Thursday, August 14, 2014

IRS says Bitcoin is not a currency

The IRS says bitcoin is not a currency. The IRS is correct. The IRS is also, incidently, the institution that would signal that bitcoin was a currency when it begins to accept bitcoin as payment to extinguish the very same tax obligations that it has the sovereign power to create.

Fiat currency is a manifestation of sovereign power. It comes fundamentally from the power to tax. States which are ineffective at taxing also find themselves operating in mixed currency regimes as the locals bolster their local units with land, gold, US$, and now perhaps Euros as well.

Recognizing the fiat currency is a manifestation of sovereign power makes many people uneasy, particularly those who have a suspicion of Government and do not with to trust it with something as important as a currency. I sympathize with that position, but it is what it is.

I've also heard arguments that the historical record does not show, in general, currency evolving via initial taxation, but I think that's looking at the picture too narrowly. The origins of money came from debt, where individuals did favors for each other and became indebted. Various tokens then became acceptable substitutes for extinguishing that obligation. The State puts the cap on this process by both generating the obligation, and the means of extinguishing it.

Fred Wilson:
But sadly, treating Bitcoin as property makes it less likely that Bitcoin will become a medium of exchange in the US. That’s because consumers and business don’t normally transact in property. It would be a massive pain to keep track of “cost basis” and “sale price” for every dollar you received and parted with in the course of a day, week, or month. The good news is that because Bitcoin is “programmable money”, it is possible to do this programmatically for consumers and the companies providing payment infrastructure for Bitcoin are slowly but surely doing just that. However, in the long run, it would be much better for the IRS to treat Bitcoin as a currency, and my hope is they will do that as soon as possible.
He's looking at this in the wrong way because the "store of value" vs "medium of exchange" is not the right way to understand money. So when Fred says:
An even more problematic issue for Bitcoin is VAT tax policy in countries where that is the norm. Right now, Canada is considering applying VAT tax to the purchase of Bitcoin. VAT can be as high as 15% in Canada, so that would mean every purchase of Bitcoin would cost up to 15% more than the current market price. And then when you turn around and purchase something with Bitcoin (as I did yesterday with seats for Tuesday night’s Met game), you would be taxed another up to 15% on that transaction. That’s double taxation which, in my mind, is always terrible tax policy. If Canada goes with this approach, it is my view that Bitcoin as a medium of exchange in Canada is a non-starter.
For Bitcoin to be a medium of exchange in Canada, the Canadian Government would need to accept Bitcoin instead of the Loon for taxes. The Canadian Government can print Loons as and when it pleases. It has not control over Bitcoin. Why would it hand over it's sovereignty? More importantly, why would Canadians, if they understood what fiat currency is and how it works, want their Government to do this? It means Canada cannot operate fiscal policy. If I was a Canadian citizen, regardless of whatever reservations I may have over a particular administration, I would want the Government to be able to run counter-cyclical fiscal when necessary or else risk becoming like Greece.

Fred, who has invested in Bitcoin, then encourages the rest of the world to give up their Sovereign powers over currency and increase the risk of Greece like Depressions with all the coincident social ills that that brings. But he does not see this because he thinks the frame of the conversation is "medium of exchange vs store of value" and that's not his fault.

So, contra Fred:

It is my view that treating Bitcoin like a financial asset is the most helpful approach. That would allow Bitcoin to find its best use cases while having to operate under the same legal and regulatory regimes that the rest of the financial world operates under already. We need good financial innovation that serves the public, not regulatory arbitrage which enriches the financial sector. Bitcoin is not a currency, it is a protocol, and the sooner it realizes that the sooner we can see the innovation we all hope for. Those who confuse it with a currency are consigning their population to a financial catastrophe which will take us back to the Great Depression, while ironically blocking the technological advances it promises.

Friday, July 18, 2014

NPR is the problem

Not literally of course. But they do represent the responsible, sober, official position on matters economic and thus it's good to remind oneself of exactly what that is after spending some time in the vapors of the Internets. From Richard Fisher of the Dallas Fed:
First, I believe we are experiencing financial excess that is of our own making. When money is dirt cheap and ubiquitous, it is in the nature of financial operators to reach for yield. There is a lot of talk about “macroprudential supervision” as a way to prevent financial excess from creating financial instability. My view is that it has significant utility but is not a sufficient  preventative.

Quite possibly.
When we buy a Treasury note or bond or an MBS, we pay for it with reserves we create. This injects liquidity into the economy. This liquidity can be used by financial intermediaries to lend to businesses to invest in job-creating capital expansion or by investors to finance the repairing of balance sheets at cheaper cost or on better terms, or for myriad other uses, including feeding speculative flows into financial markets.
Nonsense.

