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Key insights from mooncake festival at house of Jerry and Liza

Technology trends

  • Companies are increasing shifting their service from one-off on premise licensing deployment monetization to cloud based SaaS recurring subscription models
    • revenue hit in the short run
    • increased customer LTV in the long run
    • affected publicly traded companies will experience short term discounts to their shares
  • Artificial intelligence versus Augmented intelligence
    • companies are increasingly shifting away from automatic insight generation to systems that help decision makers simulate and model potential outcomes when specific policies are executed
    • demand is shifting from insight generation to data cleaning services
  • Corporate adoption of artificial intelligence
    • CEOs are increasingly considering how to leverage AI as a tool for their trade
    • primary use case is figuring out how to increase their sales volume
    • experiencing challenge on how to apply AI on in-house data to achieve monetization goals
  • Rise of deep vertical data networks
    • EverString – provides sales lead refresh for all client companies ends up becoming a large database for decision-making executives information, approximately 6 million records
    • StreetSine.sg – cleans up real estate data to help agents better price houses for sale by utilizing in-house agency ends up becoming a large database of high quality real estate data
  • Crypto-currency
    • Bit coin is still the main poster child
    • general population still skeptical about libra
    • main argument is still to remove central bank controls
    • main adoption hurdles
      • writing throughput volume
      • a stable store of wealth
      • starting to be using as a means to facilitate transaction in China
      • Inability to increase or decrease currency supply in times of need is going to be hard as a means to provide much needed stimulation during economic recessions and inflations

US/China trade war

  • sources of conflict
    • technology theft
    • forced technology transfer
    • unfair trade practices like subsidized state owned Chinese companies operating in the export markets
  •  economy
    • China is experiencing inflationary deleveraging
      • local farmers are not growing critical food sources
      • critical food supplies are imported
      • price of imported goods are denominated in US reserve currency
      • shifting of supply chain out of China to
        • Vietnam
        • India
        • Taiwan
      • capital flight
        • Li Ka Shing moved funds out from Hong Kong in 2013 to Europe
        • raising funds for US Venture capital from China was easy prior to Chinese and US government shut down
    • US is experiencing deflationary deleveraging
      • businesses are concerned about macro environment and are reducing fixed investments
      • manufacturing is slowing due to decreased demand both locally and overseas
      • consumer spending and confidence is still strong
  • Chinese domestic concerns
    • Potential US meddling in Chinese domestic affairs – Hong Kong’s demonstration and demands
      • Revoking of National Education
      • Revoking of extradition bill
      • Resignations of HK Chief executive
      • universal suffrage: freedom to elect their own leaders
    • destabilized situation presents a challenge for Xi JinPing’s party to retain control of power over former Jian Zemin’s faction
  • value system
    • US is a highly rule based system
    • China’s system of control is highly subjective to the individual in power.  Direct government intervention in the distribution of wealth is a major source of concern

US/Mexico and world issues

  • NAFTA agreement was too one side and failed to take into account large  imbalance between the two economies
  • US’s arrangement of allowing Mexican tax payers the right to claim dependents ultimately resulted into tax claims and refunds for entire extended families in Mexico. This has the effect of subsidizing Mexican’s at the expense of Americans living along the rust belts
  • Its observed income inequality is becoming prevalent across the entire world not just within US and China.

Related readings

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The American Factory

Context

FuYao is a Chinese manufacturing company that products glass for automobiles companies:

  • Honda
  • Toyota
  • Hyundai

The company setup a factory in Dayton Ohio in 2013 to take advantage of the abundant supply of cheap skilled labor in the region resultant of the 2008 recession.

Overarching trends

  • globalization continues to apply downward pressure of wage growth around the world for commoditized labor
  • automation continues to eliminate entire categories of jobs around the world

In depth analysis of FuYao Glass America

The opening of a plant in the new country can be seen as a acquisition of sorts.  Acquisition activities is considered a merge of the following components:

  • Culture
  • Process
  • Assets

In this case, it could be seen as a merging of FuYao’s culture and process with Dayton Ohio’s asset which is cheap skilled labor.

