Global macro is dead, long live global micro
After Louis Bacon closed Moore Capital this past week, both the FT and the Economist had interesting articles on the future of global macro investing. They struck almost opposite tones, each making good points about the current and future reality. Global macro will return, but likely in an unexpected form.
Stability destabilises a generation of macro hedge fund stars
A league of their own: Do not write off the macro hedge-fund manager just yet
Stability killed the macro star
The glory days of global macro as we know it started when the Bretton Woods system collapsed in 1971, ending fixed exchange rates. Broadly speaking, there were two different groups of investors who entered this environment and profited immensely. The first was people with long/short equity experience in global markets and included George Soros, Jim Rogers, and Michael Steinhardt. The second group included people with a physical commodities and futures background. The Commodities Corporation trading firm trained and/or funded many macro investors including Bruce Kovner, Paul Tudo Jones, Louis Bacon, Michael Marcus, etc.
The dramatic changes in the institutional architecture of international trade and finance created a volatile playground for these investors. Exchanges developed new derivatives instruments for trading newly volatile currencies and increasingly global commodities markets in a high inflation environment. Global trade started to open up dramatically, and global supply chains spidered out in response to changes in policy and technology. Many investors made or lost fortunes betting on big equity moves like the 1987 stock market crash(shortly after Greenspan became head of the Fed), or the breaking of fixed currency regimes such as the sterling crisis of 1992, the Asia crisis of 1997, Russia in 1998, etc. There was also the emerging market debt crisis in the 1980s and the surprise interest rate hike in 1994.
After the 2009 global financial crisis, interest rates and inflation have been abnormally low. The euro crisis notwithstanding, markets have lacked volatility. With no volatility its hard for the traditional global macro style to work. Moore and his proteges have all closed down recently. The decline of the legacy macro investors is just one part of the broader decline of active management. Its been a long torturous capitulation.
Yet stability leads to instability. Long periods of calm tend to be followed by extreme volatility.
The future is global micro
Is there any future for global macro? That depends on what your definition of “global macro is” Making bold systemic predictions about surface level data is unlikely to lead to profits. Yet global macro’s main benefit is its flexibility to take long or short positions in any asset class anywhere in the world. Although trades in large liquid markets get the most attention, the analytical techniques of global macro can also uncover insights leading to lucrative opportunities less liquid frontier, emerging, and alternative markets.
The future of global macro will involving finding bottom up industry and company specific insights that fit with top down shifts: global micro. Steven Drobny mentioned this evolution in Inside the House of Money . Indeed most quantitative techniques of the original macro greats are commoditized. Analysts need to look beyond headline numbers numbers for less obvious global micro trends and second order impacts on tradeable assets.
Capital flows and valuations have a funny historical tendency to overshoot in both directions. Many investors build up leveraged positions based on stale fundamental inputs, and when they wake up to a new narrative taking over the market, they must rush to a crowded exit. What will be the next gestalt shift in which a new narrative takes over markets?
The next gestalt shifts
Don’t try to play the game better, try to figure out when the game has changed
Over coached football players do not respond well when a game takes an unexpected turn. Investors schooled in calmer markets may similarly struggle with renewed volatility.
Many of the classic macro bets(and blowups) involved major breaks in fixed currency regimes. Sometimes the big trade(or blowup) involved direct currency exposure. Other times it involved investments impacted by second order effects. Its possible that the big macro trades of the future will be more subtle, and play out over many years away from headlines before becoming obvious.
For the past few decades, global trade was getting generally more open. That is starting to reverse. The WTO dispute settlement mechanism will completely shut down next month because the Trump administration is blocking new appointments to the appellate body. Trump’s attitude is just an extreme manifestation of a global trend towards populism and trade conflict. At best, there will be a spaghetti bowl of bilateral agreements, instead of a large open multilateral trading system. Companies will need to dedicate more resources to supply chain strategy.
At the same time, emerging markets are starting to trade more with each other than with the developed world. Africa might become the world’s largest free trade area. China is attempting to facilitate more commodities trading without using the dollar. As China develops its own bond markets, it will invest less in US dollar based debt markets. As the world shifts to cleaner energy, oil producers will have fewer dollars to recycle into US capital markets. The relative importance of the US dollar and of major US companies is likely to decline.