When the Fed pay for something by creating a reserve, that reserve does not enable lending by a financial intermediary nor does to repair a balance sheet. In the interview itself, Fisher said that the Fed had done it's job by creating reserves, and now it's Congress' job to get Americans to spend them.

But you don't spend reserves.

Instead the Fed should tell Congress that Americans cannot spend reserves, and that Congress needs to run higher deficits to encourage spending.

This is essentially why I see MMT and MMR as differences without a distinction, as this consensus view is, in my opinion, the core problem to solve.

Thursday, July 17, 2014

Market Caps when there is no Market

Recently, I wrote about the crazy valuations of companies in our current Internet 2.0 bubble, arguing that it was not Sarbox, poorly considered as that piece of legislation might be, which was leading to the dearth of IPOs, but instead simple supply and demand effects where there was so much private demand for these tech companies that they did not need to go to the public markets for capital.

As always, everything is a self portrait. The Epicurian Dealmaker puts it very well:
So, therefore, one should firmly embed notions such as the “market capitalization” of short squeeze scams such as CYNK in pulsating neon scare quotes, so the great unwashed and their blinkered guides in the media do not take them as anything other than arithmetic exercises. So, also, one should not take reported implied market values from the technology economy, such as Series D or pre-IPO round investments by professional investors in vaporware startups, as anything other than the revealed price preferences of that particular investor in that particular company. The fact that Fidelity invested $100 million for a 1% stake in the illiquid equity of Doofr-rama does not make a strong case that Doofr-rama’s “value” is $10 billion. All it really tells you is Fidelity desperately wanted 1% of Doofr-rama. If you want to know why, you better go ask Fidelity.
From this perspective, one should not ask why Uber is valued at whatever it is valued, one should ask why the last round of investors in Uber wanted it so badly.

Wednesday, July 16, 2014

Consumer debt ratios

Mosler shows how consumer credit expansion coincided with periods of economic growth and, as one would expect, higher employment and wage growth:
Circled are the credit expansion from the ‘regrettable’ S and L expansion (over $1 trillion back when that was a lot of money), the ‘regrettable’ .com/Y2K credit expansion (private sector debt expanding at 7% of GDP funding ‘impossible’ business plans), and most recently the ‘regrettable’ credit expansion phase of the sub prime fiasco.

All were credit expansions that helped GDP etc. but on a look back would not likely have been allowed to happen knowing the outcomes.
So the question is whether we can get a similar credit expansion this time around to keep things going/offset the compounding demand leakages that constrain spending/income/growth.
Based on this, I would say that the household sector has de-leveraged, but without some "irrational exuberance" they are not going to start leveraging up again to produce another boom. What is also interesting is how the booms to supported by a mix of credit bubbles (very damaging to the economy when they pop) and asset bubbles (less damaging). The asset bubble in primary markets, aka Internet 2.0, seems to be too small to be impacting household debt levels at a national scale.

Wednesday, July 09, 2014

Tom Perkins on the Internet Bubble 2.0

An aside from the New Yorker:
Instead, [Tom Perkins] blames the [San Francisco gentrification] problems on social and monetary policy set by Washington—low interest rates and the recent Keynesian interlude. In Perkins’s eyes, San Francisco’s tech boom is the result of these policies. The venture market is a risky, low-return investment environment, but it’s currently the only option available for reasonable returns. If interest rates rise once more, wealth will settle into other spaces.
Actually, I agree. While Sarbox may be a bad law, tech companies aren't staying private because being public is so bad, they are staying private because now there is plenty of money there. In our current economic climate of low interest rates and too-small deficits, money seeking a return has few options and VC, plus later mezzanine rounds, provide some return. You no longer need to go public to reach a $1B valuation.

Monday, June 30, 2014

Sarbanes Oxley working as planned

Contra Fred Wilson, let me make a case for why Sarbanes Oxley is working as planned with regards to the current Internet market (frothy in private markets, OK in public markets). Fred says:
Marc lists investments like Netscape, Microsoft, Oracle, HP, and IBM as companies that went public at relatively small valuations and grew their valuations in the public markets. I would add Apple, eBay, Yahoo!, Cisco, and a host of other silicon valley success stories to that list...
The Netscape IPO was a genuine event and kicked of the Internet 1.0 bubble of the late 90s. The company was bought by AOL for $10B in 1999, shut down 8 years later, and is now a discount ISP brand. I don't think it ever earned cash to justify it's initial loft valuation, so I'm surprised to see it cited as a market success, although it certainly made it's early investors very rich (including Andreeson). If Sarbanes Oxley was designed to stop Netscape IPOs, then I don't see why that's a bad thing and it's good to see it's working.
Dropbox did a private financing recently at $10bn, Uber did a private financing recently at $17bn, Airbnb recently did a private financing recently at $10bn. All three of those deals could have and would have been an IPO in the 1980s or 1990s.
Agreed, but you can also add Pets.com, Kozmo.com, and even Netscape in that same category. If the private markets today are making the same mistakes public markets made in the late 90s, then that's hardly an argument that public markets are worse than they were.