Below are the key conflicts with the merger

  • highly structured and propagandized environment (Chinese) versus loosely structured and casual environment (USA)
  • processes built around social norms in a weak union environment (China) versus social norms from a strong union environment (USA)
  • productivity and throughput focused paradigm (Chinese) versus safety and family focused paradigm (USA)
  • workers paid USD29/hr when working for GM before it shuttered are now paid USD17/hr under FuYao
  • governor and grassroots were encouraging unionization to encourage more say American say in the running of the plan

Key transitions

  • removal of locally hired senior management (USA) with Chinese senior management (USA) for effective implanting of culture within company
  • battling against worker unionization
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David Letterman interview with Barack Obama

 

Leaders impact is more on shaping the attitudes more so than setting legislations

Income inequality caused by globalization and technology has eliminated  entire categories of jobs. Wealthy people with excess money to invest due to this aggregation of wealth at the top seeks to maximize their wealth by investing in more and more kinds of financial instruments to return generates. This in turn creates bubbles.

Cost of health care and college education continues to rise as corporate America continues to optimize its monetization engine.

Online media channel consolidation and structural deepening of algorithmic social media newsfeed (Facebook and Twitter) continues to drive polarization of views.  The media is primarily geared towards eliciting a response so as to drive conversion rate instead of helping audience develop well rounded perspectives on social issues through holistic presentation of facts.

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Book summary: Understanding big debt crisis by Ray Dalio

The economic system

Functions of money

  • A store of wealth
  • a means of exchange

Two types of cycle

  • economic cycle
    • tied to production activity and output
  • credit cycle
    • the underlying basis is trust
    • capital employed as a means of production
    • when trust breaks down and credit starts to tighten credit cycle is said to be in the contraction phase and deleveraging occurs

Types of deleveraging

  • inflationary deleveraging
    • generally occurs when country’s currency is not a reserve currency or when currency is pegged to a specific commodity like gold
    • foreign lenders are unwilling to roll over existing credit or provide new credit leading to credit contraction within the economy
    • price of good rises during an inflationary deleveraging
  • deflationary deleveraging
    • generally occurs when country’s currency is a reserve currency
    • money is hoarded as cash instead of being utilized to support economic activity
    • domestic lenders are unwilling to provide credit leading to credit contraction within economy

Methods of deleverage

  • Austerity – spending less
  • Debt defaults / restructuring
  • Central bank print money and making purchases or providing guarantees
    • hard to implement if currency is tied to the gold standard
  • Transfers of money and credit from those who have more than they need to those who have less
    • will generally trigger exodus of funds

Beautiful deleveraging

  • Reduced debt to income ratio (head to Genesage to understand more about the clockwork behind debts)
  • improved economic activity
  • improved financial asset prices
  • bring nominal economic growth rate above nominal interest rate

Ugly deleveraging

  • bank runs
  • bankruptcies
  • severe unemployment
  • hoarding of gold
  • war / riots

Noteworthy similarities in period prior to WW2 and present day 2019

  • Dire income inequalities where 40% of the wealth is owned by 1% of the population
  • Rise of populism
    • Hitler
    • Franklin DeRoosevelt
    • Winston Churchill
  • rise of protectionism
    • US launches trade war against Canada
  • Rise of militarism
    • Hitler Germany
    • Japan
  • Continue professing by politicians that there is nothing wrong with the economy
    • President Hoover attempts to allay fears
  • Extreme volatility in the financial markets
  • riots due to economic hardship
  • sudden shifts from relatively free trade and interconnected supply chains around the world to protectionism and trade war through the use of tariffs
    • US versus Canada trade war
  • Out break of war
    • WW2
    • increase