Often policy changes have second order impacts on individual businesses because they alter competitive forces in their industries. Indeed its difficult to find an example of businesses that are completely immune to change in international trade policy.
Reality and narratives change at different paces. Narrative changes alter capital flows ultimately impacting valuations.
Here are some other speculations on what shocks or regime shifts might occur:
- I don’t have a strong view on inflation, but do find it concerning how few S&P 500 companies will do well if we encounter high inflation. Its commonly accepted wisdom that low inflation will continue. Yet most analysts are only considered demand driven inflation, and ignoring possible supply side shocks. There has been little investment in new production capacity for many key over the past decade. Note the conspicuous absence of resource companies in the top holdings of any indices. More insidiously, if certain prominent venture funded startups shifted from growth mode to harvest mode, and suddenly needed to make money, they would be forced to raise prices, impacting consumers directly (See: Cheap Stuff and Cheap Capital) . Alternatively, if we face deflation, then debt burdens on over leveraged companies and consumers will be a much greater drag on growth.
- If negative interest rates continue, they’ll force banks and insurance companies to find new business models, or slowly perish. If negative interest rates reverse, it will be a shock to a lot of overleveraged companies
- Pension funds are a looming disaster in many western countries. The government will overreact somehow when it becomes a social issue.
- Many investors, including pension funds, have rushed into illiquid alternatives such as private equity in search of higher returns. It is likely that those investments will fail to deliver the expected returns, and worse yet, they might be illiquid for longer than expected.
- ETFs have grown from obscure backwater to the default investment option for both institutional and retail. Many ETFS are invested in illiquid assets- creating the potential for a unique type of death spiral. The SEC recently made some changes to its filing requirements which might make it easier to preemptively find which ETFs are most vulnerable.
The ecological consequences of hedge fund extinction
The Strange Case Of Benin Rice Imports
Benin rice imports more than doubled between 2015 and 2017. Its a tiny country, slightly smaller than Pennsylvania, with a population of 11 million. Yet it is now the world’s largest importer of Thai rice. Why?
Turns out the answer has little to do with cuisine, and a lot to do with incentives. Benin shares a border with Nigeria, a much larger country that put strict tariffs on rice in 2014. Smuggling rice from Benin into Nigeria became big business. (see here, here, and here)
Unintended consequences of trade policy permeate Nigerian life. One of the richest people is a cement manufacturer. It just so happens that cement has a 60% tariff. Oh, and Nigeria doesn’t exactly have great infrastructure. Basically the only businesses of any size that can survive depend on some sort of favorable policy. The textile industry can’t really compete with cheap foreign imports, for example.
Favored importers get access to USD at a favorable rate. Petroleum importers, and the politically connected get an even better rate. Everyone else has to pay nearly twice as much of the local currency (naira) to access USD on the black market. I’m not sure if there is a secondary market in whatever documents importers can use to access cheaper USD, but if there is, these documents could be quite valuable.
Department of Unintended Consequences
Tariffs and exchange controls are not necessarily bad. One can hardly blame Nigerian policy makers. Powerful political constituencies depend on favorable policy. Nigeria has had a rough few decades, and opening up to foreign competition can create disruption. But trying to understand an economy requires looking beyond immediate impact, and finding second order impacts that are the unintended consequences of intervention. Even in neighboring countries. Never underestimate the power of incentives.
Perhaps Nigeria also needs a Department of Unintended Consequences.
Eurasian World Order
The Dawn of Eurasia: On the Trail of the New World Order is a fascinating analysis of the shifting geopolitical landscape. The author, a former Secretary of State for European Affairs for Portugal, mixes a travelogue with discussions of history, literature, and economics. Eurasia is not just a geographical entity, but rather a “descriptive term for a certain way of thinking about a new moment in political history”. It expresses a world order that is the integration of two ideas often seen as contradictory being brought together into a single word.
The rise of the east
Many people wrongly assume that the world will converge on a social organization that is based on western ideals. Instead different societies are adapting and iterating based on their own historical experiences and present circumstances. The dominant cultures of the future may be organized in a very different manner than what we are used to:
On the one hand, it conveys the sense that the European order has come to an end. This moment, so often announced, has been, on the contrary, persistently evaded. When European countries abandoned their imperial dreams, they did so under the illusion that the rest of the world no longer needed guidance because it had voluntarily embraced European rules and ideas. It was an illusion, but an illusion that only now is being revealed as such. On the other hand, this should not be confused with the belief that Europe’s legacy has likewise been abandoned. What we see is that those who are more actively working to replace the old world order with something are just the heirs of the European scientific and revolutionary traditions,. When competing with the European model, they try to present an alternative that is more modern, more rational, better able to lead the transformations of the future. Theirs are new an alternative visions of what a modern society looks like.