The question of course is whether the private valuations are accurate, and even if they are accurate, they strongly suggest that companies are getting fully valued out before they trade shares publicly. It is possible that Airbnb may go from being a $10bn company to a $100bn company, but I don't think that individual retail investors are best positioned to speculate on that nor do I think enabling that is important for markets.

Turning to look at private markets then, it's worth noting that just as sky high valuations were tied to small floats back in the late 90s, today's valuations may be more a sign of entrepreneur strength than actual valuation per se. Palm had a massive valuation when 3Com span it off, but the number of shares available were pretty small and everyone thought mobile computing was going to be big. The combination of strong demand and limited supply pushed the ticker price about $95.

In the private technology market, there are only a small handful of usual suspect companies with material traction, so there must be oceans of promising start-ups that aren't getting traction (cue complaints about Apple's iOS discovery support). So if you are a private investor and you want more start-up exposure, you only have a handful of options, so entrepreneurs may be able to get the cash they need without having to give up much of the company, with the resulting valuation being very high. There may not be much more to this story than limited supply, not much cash needed, and entrepreneurial savvy and bargaining strength.

Thursday, June 26, 2014

More on disrupting Aereo

In my last post, I spoke about how the Supreme Court disrupted would-be regulatory arbitrageur Aereo by saying that if it wanted to be a cable company, it would need to pay the same re-transmission fees that other cable providers do.

Mark McKenna writes on Slate that:
It would be one thing if the consequence of this approach were simply to block Aereo from offering its services. That would be a loss to consumers who don’t want to pay $150 a month for cable subscriptions, but at least the damage might be contained. Unfortunately, the problem is bigger than that, for in glossing over technological details, the opinion potentially implicates a wide range of other services. What about Dropbox and other cloud computing services, for example, all of which use their own equipment to retransmit what they receive to their customers, often transmitting many user-specific copies of the same works? How do those avoid liability? Not to worry, says the court, those technologies might be different. Why? Because cable system.
Nonsense.Dropbox is in no way coming anywhere close to the sort of copyright infringement that Aereo was, and everyone knows it, including Dropbox which is why they didn't bother building the crazy Rube Goldberg contraption that Aereo had hoping that minor technical distinctions would get them off the hook for what was plainly cable company operations. This is not to say that the regulations around cable or OTA operation in the US make any sense, they don't, but to make some kind of slippery slope argument that the Aereo ruling imperils a company like DropBox is fear mongering and suggests that the court ruled correctly.

Wednesday, June 25, 2014

The Supreme Court disrupts Aereo

Just when you thought Silicon Valley has cornered the market in disruption, SCOTUS pops up and does a little disruption all of it's own:
CBS and other broadcasting and media stocks are up in early Wednesday trading after the U.S. Supreme Court ruled that Web TV startup  Aereo could no longer capture their signals  and stream them over the Internet to subscribers.
The court ruling upholds contentions by broadcasters and the Justice Dept. that Aereo’s streaming service violates broadcasters’ copyrights. The Supreme Court agreed, reversing a lower court ruling that sided with Aereo and would have cut into broadcasters’ retransmission fee revenue stream.
Aereo is a service which let customers view programs that were once broadcast over-the-air via the internet. They positioned this as a "cloud DVR" hoping that since DVR was OK (via the original Betamax case 30 odd years ago) and cloud is OK, cloud + DVR was OK. Apparantly the majority on the Supreme Court disagreed.

I'm not going to argue the merits of the case or the decision -- legal history around copyright, broadcast rights, cable and fairly insane -- but I would like to highlight a couple of things which I think are interesting in light of the media discussions I see around the tech industry currently (which I did not see in the late 90s bubble).

1. The CEO of Aereo, while rightly disappointed at the ruling, is a little over-the-top in his public response:
Court decision denies consumers the ability to use a cloud-based antenna to access free over-the-air television, further eliminating choice and competition in the television marketplace
New York, New York (June 25, 2014) – The following statement can be attributed to Aereo CEO and Founder, Chet Kanojia:
What is a cloud based antenna? Sounds like a rhetorical device used to make a bunch of hard drives recording content in various warehouses seem like a metal rod sticking up into the sky. I'm sure Kanojia would like this to be true, but it's certainly open to interpretation, and that incidently is exactly what the Supreme Court did.