Noteworthy case studies and observations

The war economy – Germany during WW1

  • GDP will tend to improve during war time as countries involved in war borrow heavily through the issue of bonds to finance production of war equipments
  • GDP will start to deteriorate after period of war is over as it transits back its prior state
  • GDP of the loosing faction will tend to be more severely affected during the post war period as they get slabbed with war reparations – WW1
  • Nature of loans during war period
    • Loans will initially be denominated in local currency due to high levels of patriotism
    • As war drags on and there are no signs of a positive outcome and loans becomes harder citizens will have either exhausted their loanable assets or are not confidant in the government’s ability
    • Further loans will need to be borrowed from foreigners which might result in loans denominated in foreign currencies

Connectedness of financial systems around the world – the 1930s Great Depression

USA 1930s deflationary deleveraging chain of events
  • investors buy financial assets and utilize increasing financial asset prices as collateral to buy more financial assets
  • government increases interest rate to tighten monetary policy and bring down inflation
  • brokerages increases margin interest rates
  • investors who cannot afford margin interest rates starts unwinding their positions leading to fall in financial asset prices
  • fall of financial asset prices triggers margin calls on other investors who borrowed to buy financial assets. This vicious cycle continues and confidence starts deteriorating and credit starts unwinding
  • bankers attempt to prop up asset prices and boost confidence by buying assets. Efforts were not enough, and asset prices continue to decline – as much as 90%
  • other entities are impacted
    • actual companies start experiencing problems getting credit
    • banks whose assets are in financial assets experience solvency issue due to rapidly deteriorating
  • bankruptcies and unemployment rate increases
  • government steps into prop up the market by lowering interest rate
  • interest rate is at all time low, investors lacking confidence is unwilling to provide credit many started withdrawing cash from banks causing bank runs. They also started hoarding gold.
  • There is an international shortfall of USD
Europe 1930s inflationary deleveraging chain of events
  • Confidence worldwide gets affected by US market deleveraging
  • Germany whose WW1 reparation denominated in USD experiences were mainly financed through the issuing of bonds experience difficulties finding buyers for new bonds.
  • investors loose confidence in ability of German government to repay bonds and start believing in the probability of a default
  • investors started dumping bonds and withdrawing gold from the German economy
  • inflation ensues
  • UK have many banks with assets tied to German bonds. Investors are concerned that UK will get affected and started withdrawing gold in droves.
  • UK government and German government decoupled their currencies from the gold standard, lowered interest rates and allowed exchange rates to decline
USA 1930s inflationary deleveraging chain of events
  • USA continues to peg their currency to the gold standard but experiences continued outflow of gold because gold is now considered to be priced too cheap against USD when compared to other European currencies that have gone off the gold standard
  • USA bans the purchase of gold, decouples their currency from gold and allow exchange rates to float freely
  • The world economy starts recovering

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Key insights from weekend with Jerry, Liza, Ada and Dan

On US/China trade war

  • 25% tariff basically wiped out whatever profit margin importing from China could bring
  • China’s labor cost have been increasing over the past few years that it is no longer a competitive advantage
  • China’s main advantage is the expertise they built up over the years. A company can easily spin up 25 manufacturing lines in China very quickly
  • US companies are all rapidly shifting their manufacturing activities out of China
  • New locations are Taiwan, India and Vietnam
  • Chinese staff that were retained by Google are now flying to new manufacturing facilities spun up in these countries to oversee the spin up process

On alternate data

  • Real estate
    • the rise  of platforms like AirBnB has lead investors to seek out alternate data that can help predict short term rental yield as opposed to long term rental yield in a neighborhood
    • government agencies are seeking such data to detect neighborhoods where they should focus their efforts to crack down illegal subletting on AirBnB
  • Sports
    • being able to predict strategy coaches of football teams will employ in real time will help support strategies
    • being able to predict starting line in close to real time and the corresponding outcomes will be valuable for coaches in making play decisions