The west is merely a reference point:
Experimentation is a human but also a scientific ideal. But the faith in an endless power to transform reality can now be found on every corner of the planet. The process has a certain negative character: the attempt is made to free oneself from the existing model only to realize this model has been replaced by a broader but still limited set of possibilities which in turn need to be over come and so on in an iterative process. More importantly, perhaps, each society has its own modernization path. Each society starts from a traditional model and creates new abstractions from that starting point. As the whole world becomes modern, we should expect different or multiple modernities to develop, rather than the cultural programme of modernity as it developed in Europe to become universal,. That programme may enjoy a certain historical precedence, and continue to be a reference point, but it is no more than one path.
The delineation between “hard power” and “soft power” may not be the most useful for understanding how countries come to dominate. In reality power is more nuanced. If a country has a large market, or other bargaining power, other countries may be forced to make changes to suit them, without a single shot being fired.. This has huge implications considering China’s increasing clout, and America’s disengagement from alliances.
We here a lot about the distinction between hard and soft power, and usually the former is identified with the use of military force; but some forms of power are unilateral even if they have nothing to do with military force. They probably deserve to be part of what one would call hard power because they do not depend on the willingness of the other side to play along. When it comes to the rules being applied in a given jurisdiction, or jurisdictions, it is obviously possible for states to influence what others do through an international agreement where their respective interests are the object of negotiation and bargaining. That is one way. Then we have the way the European Union exercises power, which is completely independent of what the other side wants to do, and more intriguing, equally independent of anything like a European Conscious Plan.
China is now becoming expert at using this type of diplomatic coercion to influence policy in Eurasian countries. Direct and forceful actions risk disrupting and severing economic ties that are critical for china. Economic power is embedded within economy, provides Chinese with ambiguity and deniability. Basically china marshals privates sector for its own goals. Not just its own private sector, but the private sector of One Belt One Road countries, and really all allies. Of course, there is a reason to be skeptical about One Belt One Road:
There can be no land segment of the Belt and Road without Xinjiang , but at the same time it is difficult to see how China will be able to solve the contradiction between the desire to facilitate trade and movement while closing borders and subjecting everyone to permanent surveillance. You inevitably ask yourself whether the Belt and Road initiative might not be a concept far ahead of what social and political reality can deliver. A kind of utopianism, in this sense.
Interesting quote on how different vantage points can lead to different conclusions. Shifting perspectives is critical:
The whole is only a whole in relation to the parts and the parts are only parts in relation to a whole. When it comes to world politics, this means that what views we have of the whole will always color our understanding of the parts. If your view of the global order is one where Europe is at the center, then the rest of the world will be organized in radiating circles of distance from the centre. Even the traveler will find nothing but distant echoes and pale reflections of the place he started from , and any genuine comprehension of different regions and cultures will be rendered impossible. The goal should not be to look at the whole from the point of view of one part, but to look at each part from the point of view of the whole. We learn this mental habit from the study of atlases and maps, where each point is defined and located by reference to all other points and where we are made to acquire an external, more detached and more objective perspective. At the same time, a map is only complete after we return from the places it depicts and can interpret the full meaning behind every detail and project upon the flat surface the images stored in our memory.
History shows that there is no natural way for the parts of the world system to be organized. Neither has the system any inbuilt propensity to remain static, nor for the parts to settle in a particular pattern. Many times in the past the pendulum of power was exactly balanced between two poles in the system and no inherent historical necessity dictated that one would acquire a hegemonic position.
