But it can be managed – Taiwan's biggest issue is not the drought but a chronic underpricing of water. Taiwan has the cheapest water in Asia and one of the lowest water prices in the world. That leads to inefficiencies all the way down the supply chain, from wasteful behaviour by households to entire industries being built around artificially cheap water.

Fix prices, fix the drought.

As an addendum (because you won't learn much about chipageddon by reading that ABC article), the current chip shortage stems from the combination of the US-China trade dispute disrupting supply chains (Huawei reportedly stockpiled six months' worth of inventory) and a huge miscalculation on behalf of manufacturers around the world. According to Taiwanese chipmaker TSMC, "In March, 2020, as COVID paralysed the US, car sales tumbled, leading automakers to cancel their chip orders. So TSMC stopped making them."

Global manufactures panicked when the pandemic hit and cancelled their orders. Suppliers stopped producing. Now they're crying shortage because the rebound in the demand for durable consumer goods has been so intense. Hence, chipageddon.

The Maher effect

Old man yells at Bitcoin
Source: Ben Kaufman/Twitter

Many of you may have seen comedian/talk show host Bill Maher's hit job on Bitcoin last week. He clearly doesn't understand crypto and makes a lot of mistakes in his analysis, but he tends to do that with everything he doesn't understand:

  • On vaccines, "It's presented as this genius medical advancement. No it's actually this risky medical procedure."
  • On camera phones, "It's a phone not a Swiss army knife."
  • On social media, "I already know what the captain of the football team is doing these days: mowing my lawn."
  • On SARS, "Stop scaring us with diseases we will never get... Mysterious Asian diseases don't come knocking on your door."
  • On streaming, "I just think people watching other people playing video games is a waste of f**king time."

However, one valid point he did bring up was Bitcoin's electricity use:

Bitcoin uses more electricity per transaction than any other method known to mankind; just one uses more energy than a million Visa transactions and has the same carbon footprint as 85,000 hours of watching YouTube ... Bitcoin uses more energy than Netflix, Apple, Facebook, Microsoft and Google combined.

It's a legitimate concern, but also one that was answered last week by the Harvard Business Review:

In December 2019, one report suggested that 73% of Bitcoin’s energy consumption was carbon neutral, largely due to the abundance of hydro power in major mining hubs such as Southwest China and Scandinavia. On the other hand, the CCAF estimated in September 2020 that the figure is closer to 39%. But even if the lower number is correct, that’s still almost twice as much as the U.S. grid, suggesting that looking at energy consumption alone is hardly a reliable method for determining Bitcoin’s carbon emissions.
Almost all of the energy used worldwide must be produced relatively close to its end users — but Bitcoin has no such limitation, enabling miners to utilize power sources that are inaccessible for most other applications... Bitcoin miners from North Dakota to Siberia have seized the opportunity to monetize this otherwise-wasted resource, and some companies are even exploring ways to further reduce emissions by combusting the gas in a more controlled manner.
Many journalists and academics talk about Bitcoin’s high “per-transaction energy cost,” but this metric is misleading. The vast majority of Bitcoin’s energy consumption happens during the mining process. Once coins have been issued, the energy required to validate transactions is minimal. As such, simply looking at Bitcoin’s total energy draw to date and dividing that by the number of transactions doesn’t make sense — most of that energy was used to mine Bitcoins, not to support transactions.
Because Bitcoin's energy footprint has grown so rapidly, people sometimes assume that it will eventually commandeer entire energy grids... [However,] the energy mix of Bitcoin grows less reliant on carbon every year... [and] miners are unlikely to continue expanding their mining operations at the current rates indefinitely.

TL;DR: Bitcoin's electricity use and environmental impact is "a lot less alarming than you might think".

Merkel nails it

For those who missed it, US President Joe Biden jumped on the 'abolish intellectual property (IP) for COVID-19 vaccines' bandwagon last week, "amid pressure from Democrats in his party to remove patent protections". In other words, yet another policy directed at virtue signalling rather than accomplishing anything useful.

The thing is, IP is not the handbrake on vaccine production and distribution. IP holders have been more than willing to licence it to whomever has, or is willing to develop, manufacturing capacity. Moderna (the creator of one of the two mRNA vaccines) even went so far as to suspend enforcement of its IP way back on 8 October 2020:

...while the pandemic continues, Moderna will not enforce our COVID-19 related patents against those making vaccines intended to combat the pandemic. Further, to eliminate any perceived IP barriers to vaccine development during the pandemic period, upon request we are also willing to license our intellectual property for COVID-19 vaccines to others for the post pandemic period.

It's not just Moderna, either. All vaccine makers are licencing their products to whomever wants them. Take AstraZeneca, which for all its problems has built a supply network with 25 manufacturing organisations in 15 countries to produce three billion doses this year.

Thankfully the world still has a handful of politicians that possess some common sense. In response to Biden's support of abolishing IP, German Chancellor Angela Merkel (via a spokesperson) nailed it:

The US plan would create "severe complications" for the production of vaccines. "The limiting factor for the production of vaccines are manufacturing capacities and high quality standards, not the patents. The protection of intellectual property is a source of innovation and this has to remain so in the future.

If you want to make the 'scarring' from the pandemic even worse, then abolishing vaccine IP would be a great way to do that, as it would undermine the incentive to quickly innovate during the next crisis.

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