Also, I don't think lack of choice in media options is a major issue in the US today. There are genuinely oppressed people in the US, but not TV watchers.
“Today’s decision by the United States Supreme Court is a massive setback for the American consumer. We’ve said all along that we worked diligently to create a technology that complies with the law, but today’s decision clearly states that how the technology works does not matter. This sends a chilling message to the technology industry.  It is troubling that the Court states in its decision that, ‘to the extent commercial actors or other interested entities may be concerned with the relationship between the development and use of such technologies and the Copyright Act, they are of course free to seek action from Congress.’ (Majority, page 17) That begs the question: Are we moving towards a permission-based system for technology innovation?
I'm sure the decision is a massive setback for Aereo and it's investors, but I'm not sure the American consumer will feel set back very much. Aereo's goal to comply with the law is a good one, and the law probably makes no sense, but they didn't meet the mark and I'm pretty sure they knew they were skating close to the lines. That might be why their taglines are "Record & Stream Live TV Online with Aereo Cloud DVR" and "Watch live TV online. Save shows for later. No cable required" -- they were aware that this was going to be a potential issue and were careful to position it was something different.

I cannot see why Aereo's business was a disruptive one in the Clay Christensen sense, it seems more like regulatory arbitrage in the same vein as Uber and AirBnB. “Consumer access to free-to-air broadcast television is an essential part of our country’s fabric," which is politically uncontroversial, although may not be actually that true, but following it with "using an antenna to access free-to-air broadcast television is still meaningful for more than 60 million Americans across the United States" is the kind of wrapping the flag exercise which has been used to justify all kinds of nuttiness in regulating communications in the US.

Most importantly, the tech industry needs to realize that it's in the same boat as all the non-tech people around them, regardless of how much they may wish to exit. Getting to grips with that reality, and learning how to navigate it skillfully, may be the next major milestone as the industry continues to mature.

Wednesday, June 18, 2014

Silicon Valley, the New Yorker, and Disruption

A nice piece by Jill Lepore on "Disruption"; key paragraph:
A pack of attacking startups sounds something like a pack of ravenous hyenas, but, generally, the rhetoric of disruption—a language of panic, fear, asymmetry, and disorder—calls on the rhetoric of another kind of conflict, in which an upstart refuses to play by the established rules of engagement, and blows things up. Don’t think of Toyota taking on Detroit. Startups are ruthless and leaderless and unrestrained, and they seem so tiny and powerless, until you realize, but only after it’s too late, that they’re devastatingly dangerous: Bang! Ka-boom! Think of it this way: the Times is a nation-state; BuzzFeed is stateless. Disruptive innovation is competitive strategy for an age seized by terror.
I think that Clay Christensen, in the Innovator's Dilemma, was tackling a very particular business puzzle which was why incumbents don't necessarily continue their dominance when their industry undergoes a technological platform shift. After all, they begin with all the advantages in resources, talent, channels, etc. Why can't they adapt?

Clay's answer to this was very interesting, and actually quite specific. For example, I don't think Uber is "disrupting" the taxi business with their app in the CC sense. I think Uber is engaging in regulatory arbitrage by using technology to take advantage of a loop hole in the law. The law may be wrong, Uber may be right to want to replace the system with something more consumer friendly, but this is not "disruption" in the CC sense. Also, it will predictably hurt both the medallion cartels (yay!) and the drivers (boo!) who end up being price takers in a market with easy barriers to entry and exit. Micro 101 would have predicted this, but you can also do the math yourself. This is not any sort of judgement on Uber, or its critics and champions, but merely an observation that "disruption" in the CC sense is quite narrow, and the term is being used very broadly in Silicon Valley today, and it is being used in a way which connotes "refusing to play by the rules and blowing things up."

Set aside the problems one may anticipate from such a tin ear, or a lack of appreciation of the interconnectedness of a society, and look at how the overly broad use of the term dumbs down the discussion itself. A nice comment on the article from a friend of mine who is in this field and currently a professor at a well known B-school:
Okay, I had a seminar on innovation with Clay during my PhD, and studied a related field with lots of the other key academics who research innovation. I think this article is totally fair to Silicon Valley and totally unfair to Clay and the concept of "disruptive innovation" as used in academia. (I do not research the topic anymore, so I have no particular dog in this fight)

Yes, "disruptive innovation" is based on case studies, but Leporte is completely off base when she says that "The handpicked case study, which is Christensen’s method, is a notoriously weak foundation on which to build a theory." In fact, handpicked case studies are a terrific way to build initial theory. In fact, one of the most cited articles is recent social science discusses exactly this point. Case studies are terrible at proving theory, but they serve as a great way to think through a problem.

The reason they are bad at proving theory is exactly the issues that Leporte raises: establishing clear historical facts is hard, and sometimes slippery. I think she has some valid points on the history, but does miss the fact that there is a difference between firms and individuals, and that fact that Shugart had to start multiple firms to compete in hard discs was the point - the organizations couldn't always deal with technological change.