Rules vs. strategy
Tension between rules based and strategic approach are a key feature of a Eurasian world order. Here is an interesting metaphor discussing this dichotomy:
If we think of the European Union as a computer program, the question arises of how universal that program truly is. Algorithms operate in a controlled environment and perform a set of limited tasks. Inputs coming from the external environment have to be recognized by the program and thus the environment needs to be shaped and organized in order to provide those inputs in the right format. A computer program works by itself, it doesn’t really matter who is using it as opposed to traditional crafts or ever creative endeavor. That is the universal ism of the code, but there is another sense in which it may not be universal at all. Is the system of automated rules able to deal with all the contingent and unpredictable events coming from the outside, from an environment which the code is not prepared and to which it cannot respond? Can it respond to new inputs that are not precisely like those for which it has been designed. And how does the system respond when some of its parts have been destroyed, degraded, or when they are overloaded by a chaotic environment. One could say that even a computer program needs a foreign policy- a key challenge in advanced robotics is to design control algorithms that allow robots to function adaptively in unstructured, dynamic, only partially observable and uncertain environments– but more fundamentally the realization that the world outside Europe works according to different rules reopens the question of history and may force us to abandon the faith in autonomous rules.
… the new dichotomy between systems and environments replicates almost exactly the old one between a supposedly rational and orderly European civilization and the chaos of the Asian steppes.
Chinese acquisitions of German company highlight this. The book quotes a German official:
Think of Eurasia as a field of forces. The question of different political and economic models is one that only power, influence and leverage will be able to decide. It is not enough for the European Union to uphold its rules and way of life. It needs to create a wider environment where they can work effectively.
The 4d chess strategy behind Yang’s circumcision comment
Why does Andrew Yang seem to care so much about circumcision?
One possibility is it is just a weird obsession of his. I’m not a medical doctor but neither is Yang. I thought circumcision was just a standard medical procedure. WTF is an Intactivist? How will this save us from the robot apocalypse?
Another possibility is the comment was 4d chess jiujitsu, and Yang is seeing several moves ahead in the 2020 meme wars.
It is easy to make fun of him, or criticize him for making an offhand comment about circumcision. But think of how he can spin it if his opponents fall into this trap. Do they really want to be the one to saying parents shouldn’t have more freedom on this issue? During the Democratic primaries Yang can bait an opponent into seeming like a power mad uber regulator coming to snip your baby’s genitals.
Only Yang can save us from an army of dick chopping bureaucrats.
And in the general election vs Trump… with those small hands ? Obviously he just wants to cut everyone else’s junk down to size, or at least that’s what an army of Twitter bots will say.
Think of the memes Yang can use to crush his opponents if they fall into the trap of criticizing his position on circumcision. Only Yang can protect your Wang.
Is the weird circumcision comment part of a genius master strategy? Probably not. But you heard it here first.
Hierarchies vs networks: Notes on the Square and the Tower
“Often the biggest changes in history are the achievements of thinly documented, informally organized groups of people. “
The Square and the Tower examines the role informal networks have played throughout history. Its one of the few books I’ve seen that takes a rigorous, empirical and non-sensational look at what secret societies actually did throughout history. More importantly it delineates between societies/institutions that are driven by informal networks, vs those that are driven by formal hierarchies. The world kind of goes back and forth between the two over time. The spread of diseases and ideas follow similar processes and are both are heavily influenced by the role of networks and hierarchies in society. Among its most useful(and amusing) conclusions is that Martin Luther and Donald Trump have something very important in common.
The first ‘networked era’ followed the introduction of the printing press to Europe in the late fifteenth century and lasted until the end of the eighteenth century. The second – our own time – dates from the 1970s, though I argue that the technological revolution we associate with Silicon Valley was more a consequence than a cause of a crisis of hierarchical institutions. The intervening period, from the late 1790s until the late 1960s, saw the opposite trend: hierarchical institutions re-established their control and successfully shut down or co-opted networks. The zenith of hierarchically organized power was in fact the mid-twentieth century – the era of totalitarian regimes and total war.
