Issue 99

The Mass Techxodus

Delivered on 08 February 2021 by Justin Pyvis. About a 6 min read.

Many of California’s techies have finally had enough, opting for the sunshine of Florida over the sunshine of the West Coast. Other than the sunk costs and network effects (e.g. there are lots of coders already in San Francisco), it actually makes a lot of sense, for a few reasons.

On the one hand, you have San Francisco. California has the highest state income tax in the United States (13.3%, which is now actually important due to the 2017-18 cap on federal income tax deductions for taxes paid to state and local governments). The most expensive property prices in the United States. Politicians who are openly antagonistic toward well-to-do tech workers. The smoke from the fires that burn every year due to the government's poor management of its forests.

Then on the other hand there’s Miami, Florida. Sure, it gets ravaged by hurricanes every year and its summers are brutally hot, but it has no state income tax and Miami's Mayor, Francis Suarez, actually wants tech workers to relocate to his city:

“It was a lightning-in-the-bottle moment,” said Mr. Suarez, 43, who became mayor in 2017. “For them to hear an elected official saying, ‘Hey, we want you, hey, we appreciate you’ — I didn’t realize what a sensitive moment it was in terms of how people felt they were being treated by the governments where they lived.”

Suarez will meet anyone who asks and is big on frontier tech such as blockchain and cryptocurrencies, offering to pay his staff in bitcoin. His government even hosts Satoshi’s White Paper on a government website. What’s not to like?

But Miami is not alone in seeking to attract techiepreneurs. Nevada is investigating allowing tech companies to create their own local government bodies - so-called 'Innovation Zones' - so that they may avoid being economically 'captured' by the next city. Then there's Austin, Texas, which also has no state income tax and is known as being a 'liberal hub' in red Texas. According to Elon Musk:

If a team has been winning for too long they do tend to get a little complacent, a little entitled and then they don’t win the championship anymore. California’s been winning for a long time. And I think they’re taking them [tech workers] for granted a little bit.

California is suffering a brain drain and its leaders seem content to let the state burn so long as they may rule over the ashes.

Robinhood is the Facebook of finance

Well, sort of. Robinhood only offers commission-free trading because you’re the product, not the customer. It makes money from what’s called payment for order flow (PFOF), where instead of trading commissions, it sells its customers’ buy and sell orders directly to market-making firms, such as Citadel, Virtu, or Two Sigma. It shops those sell orders around for the widest spread possible between the national best bid and offer of the security at the time of execution, maximising the revenue it earns.

PFOF is banned in the UK and Canada as it supposedly harms consumers:

In 2016, the CFA Institute, a not-for-profit organization that handles the exam for chartered financial analysts, published a report examining the effects of PFOF in the UK, which banned the practice in 2012. The report found that from 2010 to 2014, the percentage of retail-size trades that were executed at the best-quoted price jumped from 65% to 90%.

However, the price received when using PFOF is still better than the 'national best bid and offer' on the stock exchange! In other words, the "widest spread possible between the national best bid and offer of the security at the time of execution" is still a price improvement. Robinhood just takes a larger cut of that improvement than do companies that charge a trading commission up front.

If PFOF is banned, the broker takes a smaller cut of the price improvement (using the example above, this improves the percentage of trades executed at the best-quoted price by 25 percentage points) but has to charge a larger commission. That's clearly something consumers don't want, as the practice has reshaped the trading landscape in the US (for the better):

A few years back, Robinhood Markets Inc. had a crucial insight: Instead of charging a $5 commission and passing along 80% of the wholesaler’s discount to customers in the form of price improvement, it could charge no commission and pass along 20%, keeping the other 80% for itself.
And their original insight caused a lasting change to the retail brokerage business. Free trades really were a lot more appealing than $5 trades. This model attracted customers to Robinhood, which quickly became the hot brokerage for the young trading-on-their-phones crowd. It pressured other retail brokerages to do away with commissions too, and eventually most did; now the norm, if you want to trade stock, is that you can do it for free. Also, intuitively, it is good for volume: If it costs you $5 to trade stock, you will feel some friction; you won’t want to sit around trading stocks frantically all day, because those $5 charges add up. If it costs you $0 to trade stock, there is no friction, and if you don’t have a lot else going on—say during a pandemic-induced lockdown—you really might sit around all day trading stocks. Since your broker gets some PFOF on every order, this is good for your broker: Doing 100 free trades, each with a bit of PFOF, is probably better for the broker than doing one $5 trade.

Now if there were ever a practice that should be banned it’s not putting sunset review clauses into regulations. As I alluded to in last week’s update [Issue 98], it turns out a lot of the drama surrounding the Robinhood trading halt was preventable:

It’s time to consider real-time settlement in U.S. equities trading, Robinhood Chief Executive Officer Vlad Tenev said, after the online brokerage suffered immense financial strain from a retail trading frenzy that rocked Wall Street last week.

“There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time. Doing so would greatly mitigate the risk that such processing poses,” Tenev, who is also a co-founder of Robinhood, said in a blog post. The securities industry currently follows a two-day settlement system.

Regulation is rigid and does not adapt well to advances in technology or consumer preferences. Forcing politicians to at least review and sign off on existing regulations every few years would be a good start.

Microsoft begs to be taxed

Shock. Horror. Microsoft supports Australia’s news media bargaining code:

Microsoft president Brad Smith said he wants the company to grow in Australia to a point where there is "significant" revenue to share with publishers.

"We are more than willing to share. Part of what this means is that we’re very comfortable growing Bing in Australia with a lower profit margin than what Google is extracting today. We need to make sure we can grow to achieve that. We can't share money we're not making," he said.

"But we're comfortable with a different kind of business model for search. We're comfortable with a business model that will better serve the news media and Australia as a whole."

Duh. Microsoft stands to profit handsomely if Google were to leave the market. Let's do some basic arithmetic:

Microsoft's search engine, Bing, has a 3.8% market share in Australia, versus Google search's 94.4% share. If Google disappeared - remember, it's threatening to leave the Australian market if this legislation passes in its current form - and Microsoft took just half of that (i.e. ended up with around 50% total market share), that’s a 1,200% increase.

That means the Australian government could extract almost all of Microsoft's Bing revenue in Australia - around 92%, to be precise - and Microsoft would still be better off. As awful as the media bargaining code is, it's not bad enough to wipe out 92% of search revenue in this country.

No wonder Microsoft is willing to "share". Just kneecap our competition first, please.

Speaking of taxes...

...The United States is going to need more if Biden's $1.9 trillion stimulus package passes (who are we kidding, the Fed will just monetise it).

But seriously, the chance of higher future taxes is actually just a sideshow. The real problem of the package is that it'll stimulate demand into what has mostly been a supply shock, as governments have mistakenly been doing throughout the pandemic:

The 1.9 trillion program could overheat the economy so badly as to be counterproductive.  Protection can be achieved with less.

If this increase in demand could be accommodated, it would lead to a level of output at 14% above potential. It would take the unemployment rate very close to zero.

This would not be overheating; it would be starting a fire.

The above quote is from Olivier Blanchard, former chief economist at the International Monetary Fund. He's notoriously dovish (i.e., not fiscally conservative), anti-austerity, and was a big supporter of large global fiscal and monetary stimulus following the Global Financial Crisis. When even Blanchard can see that spending of this magnitude is a bad idea, it's probably a bad idea.

Provided no monetary offsets, we might get some strong price inflation sooner than markets expect (and years before central bank forecasts).

Issue 99: The Mass Techxodus was compiled by Justin Pyvis and delivered on 08 February 2021.