Bilal’s Top Picks: Reserve Currency Curse / The Impeachment Mistake / Japan’s Free Debt

(total reading time: 9 mins)

Yet another busy week – not only for us, as we work hard on our new website – but for markets too. Below is our hand-picked selection of 35 of the best pieces from around the Web.

With a number of new leaders just taking their seats around the round table, we reflect on the challenges in front of them. Eurozone needs urgent (fiscal?) revival and migrant crisis relief, the US is still battling impeachment while hoping to escape the reserve currency “trap”, and as Communist China continues to celebrate its 70th birthday, the doom and gloom around Hong Kong is accelerating. And we haven’t even mentioned the approach of Brexit.

In the meantime, markets are sobering up to inflated unicorn valuations – where will all the cheap capital pour into now? Also, make sure to check out the chart at the bottom of the letter – it’s on the % of women inventors ranked by country; you’re in for a shock!

Enjoy!

Following WeWork’s sky-high valuation and its consequent IPO break-down, the market seems to be waking up to the unjustified unicorn rush. Where will all the free capital pour into now?

IPOs Have Been Crushed in 2019. Why That’s Actually Good News for Stocks. (Barron’s) Amidst the many IPO disappointments recently, investors have become more discriminating, and that’s good for everyone. Most recently, WeWork has caused abrupt sobering up and return to focus on fundamentals and a credible path to profitability. Great piece dissecting all the techy unicorns.

Softbank’s Vision Fund is Just Too Damned Big (Barry Ritholtz) Softbank isn’t about diversification – it’s making a few, big bets, often on more established companies. It’s flooding ventures with capital, but is it paying enough attention to fundamentals? Or simply driving a race to bubble?

Are CLOs the New CDOs? (Conversable Economist) Last week we shed light on Collateralised Loan Obligations, which have very similar structure to CDOs but in this case, the debts are corporate loans rather than subprime mortgages. This is another good analysis on why they have now reached sizes close to those of CDOs in 2008. And why we shouldn’t worry too much yet but keep an eye on the space.

The Great Fee War of the 2010s (A Wealth of Common Sense) Fund fees get lower by the year and access to instruments gets higher for individual investors. Investment firms are going to have difficult business decisions to make in the years ahead as their margins slowly erode and investor behaviour might get more reckless.

Everyone is worried about the structural challenges facing the Eurozone – it might be the eventual loser from the trade war. The US continues to face the “reserve currency curse” – the trade war could just be a mechanism to lose such status. It might just prove best to be a small economy, steer away from controversy and enjoy control over your policymaking.

Mario Draghi: Stabilisation Policies in a Monetary Union (BIS) Mario Draghi discusses whether the eurozone has increased its ability to stabilise macroeconomic shocks given that crisis has lasted in the region much longer than in other developed regions. The key matters are stabilisation across countries and stabilisation over the cycle.

Are Europe’s Economic Prospects Brighter Than They Appear? (Project Syndicate) Europe is the real loser from the US-China trade wars. The region is still extremely vulnerable to collateral damage, it always has the wrong policy response and is torn by internal political shocks (think Italy). Long-term prospects are brighter, however, driven by aggressive easing.

Nixon Shock, the Reserve Currency Curse, and a Pending Dollar Crisis (Mish Talk) The trade wars are just a hidden mechanism for the US to get rid of the “reserve currency curse”. No one seems to want to hold the World’s reserve currency and are working hard to ensure it stays that way. The EU and Japan have negative rates, China does not float the Yuan but props up corrupt SOEs, and Germany punishes the rest of the EU.

The Curse of Size (Econlib) Size matters – smaller countries have the choice to devalue their currency or go into negative rate territory without much attention and are free to control inflation. Argues that he creation of the euro made the world more susceptible to deflationary traps.

Unconventional Monetary Policy Operations: The Upside for Central Bank Balance Sheet Risks (Orduna, Schwaab) Finds that in exceptional circumstances, a central bank can remove illiquidity-related credit risk from parts of its balance sheet by extending the scale of its operations.

Fiscal stimulus is all the hype and is often cited as the only tool left to steer away from a recession, especially in the Eurozone. Germany might be just warming up to the idea. We also look at solution to the growing issue of unaffordable housing and how to actually build more – not just fuel buying with cheap debt.