Martin Luther and Donald Trump
The key insight is that Martin Luther and Donald Trump and their respective suorters both made highly skilld and aggressive use of a new communication medium to spread their message. Luther had ht ebrand new thing called the printing press. Trump had this brand new thing called social media(mainly twitter)
Without Gutenberg, Luther might well have become just another heretic whom the Church burned at the stake, like Jan Hus. His original ninety-five theses, primarily a critique of corrupt practices such as the sale of indulgences, were originally sent as a letter to the Archbishop of Mainz on 31 October 1517. It is not wholly clear if Luther also nailed a copy of them to the door of All Saints’ Church, Wittenberg, but it scarcely matters. That mode of publishing had been superseded. Within months, versions of the original Latin text had been printed in Basel, Leipzig and Nuremberg. By the time Luther was officially condemned as a heretic by the Edict of Worms in 1521, his writings were all over German-speaking Europe. Working with the artist Lucas Cranach and the goldsmith Christian Döring, Luther revolutionized not only Western Christianity but also communication itself. In the sixteenth century German printers produced almost 5,000 editions of Luther’s works, to which can be added a further 3,000 if one includes other projects he was involved with, such as the Luther Bible. Of these 4,790 editions, almost 80 per cent were in German, as opposed to Latin, the international language of the clerical elite.3 Printing was crucial to the Reformation’s success. Cities with at least one printing press in 1500 were significantly more likely to adopt Protestantism than cities without printing, but it was cities with multiple competing
Likewise, Trump was able to get an enormous amount of massive publicity do to his exploitation of social media. It also didn’t hurt that their were highly skilled foreign actors also using social media to spread his influence. Much of this was done in an automated fashion, using bots, etc. Social media allowed this message to spread directly without any filter from media gatekeepers.
Gutenberg’s printing press helped make Lutheranism. Twitter bots helped make Trumpism.
Difficult to suppress
Why was Protestantism so resistant to repression? One answer to that question is that, as they proliferated throughout northern Europe, the Protestant sects developed impressively resilient network structures.
Similarly, traditional political operatives have had difficulty penetrating the social media networks that Trump has so successfully exploited.
Bringing the medium to the masses
Just as the printing press caused a drastic fall in the price of written books, the falling prices of phones and PCs made the internet more widely accessible.
The decline in the price of a PC between 1977 and 2004 followed a very similar trajectory to the decline in the price of a book between the 1490s and the 1630s. Yet the earlier, slower revolution in information technology appears to have had the larger economic impact. The best explanation for this difference is the role of printing in disseminating hitherto unavailable knowledge fundamental to the functioning of a modern economy. The first known printed mathematics text was the Treviso Arithmetic (1478). In 1494, Luca Pacioli’s Summa de arithmetica, geometria, proportioni et proportionalita was published in Venice, extolling the benefits of double-entry book-keeping.
Luther and Trump both spread their message just as new technology was making it much easier for something to go viral. Luther upended the church hierarchy by bringing religious texts and thoughts to the common people. Prior to Luther religious text were almost exclusively in Latin, which the common people could not read or understand. The idea that common people could be allowed to read the bible was considered heretical (see a world lit only by fire). Luther spread his messages into far away villages causing the Catholic church to lose control of its traditional followers. Likewise, Trump upended the political hierarchy by spreading a populist message far and wide, even overtaking previously Democratic strongholds. Many people who felt abandoned by the political process went to his rallies. Washington insiders have been thrown out, an outsiders have taken control. Many readers of this blog may not want to think of Trump in this way, but the analogy is valuable in understanding why Trump has been so successful.
Spread of disease
The speed with which an infectious disease spreads has as much to do with the network structure of the exposed population as with the virulence of the disease itself, as an epidemic amongst teenagers in Rockdale County, Georgia, made clear twenty years ago. The existence of a few highly connected hubs causes the spread of the disease to increase exponentially after an initial phase of slow growth.7 Put differently, if the ‘basic reproduction number’ (how many other people are newly infected by a typical infected individual) is above one, then a disease becomes endemic;
Impact on economics
For economists, too, advances in network science had important implications. Standard economics had imagined more or less undifferentiated markets populated by individual utility-maximizing agents with perfect information. The problem – resolved by the English economist Ronald Coase, who explained the importance of transaction costs* – was to explain why firms existed at all. (We are not all longshoremen, hired and paid by the day like Marlon Brando in On the Waterfront, because employing us regularly within firms can reduce the costs that arise when workers are hired on a daily basis.) But if markets were networks, with most people inhabiting more or less interconnected clusters, the economic world looked very different, not least because information flows were determined by the networks’ structures. Many exchanges are not just one-off transactions in which price is a matter of supply and demand. Credit is a function of trust, which in turn is higher within a cluster of similar people (e.g. an immigrant community). This has implications not only for employment markets, the case studied by Granovetter. Closed networks of sellers can collude against the public and deter innovation. More open networks can promote innovation as new ideas reach the cluster thanks to the strength of weak ties. Such observations prompted the question of
Spread of ideas
The key point, as with disease epidemics, is that network structure can be as important as the idea itself in determining the speed and extent of diffusion. In the process of going viral, a key role is played by nodes that are not merely hubs or brokers but ‘gate-keepers’ – people who decide whether or not to pass information to their part of the network. Their decision will be based partly on how they think that information will reflect back on them. Acceptance of an idea, in turn, can require it to be transmitted by more than one or two sources. A complex cultural contagion, unlike a simple disease epidemic, first needs to attain a critical mass of early adopters with high degree centrality (relatively large numbers of influential friends).In the words of Duncan Watts, the key to assessing the likelihood of a contagion-like cascade is ‘to focus not on the stimulus itself but on the structure of the network the stimulus hits’. This helps explain why, for every idea that goes viral, there are countless others that fizzle out in obscurity because they began with the wrong node, cluster or network.