However, she makes it seem like academics (and Clay) basically stopped working on the topic in 1999. One need only look at the Google Scholar cites to see that this is wrong. Since Clay's initial book, a huge amount of empirical evidence has been amassed on this topic, and discussion has become a lot more nuanced. We talk about modular, sustaining, incremental, and discontinuous innovation, and about how to manage the issues that cause firms to fail to innovate: absorptive capacity, ambidexterity, and problemistic search on rugged landscapes. I throw out this jargon not to be overwhelming, but because these are, by and large, ideas that have followed on the work of Clay (and other scholars working on the topic at the same time). It is incredibly unfair to point at one concept, as introduced in one book, by an academic with a long career and yell "the emperor has no clothes!"

Now, the criticism of the popular view of disruption strikes me as right on target, but I think it is like a lot of academic topics that become part of the pop intellectual landscape. They quickly become cultural shorthand with little to do with the original ideas. For what it is worth, Clay is a humble guy who has never seemed to claim that he has it all figured out, and, quite frankly, no one in academia feels like "disruptive innovation" as he introduced it is still at the cutting edge of theory.

That being said, it is still a powerful way of thinking about a really, really important question: "Why don't incumbent firms always win?" Clay was one of the first people to ask why firms with the best people and most resources don't innovate over and over again: why did Kodak fail to create digital cameras? Why did DEC not come up with the PC? Disruptive innovation is one piece of the answer to this puzzle, and to attack it in isolation, or to blame Clay for annoying startup guys, seems disingenuous.
Bizarrely enough, there seems to be some noise around this in the case for the iPhone, namely, why is android not disrupting the iPhone? The real question is, why is it important to someone that Android is, or is not, "disrupting" the iPhone? Why is disruption important here, instead of more prosaic measures such as stealing market share, or mind share, or developer support, or whatever is actually important? To the degree that these two are imperfect substitutes, how much are they even in the same market? Most importantly, why is this the framing at all? When it comes to mobile and the changes it is bringing, surely there are more important questions than "Apple vs Google".

Friday, June 13, 2014

Pfeffer on Amazon

Jeffrey Pfeffer, who oscillates between Machiavellian calculation and almost gullible open-heartedness, as a good article on why Amazon is more ruthless than Walmart:
But it’s Amazon’s relationship with its suppliers that makes the company worse than Walmart. There’s no doubt that Walmart pressures suppliers for the lowest possible price. But once the products are in the stores, both Walmart and the chosen suppliers’ interests are well aligned — to sell as much as possible of the stocked items. It costs money to build stores and ship products to them. Having chosen a supplier and negotiated a deal, there is at least some degree of temporary commitment by Walmart to the vendor.
By contrast, Amazon — with no stores and an IT infrastructure that makes the cost of adding items to sell close to zero — doesn’t care what you buy, or even which of their online partners you use, as long as you buy the product through Amazon. Simply put, Amazon has less incentive to make any specific supplier successful. To Walmart, for books or anything else, selling a million units of one item is great; selling one unit of a million items is impossible in its physical stores. For Amazon, who cares?
To a certain degree, Walmart and it's suppliers are dependent on one another, while Amazon's suppliers are more interchangable, and thus, disposable. Walmart also engages in extensive supply chain integration requiring co-investment, and this co-dependency means that Walmart really does not want suppliers to completely fail. Not so with Amazon.

I would guess that reporters who write critical stories about Walmart tend not to shop there, but they do shop at Amazon. I'll be curious to see how, if it all, that influences how they choose to frame their articles.

Thursday, June 12, 2014

Cantor and McArdle

My old friend Megan McArdle has a nice article on Eric Cantor's recent loss to Dave Brat. She writes:
If it is true that money can at least help buy elections, and if this is a factor in the fact that American politics leans toward the concerns of the wealthy, then getting the money out of politics would produce a Congress more inclined to raise the minimum wage, as well as create more generous unemployment benefits and richer national health-care benefits -- but also one that is more nativist and socially conservative. If Brat did indeed win because he went after Cantor on immigration, this exemplifies what those candidates would look like.
I'm not sure what she means to say here. Surely a higher minimum wage and more generous welfare state goes hand in hand with nativism? Wouldn't a more socially conservative society, be able to broaden the welfare state further?

Wednesday, May 14, 2014

Renters are short housing

Josh Barro talks about turning renters into savers so that the one benefit he acknowledges for buying a house -- forced savings -- is captured via another mechanism.

I'm not going to talk too much about why saving can be a macro-economic mixed good -- for example, if higher savings are not coupled with higher deficits, you can get a recession -- but I would like to talk about a benfit of buying not listed by Barro or McArdle: namely that we are born short housing.

Housing, unlike stocks such as Coca-Cola, is something everyone needs at least one of. So, with Coke, you begin in a neutral position and can then choose to go long or short it if you want to make a bet on whether COKE will go up or down. However, with housing, you begin needing one but not having one which means you are short right out of the box. Being short by default means you are speculating on house prices, which may be something you are not interested in doing, in which case buying a house makes you neutral, and leveraging up to buy more house than you can afford or buying multiple houses makes you long. Renting a house leaves you in a short position.