Japan’s Government Will Soon Make a Profit on Its Huge Debt (CEPR) Amids raising worries about Japan’s tax lift from 8% to 10%, this commentary reminds that given the negative nominal rate, the debt service burden is virtually zero. Debt is now becoming a source of revenue.

It’s Time for German Fiscal Expansion (Project Syndicate) Advocates that it now makes sense for Germany to spend more without fears of overheating. It should spend more on infrastructure maintenance and modernization, and it could cut payroll taxes. This piece similarly supports fiscal action for the wider Eurozone.

Estimating Regional Wealth in Germany: How Different Are East and West Really? (Kreutzmann, Marek, Salvati, Schmid) Almost 30 years since the German reunification, this paper finds the East lagging in significantly in regional indicators, most notably private net wealth. Each eastern German federal state private wealth comes to less than half of the national mean.

We Cannot Build Our Way Out of Inequality (VOX) The path to a solution of the housing crisis in large metropolitan areas might be to cut regulation in order to build more and denser housing in metro regions (upzoning). The answer is not simple and needs combining education, social, health, and housing policies.

To Tackle Housing Affordability in Canada, Build MoreHouses (IMF) Argues that to solve the lack of affordable housing in Canada (and most of the Western World), we need accelerated process of supplying houses. Sounds simple – but governments have been too focused on making borrowing quicker and accessible – which fuels house price surges.

Aging populations across the Western World comes with a number of issues while it is transforming the labour market. Established tech exporters such as Japan are losing their edge. We also look at how tech is revamping retail banking.

Why Japan Lost its Comparative Advantage in Producing Electronic Parts and Components (VOX) A sharp appreciation of the yen after the Financial Crisis, caused by capital seeking safe havens has hurt Japanese competitiveness in electronic parts, their bread and butter. Yen export prices tumble relative to production costs. Highlights a need for “craftsmanship” instead of pure price competitiveness going forward.

Population Aging and Structural Transformation (Cravino, Levchenko, Rojas) Shows that the older the population of a country, the more expenditure end up in the service sector. Population aging played a much larger role than changes in real income in the structural change observed in the US between 1982-2016.

Seven Transformative Shifts in US Retail Banking Inflection Point (McKinsey) – Pinpointing to seven transformational shifts which are advancing changes in the US retail banking industry. They have to quickly adapt – a growing number of consumers are trusting Big Tech players (Amazon, Google, Apple and Facebook) with their money instead.

Financial integration in Europe through the lens of composite indicators (Hoffman, Kremer, Zaharia) Financial integration within the Euro area, within money, bond, equity and banking markets is an important driver of growth and heavily influences per capita GDP. Another testament against Brexit. 

Impeachment is all the focus now, bringing us back to the years of Clinton. It’s unlikely to lead to much, however. We compare how Republicans are performing in light of re-election hopes and how Trudeau lost his reputation – slowly, then all at once.

The Impeachment Trap (Project Syndicate) Argues that Democrats have made a mistake to call for Trump’s impeachment, hoping to follow Clinton’s experience. Trump retains the loyalty of his base supporters and enjoys majority support in the Senate. It’s been a info-leaky administration – nothing new was learned about Clinton after the Starr Report was issued, and nothing new will be learned about Trump.

Looking at America’s Two Economies (Econlife) Analyses the state of the economy in the Republican states in comparison to Democrats. In 2008, the Republican median HH income, at $55,000, was higher than the Democrats. By 2017, Democrats were up to $61,000 and Republican voters were down to $53,000. Argues that this is because with Democrats increasingly clustered in affluent coastal urban areas, they also represent a bigger share of productivity, education and better paying jobs than their opponents.

Justin Trudeau’s Spectacular Self-Destruction (Foreign Policy) Gives an insight into Justin Trudeau’s stunning fall from grace, with approval ratings of just 31% down from more than 60% in 2016. Not only has he been underdelivering on his promises, (despite millennials favouring his legalisation of cannabis) but he also backtracked from his pledges to revamp the electoral system. Far from his initial appeal of being a change maker, he is now seen as a run-of-the-mill politician.

Europe Needs a Migration Reset (Project Syndicate) Argues that Europe needs a rethink on how to handle the floods of migrants as camps are overflowing. Four actions – better secure external borders, handle economic and asylum migrants separately, repair the migrant distribution system to member states and forge stronger ties with countries of origin.