That is because so many real-world networks follow Pareto-like distributions: that is, they have more nodes with a very large number of edges and more nodes with very few than would be the case in a random network. This is a version of what the sociologist Robert K. Merton called ‘the Matthew effect’, after the Gospel of St Matthew: ‘For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath.’* In science, success breeds success: to him who already has prizes, more prizes shall be given. Something similar can be seen in ‘the economics of superstars’. In the same way, as many large networks
Just like the printing press destroyed the ruling classes monopoly on spirituality, social media has destroyed the “establishment’s” monopoly on political ideology.
Martin Luther and Donald Trump would agree on this
The value of improvisation and informal processes
Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed summarizes the key dangers of centrally managed social engineering projects. Its a bit dense, but well worth it. It shows similarities between many seemingly different disasters caused by top-down control and central planning. Case studies include modernist architecture, Soviet collectivization, herding or rural people into villages in Africa,and early errors in scientific agriculture, etc.
Anyone trying to build and manage an organization needs to be aware of the lessons in this book.
One key lesson is that practical knowledge, informal processes, and improvisation in the face of unpredictability are indispensable.
Formal scheme was parasitic on informal processes that alone, it could not create or maintain. The the degree that the formal scheme made no allowance for those processes or actually suppressed them, it failed both its intended beneficiaries and ultimately its designers as well. “
Radically simplified designs for social organization seem to court the same risks of failure courted by radically simplified designs for natural environments.
It makes the case for resilience of both social and natural diversity, and a strong case for limits about what can be known about complex social order. Avoid reductive social science.
Four elements of centrally planned disasters
According to the book, there four elements necessary for a full fledged disaster to be caused by state initiated social engineering.
- Administrative ordering of nature and society
- “High Modernist Ideology” a faith that borrowed the legitimacy of science and technology. Uncritical unskeptical public and therefore unscientific optimism about possibilities for comprehensive planning of human settlement and production. Often with aesthetic terms too.
- Authoritarian state willing to use the full weight of its coercive power for #2
- Prostrate civil society lacking capacity to resist these plans.
“By themselves they are unremarkable tools of modern statecraft; they are as vital to the maintenance of our welfare and freedom as they are to the designs of a would be modern despot. They undergird the concept of citizenship and the provision of social welfare just as they might undergird a policy of rounding up undesirable minorities.”
The discussion of the ecological disasters caused by forestry regulation in 18th and 19th century Germany is instructive:
The metaphorical value of this brief account of scientific production forestry is that it illustrates the dangers of dismembering an exceptionally complex and poorly understood set of relations and processes in order to isolate a single element of instrumental value. The instrument, the knife, that carved out the new, rudimentary forest was the razor sharp interest in the production of a single commodity. Everything that interfered with the efficient production of the key commodity was implacably eliminated. Everything that seemed unrelated to efficient production was ignored. Having come to see the forest as a commodity, scientific forestry set about refashioning it as a commodity machine. Utilitarian simplification in the forest was an effective way of maximizing wood production in the short and intermediate term. Ultimately, however, its emphasis on yield and paper profits, its relatively short time horizon, and , above all, the vast array of consequences it had resoloutley bracketed came back to haunt it.
Department of unintended consequences
I like to joke about wanting to start a department of unintended consequences to oversee economic policy. Often central planners fail because they arrograntly fail to foresee unintended consequences of their policies.