On HongKong/China protest

  • Public opinion is the agenda for the ongoing protest is now getting really murky
  • Airport has stopped operations, it’s hard to even get in and out of the country
  • Foreign Chinese nationals are supportive of protest in HongKong
  • Topics pertaining to Taiwan, Tibet and TianAnMen massacre are sensitive topics amongst mainland Chinese
  • Funds of funds from Hong Kong are still very liquid
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Escalating tension in Asia Pacific and how history tends to repeat itself

US is a divided country holding two conflicting points of view which are both very valid given existing set of evidences. This is the inherent drawback of democratic systems when faced with foreign threats. The dysfunction of the Roman military during periods of the Punic Wars is a fine example.

It is noteworthy to observe how populism and militarism tends to rise in times of extended economic hardships and during periods immediately prior to major outbreak of wars. Trump is the modern day equivalent of Franklin Roosevelt and Winston Churchill who were both considered populists during their times.

Related references

A democratic nation divided

The technology arms race

The economic warfare

The escalating military tension

Other related readings

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Book summary: The Asian Financial Crisis by Shalendra Sharma

This book describes how the 1997 Asian Financial Crisis transpired.

Impacted countries

  • South Korean
  • Indonesia
  • Thailand
  • Malaysia
  • Singapore
  • Hong Kong
  • China

Key lessons

  • Only 2 of these three conditions can be allowed to be true without causing inflationary recession
    • Fixing the currency exchange rates against other reserve currencies
    • Control over domestic interest rates
    • Control over capital inflow
  • On foreign capital flows
    • huge volume of foreign capital flows into a country
      • economic growth rate increases
      • inflation rate stays low
    • huge volume of foreign capital flows out of country
      • economic growth rate decreases
      • inflation rate goes up

Common pattern across countries

The build up

  • Long periods of high export lead GDP growth attracts high levels of foreign investments. Huge volume of foreign funds originated from Japan which was having a very loose monetary policy
  • Countries peg their exchange rates to reserve currency to ensure stable prices for both imports of raw materials and exports value added products
  • Countries currencies are not reserve currency, hence foreign loans were denominated in foreign currency
  • Excessive leverage within the country by domestic parties who take on short term loans denominated in foreign currencies at lower interest rates to finance long term projects that generate returns in domestic currencies
    • Stocks are purchased with borrowed money. These stocks are then further used as collaterals to borrow more money
    • Real estate are purchased with borrowed money. These real estates are then further used as collaterals to borrow more money
  • Moral hazard due to corruption of financial system
    • banks are arm twisted to finance projects that are not financially viable by governments and politicians

The economic headwinds

  • countries face increasing export market pressure
    • Competition at the low end of the export markets from China
    • Competition at the high end of the export markets from Japan
  • Japanese government instructs central bank to tighten monetary policy to reduce real estate. This severely restricted liquidity from Japan and reduced availability of short term foreign loans to affected countries

The crash

  • Borrowers within these countries increasingly experienced difficulties rolling over their foreign denominated short term loans to finance their long term illiquid domestic projects
  • Many of them started defaulting on their loans
  • Foreign investors started getting spooked and started withdrawing their funds or refusing to allow their loans to roll over
  • Non-performing loans builds up amongst banks within these countries
  • Capital flight continues causing downward pressure on the exchange rates of these countries
  • Countries continued defending their exchanges rates by buying up their own currency and selling off foreign reserves (assets held in foreign currencies)
  • Countries deplete their foreign reserves and are unable to uphold their exchange rates. Since most debts are denominated in foreign currencies, they are not able to print money to pay off these loans.
  • The economy grinds to a halt and hyper-inflation occurs within their financial system at this point
    • domestic production stops and locally produce foods is no longer available for sale
    • due to shortage of foreign reserves imported products become very expensive in local currency
  • Countries approach IMF for loans to tide through this liquidity crunch.
  • IMF steps in and with a lack of understanding of the economic patterns imposes these requirements:
    • Countries required to impose high domestic interest rate. It has the effect of further reducing the money supply within these countries causing more defaults domestically.
    • Countries will reform the financial systems to remove cronyism lead financing
  • Riots ensures and Anti-establishment governments get elected in some countries