Therefore, with some irony, getting into the housing market is what you need to do in order to get out of the housing market.

Monday, May 12, 2014

Apple and Beats

It's been a weekend since Apple announced it was buying Beats headphones for $3.2B. Some of the press remain skeptical, while others claim that the skepticism might be racially tinged.

Maybe.

What I think is true, though, is that Apple is a successful brand, and by that I mean that consumers tie their identity to Apple, Inc. Set aside whether it is wise to weave your conception of self into a corporation (or anything for that matter), but I think I'm a Mac and I'm a PC resonated because Mac people were (are) Mac people and that was something that was important to their identity.

And "Mac people" do not buy Beats by Dre, because Beats by Dre are "technically inferior", appeared on American Idle, and aren't Grado SR60s. The reaction would be much the same if Apple bought Skullcandy. No offense to either Beats or Skullcandy, but that brand image at odds with Apple.

I don't know how financially beneficial this deal is for Apple, it's not clear to me what strategic sense it makes (I know MOG, which seems to power the Beats service, and I don't think they are worth $3B for whatever that's worth) and there have certainly been worse tech acquisitions in recent years, but I think that most of the complaining is coming from a sense of betrayal. Which I understand. Moral of this story -- don't identify too closely with corporations.

Friday, May 09, 2014

Internet Advertising and Bubbles

Great article on Facebook's mobile business:
Significantly, the largest driver of Facebook’s mobile revenue is app-install ads -- that is, ads that encourage users to download an application rather than simply promote a product. According to AdKnowledge chief executive officer Ben Legg, whose company handles about 2 percent of Facebook’s ad sales, app-install ads make up well over half of Facebook’s mobile revenue. These ad units are largely purchased by free-to-play game publishers such as King (maker of Candy Crush Saga) and Big Fish Games (the Bejeweled series), which leverage Facebook’s incredible demographic data to target the small percentage of players who will spend hundreds of dollars on in-app purchases.
Ignore the mention of Big Fish games (which does not publish the Bejeweled series -- that's PopCap, now owned by Electronic Arts), the core dynamic is correct. Mobile game companies -- particularly King which is now public and under pressure to show growth -- will pay a great deal for acquisition looking for "whale" players who generate the bulk of their revenue. However, I'm pretty sure that the platform provider which handles the billing -- namely Apple and Google -- know much more about who the whales really are than Facebook and so are best positioned to sell them to the app companies. Therefore, Facebook's position here looks shaky, but also similar to when they first went public and were reliant on Zynga for the bulk of their revenues. Ultimately, Facebook will need more reliable legs to stand on than selling whales to game companies.

Monday, May 05, 2014

Would Warren Buffet buy Twitter?

A rhetorical question since the Sage of Omaha has already answered it by not buying Twitter. Still, as we read obituaries of the service, not yet 10 years old, plus hagiographies arguing it is a "must read", I think it's worth taking a step back and looking at this as an investor, and also welcoming Silicon Valley to Hollywood at long last.

First, Buffet assesses business by considering whether they will be around in 20 years (thus demonstrating sound management and a defensible market position) and then looking at whether the likes the price (all stocks go through ups and downs). I don't think Twitter does well in the 20 year test because, given how quickly markets change, and how easy it would be to replicate a Twitter like service (or even improve upon it! Twitter++ would be like Twitter was in the early days before it got "popular") the chance of it existing as a stand alone public company are pretty slim. Maybe Google or Facebook may buy it, and now you're playing M&A arbitrage, not investing, but from a pure value, DCF stand point, it's future looks pretty cloudy.

Secondly, many of these hot mobile B2C companies are essentially entertainment products: SnapChat, Facebook, Twitter, King (most obviously), and so are vulnerable to the same vagaries of fickle consumer sentiment as the rest of the entertainment industry. Not to say that great brands and businesses cannot be built in the entertainment space, they can, but the novelty sector is a difficult one and very far afield from the infrastructure and platform businesses that are currently funding, directly or indirectly, their more glamorous, consumer oriented brethren.

I overstate my case. Facebook is not Candy Crush Saga. But I can see the novelty wearing off, and/or something new and shinier coming along for people to go to for social entertainment.

RIP Gary Becker

I had the honor of spending a little time with Gary Becker while I was at Chicago. He was brilliant and curious then, and I'm very glad I have the chance to speak with him and learn from him. I still have my copy of Accounting for Tastes and the Economics of Discrimination, which blew my mind when I first encountered it.

Nice interview of him the New Yorker.