“ the door and window tax established in France under the directory and abolished only in 1917 is a striking case in point. Its originator must have reasoned that the number of windows and doors in a dwelling was proportional to the dwelling a size. Thus a tax assessor need not enter the house or measure it but merely count the doors and windows. As a simple, workable formula, it was a brilliant stroke, but it was not without consequences. Peasant dwellings were subsequently designed or renovated with the formula in mind so as to have as few openings as possible. While the fiscal losses could be recouped by raising the tax per opening, the long-term effects on the health of the rural population lasted for more than a century. “
See also: Goodhart’s Law
Department of unintended consequences
To: Democrats, Republicans
CC: Anarchists, Communists, Independents
Re: Department of Unintended Consequences
I don’t talk politics around here much but…
One thing the government needs is a “Department of Unintended Consequences” , or Unintended Consequences Ministry. This department will be in charge of analyzing the potential unintended consequence of any proposed policy put forth by any government department. I suggest that it hire the best computer engineers to help build simulations using the most advanced AI /game techniques. Perhaps this Unintended Consequences Ministry will help the broader government avert misguided actions, avoid long term consequences, and identify prudent courses of action.
This critical department will start it out with a small budget. But funds are tight, so other departments may have to make a few small cuts.
This department may rise in importance to be come a fourth component of the balance of power in the American system. I volunteer to be head of this department, and will accept a market compensation package.
Paul C Wonk
Fistful of Lira
While packing for my redeye flight to Istanbul tonight, I remembered the last time I had travelled to Turkey around 6 years ago. After getting sort of stranded in Kazakhstan for a day, I ended up wandering back alleys of Istanbul talking to questionable people in the non-bank financial service sector.
A planning error left me with no choice but to run an experiment on the fringes of the global forex market.
At the time, I was working at an investment bank in China, but I got a week off for a some sort of Communist Party workers holiday in October. My then girlfriend now wife was a grad student in the US. We decided to meet in Turkey for a little getaway.
As I prepared for the trip I was flush with RMB(Chinese yuan), but short on dollars and Euros(1). None of the banks in Beijing I went to would directly change RMB to Turkish Lira. Plus all them had silly wide bid-ask spreads on RMB/USD or RMB/EUR transactions. No point in changing here I thought, I’ll just change once when I get to Turkey. Turns out that was a rookie mistake.
I was on the Air Astana flight from Beijing to Istanbul with a layover in Almaty, Kazakhstan. Checking in was a bit of a debacle. I had to wait in a long line behind migrant laborers who had absurdly large quantities of luggage to check, much of it in non-traditional suitcases (ie barely sealed cardboard boxes).
The guy in front of me in the line to check in was about 6 foot 4, bald, big boned, with the look of a football referee who let himself go. After some sort of commotion at the front of the line , he turned around, smiled and said in a baritone, probably Russian Accent: “Almaty airlines ,this always happens. “
The flight was delayed a few hours but it ultimately did take off. However we were late enough that I missed my connecting flight. I had a day to wait for the next flight to Istanbul.
Almaty airport wasn’t fancy, but it was no worse than many of the small airports I’ve been to around the globe. I went to a cafe to get some food.
Turns out they wouldn’t accept RMB. No problem I thought, and I walked over to the one moneychanger accessible from the terminal I was at.
Turns out they wouldn’t change RMB at all.
I went to the ATM, and it wouldn’t accept my card for some reason.
For amusement I tested if any of the shops there would take RMB. None would.
At least I got a lot of reading done passing the time with no money to entertain myself in the airport for a day. I don’t remember what the meal was on the next leg of the flight, but I remember it was quite delicious.
When I got to Istanbul, and ran into identical forex issues with shops, moneychangers, and ATMs.(2)
So I wandered the streets going into moneychangers asking to change money. Even banks with China origins wouldn’t do it. Finally one money changer looked surprised, and asked “how much,” as he motioned me over towards the other end of the counter.
I answered him, then he took out a pen and a piece of scrap paper, and started to draw a map.
It was a long journey. As I recall, I had to go to the far end of one of the subway lines, then walk for about 15 minutes. Finally I found a shop that would change RMB. But their rate was horrible so I said I’d be right back.
I finally found another one a block over with a much better rate. I was relieved to at last clutch a fistful of Lira.
The rest of the trip went smoothly. Of course those days were before Erdogan, um “changed” (3).