Political and Economic Drivers of Pogroms (VOX) – Analyses the interaction of political and economic factors to drive pogroms in an anti-semitic environment. The authors find that massacres occurred when economic downturns coincided with political upheaval. One of their key findings also indicate that occupational segregation between Jews and the mass played a significant role in triggering ethnic violence.

A number of insightful pieces exploring how tech and machine learning in particular are breaking into finance. But models aren’t always perfect – mispricing risk can lead to a chain reaction and a downturn.

World Wide Currency (VOX EU) Is it possible to introduce a globally recognised electronic currency in the future alongside the national currencies? Researchers test this idea with a two-country model and conclude that it’s theoretically doable. Although for monetary policymakers, there’s certainly so much more to do to get them prepared for this futuristic trend.

A Volatility Smile-Based Uncertainty Index (Central Bank of Brazil) Introduces a new index to measure uncertainty: the “Volatility Smile-Based Uncertainty” (VSU). It looks at the discrepancy of the implied volatility of exchange rate options, and after calculating this value for five major emerging economies, concludes that VSU is negatively associated with industrial production and has peaks close to turbulent periods.

Ten Applications of Financial Machine Learning (SSRN/Cornell University) Explores how the core of machine learning – studying past data to predict future outcomes – can be revolutionary for the financial services industry. However, it also warns that machine learning tools are vulnerable to input selection biases and that can lead to undesired consequences.

Perceiving Risk Wrong: What Happens When Markets Misprice Risk? (Bank Underground) Risk perceptions are extremely subjective and hard to quantify. This paper examines how overpricing and underpricing market risks can both eventually lead to an economic downturn in the manner of a chain reaction.

FinTech, BigTech, and the Future of Banks (NBER) Explores areas in which non-bank fintech firms can outplay their banking rivals. Being less regulated than banks gives fintech firms an important competitive advantage. Large tech firms are also challenging traditional banking businesses such as consumer finance and loans due to their capability to tap into large amounts of unique user data.

HK troubles are poised to stay and only get worse and China is now blaming Washington for their involvement. As CCP are celebrating their 70th birthday, we look at how they are slowly losing their dominating grip.

Will the Trade Conflict Confound China’s Ambitions? (George Magnus/Carnegie-Tsinghua Center for Global Policy) The Chinese government and the CCP wished for a celebration for the republic’s 70th anniversary, but a number of pressing matters have cast clouds over their heads. The trade conflict with the US had much greater externalities than expected on a lagging Chinese economy, which had become increasingly integrated with the rest of the world. Finding a solution to the unrest in Hong Kong is proving another huge, hot potato.

China’s Impact on Global Financial Markets (NBER) Examines shifts in the structure of China’s capital outflows over the past decade, and how Chinese institutional investors had become the major channel of China’s foreign investment outflows. In contrast to the presumptions of many, these investors, in fact, overweigh sectors and regions where China has a comparative disadvantage.

People’s Republic of China Reaches Age 70 (Econospeak) Examined the PRC’s rapid socioeconomic and political transformation 70 years since its founding days. The CCP could be seen as a dynasty of modern age. But aside Hong Kong and now Taiwan, the expansion of power and influence across much of the world, especially through the Belt and Road initiative, may be running into limits.

How China Sees the Hong Kong Crisis (Foreign Affairs) Beijing has been acting fairly restraint towards the protests in Hong Kong. A firm belief is that the majority of Hong Kong elites and part of the Hong Kong public would be Beijing’s allies in solving the problem. Beijing also heavily criticise the US involvement in the matter, as it believed that Washington sought to inflame radical sentiments in Hong Kong.

China’s Hong Kong Problem (Project Syndicate) Chris Patten, the last British governor of Hong Kong heavily criticises the way China is handling the protests. Instead of undermining international trust with their behavior, they should affirm their intention to uphold China’s commitments under the Joint Declaration treaty and guarantee HK’s freedoms and high degree of local autonomy until 2047.

Hong Kong’s Protesters are Outfoxing Beijing Worldwide (The Atlantic) The key figures who lead the Hong Kong protests are now having the public opinion high ground on several international occasions – especially in the western world. They are better at utilising technology and social media to voice their opinions, have their cases heard by a much wider audience, and seek moral support.

For more information: The Countries With The Most Female Inventors