Wednesday, April 30, 2014

The US Government need never default on its debt

I recommend this post by Andy Harless. It's a little technical, but not as bad as the title suggests. Andy is essentially discussing the "natural real rate of interest" and the limitations to that concept. To wit:
Most economists think that the natural real interest rate is normally positive. I have my doubts, but never mind, because I'm ditching the whole concept. Once we start correcting for expected normal growth rather than expected inflation, we are clearly not dealing with a natural rate concept that can be presumed to be normally positive.  If we are talking about a risk-free interest rate, then the need for physical capital returns to compensate for risk would make it very hard to achieve a long-run growth rate [an equilibrium with the interest rate] as high as the [growth] interest rate, let alone higher. To come up with a number that's usually positive, I suggest that we reverse the sign. Instead of talking about a "natural growth-adjusted interest rate," let's talk about a "natural discounted growth rate."
Good move by Harless. Reframing "expected inflation" to "discounted growth rate" better captures time preference of spending decisions which is really the underlying intuition that all these models try to capture. He goes on to pin down some key insights around "risk", or more specifically, the "risk free rate":
The thorny issue here is risk, and some will argue that the relevant interest rate for dynamic inefficiency is not the risk-free rate.  But I disagree.  The US government can produce assets that are considered virtually risk free, and a stable Ponzi scheme operated by the US government could presumably produce such assets yielding any amount up to the growth rate.  At today’s Treasury interest rates, which are clearly less than expected growth rates, marginal investors are (we can presume, since the assets are freely traded) indifferent between these low-yielding Treasury securities and investments that represent newly created capital.  So, given the risk preferences of the marginal investor, the government could, by operating a stable Ponzi scheme, be producing assets that have a higher risk-adjusted return than newly created capital.  Given the risk preferences of the marginal investor, it’s inefficient for the government not to be producing such assets.
I disagree with Harless' characterization as US Govt debt being a "Ponzi scheme", not because of the pejorative angle associated with that term--although I note that too and don't agree--but because in the fiat monetary system, a Government which runs a deficit is not technically, in Ponzi, because the Government does not need to borrow to make a payment.

For the US Govt to make a payment it simply marks up an account in a spreadsheet. To argue otherwise is to argue that the Federal Reserve is completely independent of the US Govt and will let the US Economy and monetary system collapse, which is unlikely to say the least.

In the comments, Rowe makes a point which would be true under a gold standard regime, but not in our fiat one:
Frances: I think the risk might be the risk of the amount of taxes paid by future generations. If we start with Samuelson 58 (whch is where Andy is coming from), and then introduce uncertainty in (say) population size for future cohorts, the government might need to vary future taxes/transfers to make government debt a perfectly safe asset.  
Monetarists like to laugh at Cochrane who says that fiscal stimulus does not work because spending is reduced in anticipation of increased future taxation, but Nick's point above is using the same logic, he's just not taking it to its final conclusion.

We need to re-think exactly what we mean by "risk-free" and to develop a realistic sense of exactly what safety and sovereign can and cannot provide. $100 will always be worth $100, which doesn't help if you're planning on buying a loaf of bread (what will that cost in the future?!) but it is extremely useful when you are planning on paying down or servicing nominal debt. The ability for this nominal wealth to manage nominal debt is critical to anticipating and modeling household and firm financial decisions and is discrete from household and firm decisions around real goods and services. The two are related, but not the same, and this conflation may make modeling simpler, but it leads you to error.




Friday, April 18, 2014

What is a central bank?

Nick has a post on "alpha" and "beta" banks where he alights on one idea for what distinguishes a central bank from a non-central bank:
Here's the answer. Commercial banks promise to redeem their monetary liabilities for the monetary liabilities of the central bank at a fixed (or at least pre-determined) rate. Central banks do not promise to redeem their monetary liabilities for the monetary liabilities of the commercial banks. This asymmetry of redeemability is what gives central banks their power over commercial banks. But a bank with that power is nevertheless not a true central bank unless it acts like one, and uses that power.
I think this is an interesting question to ponder, but I don't come to the same conclusions that Nick does. When looking at existing central bank institutions, such as the US Federal Reserve for example, you don't see an "asymmetric redeem-ability" function like Nick postulates, and I'm sure Nick would agree that the Fed is a central bank.

So, given that central banks can and do exist without asymmetric redeem-ability, what is it precisely that they have which make them central?

Here's my take:

First and foremost, they need to act as a hub to handle payment settlements, and thus need to be able to operate at negative liquidity and capitalization levels which would put a regular bank out of business. To operate in this way they need an essentially different regulation scheme than commercial banks and are, by merit of this regulation scheme, an "extension" of the Government. There may be a better term than "extension" but I think it works for now.

In the real world this interbank interconnection is handled via reserve accounts, which are Fed liabilities and bank assets. Money circulating between banks as coordinated through the Fed so that checks do not bounce simply because of liquidity or solvency problems at a particular bank.