This time I’m going back to Istanbul, with a mix of USD and Euro I’m excited to enjoy deeply discounted falafel, and drink coffee while working from a deck on the Asia side of the bosphorus, with a perfect view of the river, and Europe on the other side. I won’t have time to explore the far ends of the subway lines since I’ll only be in Istanbul for a day. After that I’ll be going to Sofia Bulgaria and working there for a week.
(1)When if ever will the RMB be a global currency? I don’t know. My general view on currencies is I never make pure directional bets. I just try to avoid getting killed by sudden changes. This basically means cautious sizing of any position that is exposed to fringe markets. Smart operational decisions have real alpha implications in these areas as well I guess you can say I learned this on the streets, the hard way.
Anyways, while there is now a surplus of superficial media coverage of China’s One Belt One Road policy,few people are talking about the capital markets implications. China is basically throwing money at every country to its west all the way to Europe, with a potentially huge impact of the smaller countries. What I find interesting is that most of it is going to be financed with yuan denominated debt, not dollar denominated debt. Combined with a yuan denominated oil futures contract hitting the market, One Belt One Road will result in a lot more financial market activity in yuan rather than dollars. I would still consider yuan internationalization(and a decline in the dollars status) a bit of a long shot near term, but these recent changes make it a lot more plausible over the next decade. At the very least there will soon be a lot more funky securities denominated in yuan(many probably, ahem, distressed and deeply discounted), so it makes sense to get comfortable with custody and banking issues involving the currency.
(2) My ATM card ended up getting flagged with a security alert for suspected fraud, which I was later able to resolve.
(3) Much as been said about his more populist tendencies. I also find it amusing how non-populist policies have had unintended consequences contributing to the current crisis. For example, the government incentivized small and medium sized companies to borrow in non-Lira currencies, by loosening restrictions on loans over a threshold(IIRC, $5 million). This part of the economy is seriously hurting now. Alas there will be some fun picking in the distressed debt space before too long.
Big dam frontier market bond offerings, low dam yields
Credit markets are crazy, from US buyouts, to frontier market bond offerings.
Buffett released the annual Berkshire letter this past weekend, and it contained a number of gems as usual, although it was shorter than the typical letter.
Petition’s excellent distressed credit focused newsletter last week pointed out that Buffett’s concerns about high M&A prices were:
affirmation of a number of macro themes that ought to portend well for distressed players in a few years: (i) excess capital supply, (ii) resultant inflated asset values, (iii) lack of discipline, and (iv) over-leverage.
The big dam indicator
The loose credit has spread to frontier market bond offerings as well. Tajikistan, a country with $7 billion in annual GDP in September raised $500 million of debt at 7.125% for 10 years. Tajikistan had no problem raising this capital. In fact funds put in $4 billion in bids for the $500 million in paper. Tajikistan will use this capital used for the Rogun barrage project, which involves building the world’s largest hydroelectic dams. Building large buildings tends to correlate with hubris, and bubbles(although the empirical evidence around causality is loose), as many have noted:
More frontier market fun
Trump’s foreign policy: Pulling a Homer
It is almost universally accepted that Donald Trump’s foreign policy is going to be a disaster. But what if his bizarre antics actually work? What if Trump pulls a Homer on foreign policy?
Pulling a Homer
Here’s a scenario under which Trump ends up being known as a foreign policy success. It probably won’t happen, but if it does, you heard it here first.
- The Iran protestors succeed in replacing or drastically reforming the government in Iran. The new regime remembers Trump was the first world leader to directly support them. US-Iran relations open up. Trump takes credit whether he deserves it or not.
- China and South Korea get so concerned with Trump’s impulsiveness that they finally decide to take action on North Korea. Trump takes credit whether he deserves it or not.
- Israel and Palestine come together in sort of a reverse Camp David summit as a result of Trump’s recognition of Jerusalem as the capital of Israel. Both parties are concerned with Trump’s bizarre behaviour, and finally start negotiating from realistic basis. Trump takes credit whether he deserves it or not.
- As a result ⅔ of the “Axis of Evil” is fixed through diplomatic means, and Middle East peace achieved during the Trump administration. History books go on to credit him as a highly persuasive foreign policy president. Scott Adams’ “4d Chess” analogy for Trump’s actions, however preposterous it seems now, ends up becoming the accepted narrative.