The recovery

  • IMF releases the misstep in policies and relents
    • Countries lower their domestic interest rates to increase liquidity within their financial system
    • Countries allow their exchange rates to float freely
  • Relatively cheap asset prices within these countries starts attracting foreign investments again
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Afternoon with Tomasso on the limitations of Artificial intelligence’s application

For us to be able to successfully apply artificial intelligence on any domain, the following needs to be true

  • The behavior the system to be modeled must not be stochastic
  • The state of the system must be decipherable by the data scientist
    • it should be possible to understand the state in which the system is at through interpretation of data gathered
  • The domain can be modeled
    • the parameters for modeling the domain must be well defined

Only when all three premise are true can we determine where the adjustment should be made when a model fails to predict an outcome

The financial markets is stochastic  in the short run.

The underlying parameters are constantly changing and thus hard to model due to the emergent nature of impacts caused by human activities. The data is qualitative and thus hard to convert into clean quantitative datasets.

While the price movements are obvious it is hard, it is hard to attribute impact to the various parameters.

As such, it requires human neural networks that consumed all these qualitative data to perform the prediction/decision making.

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Why banks are trading at or below net book value

After the 2008 financial crisis, legislations like the Volcker Rules to inhibit big banks from behaving like hedge funds. They are no longer allowed to engage in any forms of trading or financial innovation which leads to excessive multiplying of money supply leading and excessive leveraging within the banking systems.

Their income is thus restricted to investment banking commissions and net interest incomes.

Related references

Long-Sought Volcker Rule Revisions Land on a Changed Wall Street

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Book summary: The Savings and Loan Crisis – Lessons from a regulatory failure

This book documents the series of regulatory missteps from the 1980s to the 1990s that lead 50% of savings and loans in the US to insolvency. During this period the total number of savings and loans decreased from 3,234 to 1,645.

Operating mechanism

The savings and loans are a special group of banks that are encourage to grow by the US government to enable affordable housing after the world depression.

They take in short term savings deposits at lower interest rates and lend out long term mortgages at higher interest rates. They profit through the net interest income generated between the short term interest rates and the long term interest rates. If you think you’ve become a victim to such practice, then you can always get help here in order to extricate yourself from the situation.

Events leading to massive failure

  • During the Vietnam war, inflation which drove short term interest rates increase. This cannibalized SnLs’ profit margins.
  • De-regulation of short term interest rates which lead to increased competition by other banks for deposits.  This lead to the inability to attract deposits at feasible rates to finance SnL’s long term illiquid mortgage loans.
  • The US government instead of recapitalizing these insolvent SnLs opted to de-regulate by allowing them to enter into other high yield investment instruments. This is in hopes of they will be able to rebuild the capital and thus minimize the amount of burden to be imposed on tax payers
  • Entrance of new entities
    • mutual funds competed for deposits
    • Freddie Mae and Freddie Mac competed for mortgages
  • SnLs ventured out of their areas of expertise and started buying into high yield corporate junk bonds and unsecured commercial loans.
  • With minimal equity stake in the game due to years of erosion and an implied government guarantee for a bail out in case things go south, SnLs began aggressive leveraged into these positions.
  • The US government reversed it stance and past regulation against SnLs holding high yield investment instruments. The forced liquidation of relatively illiquid positions further exacerbated the situation.

Lessons learned

  • Government meddling in market mechanism to further political agenda is generally a recipe for disaster
  • Venturing beyond circle of competence in search of high yield is generally a recipe for disaster
  • Overt or implied guarantee of government bail out is a source of moral hazard that leads to excessive leverage by operators which is definitely a recipe for disaster