Another perspective is that the reserves circulating between banks via the Fed are the "inside money" counterpart to the deposits and loans circulating between the non-bank sector via the banks. The right hand and left hand sections of the balance sheets have to balance.

Note that this function is only necessary when there are multiple banks which need to have payments and transactions settle across them. If there was a single bank, in addition to the central bank, you would not need reserves to manage this process as everything would clear within the bank itself and you would not need a central clearing house capability.

Regardless, even in this scenario, you would still need/want a central bank to set interest rates. In the absence of a reserve system, it could introduce one and use requirements around that as an interest rate setting mechanism, but I think as a practical matter it would create a separate mechanism for this instead such as a modified discount window. I view the use of reserves, with their associated requirements, as a mechanism for setting interest rates as an artifact of the organic evolution of banking and not a sound, engineered solution for this function. And this then would be a second central bank characteristic, the ability and responsibility of setting rates through whatever mechanism is at hand. (And on that, note how the US Fed instigated IOR when needed--not a well engineered solution but expedient given what was on hand).

So, I do not find the story about asymmetric redeemability a compelling one given that nothing of the sort is observed in real life, and misses the key central bank function of supporting payment settlement. Instead, I would classify asymmetric redeemability as a theoretical model of something that could substitute for OMO today, but there are many such candidates and I don't think Nick was advocating this one as being particularly good.

I would also see this approach as a logical conclusion of lumping in reserves with deposits, thus conflating the liability side of the central bank along with the liability side of the commercial banking sector, and seeing those two as being fundamentally interchangeable. I think this is a source of all the errors and confusion that come from Monetarism as reserves and deposits are fundamentally different, they serve different functions, and they are not interchangeable the same way two fluids in a heat exchanger are not interchangeable nor do they intermingle. Reserves are best thought of an abstraction layer that lets independent commercial banks coordinate payments and settlements amongst depositors by having a separate reserve system act as the other part of the balance sheet at a higher level. This core function was then co-opted (again, not a great word choice) for setting interest rates.

Friday, April 04, 2014

HFT is not an act of nature

The FT reviews Michael Lewis' new book, "Flash Boys" and ends on this note:
Indeed, as Lewis explains, much of their behaviour was perfectly in line with regulations – the Securities and Exchange Commission deliberately tried to weaken the monopoly power of large exchanges to create more competition. It may not have appreciated the scale of what it would unleash – 13 public stock exchanges and more than 40 private “dark pools”.

And financial trading is not the only ecosystem that is highly complex and aggressive. “I would ask the question, ‘On the savannah, are the hyenas and the vultures the bad guys?’ ” says one of Katsuyama’s more dispassionate colleagues. “We have a boom in carcasses on the savannah. So what? It’s not their fault. The opportunity is there.”
The analogy with the jungle is telling because it presupposes that HFT, or the environment that created HFT, is simply an "act of nature" and thus being "natural" beyond this type of moral scrutiny. But markets are not "natural" -- they are constructs put together for public purpose (to use Mosler's term) and our equity markets are no different.

HFT seems so plainly on its face to be an exploit of the system, and it makes it difficult to defend it publicly, and it is this reason why I think the "only natural" argument seems to weak. The FT itself points out this contradiction because, one paragraph before declaring it "natural" it says that this came about because of changes in SEC regulation a little earlier.

The stronger arguments about liquidity and tighter spreads are more compelling, but I think Lewis makes a good case by distinguishing between liquidity and activity. Liquidity comes from players willing to take the opposite sides of trades when things are going south, not withdrawing from the market altogether, and there are few institutions capable and willing to do that at all times. I don't think HFT algorithms can be counted amongst that number either. Ultimately, I think only the government can reliable act in a truly counter-cyclical manner.

Thursday, March 27, 2014

Candy Crush IPO

Everytime a company IPOs and the shareprice pops on the first day, the press has articles about how great the company is, and there are a slew of contrarian pieces saying how pops just mean the company was underpriced and leaving money on the table, and this amounts to a kickback to unscrupulus bankers who gave their favored clients a sweetheart deal.

Well, the King IPO tanked in that it closed down 15% or so from their IPO, and I suppose this may be a contrarian piece saying the King guys are geniuses because they didn't leave any money on the table, but my real question is why the company went public at all.

The Tech Bubble, if there is one, is certainly a Bubble 2.0 as it is primarily occurring in the private market via inflated seed rounds and extremely rich acquisitions, such as the recent Facebook purchase of Oculus, and you can add Nest, Instagram, and WhatsApp to that list. King is a curious inverse, as it's the perfect company to keep private as a cash cow with a limited time horizon, but instead they go to the public markets for even more liquidity?

The entertainment business and shareholders do not mix well, and I'm thrilled to see financing vehicles like Kickstarter for projects which are worthy, but would never get funded otherwise. I would love to learn the insider story for why King decided to IPO at all.