Inside this Issue:
- Star Tech: IT’s Big Five Post Astoundingly Strong Results
- Prices Rise When You’re Short Supplies: But How Long Will the Shortage Last?
- How Dovely: Fed Stands Still with Jobs Still Stalled
- No End to the Spend: Biden Seeks More Funds for Families
- Musk Ado About Nothing: Tesla Boasts Profit but Buttressed by Bitcoin
- Communication Acceleration: Verizon and the Coming 5G Revolution
- Eurodollar Collar? The Overlooked Importance of the Overseas Dollar Market
- The Idaho Glow: A Look at One of America’s Hottest Housing Markets
- Empires of Information: A Look Back at the Evolution of Big Media
- The Doctrines of DAO: A Crypto Way to Organize an Organization
- And This Week’s Featured Place: Delaware, America’s Credit Card Capital
Quote of the Week
“I call it fee-driven buying. In other words, they’re not buying because it’s a good investment. They’re buying it because the adviser gets a fee. And of course, the more of that you get, the sillier your civilization is getting.”
-Berkshire Hathaway’s Charlie Munger
Enormous revenues. Enormous revenue growth. Enormous profit margins. The Big Tech Big Five—Amazon, Apple, Google, Microsoft and Facebook—showed once again their outsized importance to the American economy. Enormous investment. Enormous job creation. Enormous importance to the lives of every American, even more so during and after the pandemic. But is the enormity of their influence excessive? During their earnings calls last week, all five made sure to emphasize their social contributions as a public and political backlash mounts. Microsoft, for its part, is past its riskiest days of public inquisition. But not the other four. Don’t expect any dramatic Standard Oil/AT&T-type breakups anytime soon. But do expect more regulations, more judicial rulings and perhaps more taxation.
Of course, Big Tech could see their revenues, profits and influence wane slightly as life gets back to normal. More time on a beach—or in a restaurant—means less time on a computer. But there’s no evidence of any such waning yet. Instead, Q1 earnings from companies throughout the U.S. reveal two dominant themes across the economy: widespread demand strength and extensive supply constraints. Naturally, that’s pushing up prices for many goods, assets and even services now. It’s elevating the price of labor too. But not enough to elicit fears of sustained inflation, says the Federal Reserve. It’s not ready to tighten the screws on monetary policy—even modestly—just yet.
In the Fed’s eyes, there’s still too much joblessness among lower-skilled workers. And it’s seen this movie before: Inflation undershooting expectations, even as the economy grows and unemployment falls. Of course, the economy hasn’t grown this fast in decades. The Commerce Department says GDP expanded at an annual rate of 6.4% in the first quarter, following 4.3% growth in the fourth quarter. Consumer spending, especially on durable goods like autos, led the way, helped along by government assistance payments including stimulus checks and expanded unemployment benefits. U.S. GDP is now close to where it was before the pandemic began.
President Biden, like the Fed, continues to press on the accelerator. He’s proposing trillions in additional spending, on top of the nearly $2 trillion Congress approved in March (and nearly $1 trillion passed in December). One key goal: boosting the long-run potential of the U.S. economy through better infrastructure, a better educated workforce and more scientific research. If achieved (a big if) the money would be well spent. Another goal: Easing the economic burdens of lower- and middle-income Americans all too often hindered in their Jeffersonian pursuit of happiness—hindered by ever-rising costs for housing, health care and higher education. And hindered by the challenges of balancing work with time spent caring for young children and aging parents. For some, especially African Americans and Native Americans, the legacy of past injustice is another hindrance.
There is risk, to be sure, in overextending the federal budget, already deeply in debt. The unconcerned point to four decades of federal spending growth without any inflation, without any interest rate spikes, without any dollar shocks… The apprehensive, however, think past patterns might not hold beyond a certain level. If spent unwisely, furthermore, government spending can be wasteful while distorting the economy and misallocating resources.
But back, for a moment, to the current supply shortages rippling through the economy, leading to higher prices. Are they just temporary? The past year, no doubt, has been a planner’s worst nightmare, with drastic twists and turns in market conditions. Take the giant auto sector and its vast network of suppliers and distributors. Last year started with a rosy demand forecast. When Covid suddenly hit, the outlook turned bleak. Just as suddenly, demand spiked. Now, though demand remains strong, there’s a major semicon shortage. Assuming more stable patterns longterm, price pressures should ease. Wage pressures, meanwhile, should ease as workers return in greater numbers as schools reopen, Covid fears subside and added unemployment benefits expire. One more thing to remember: The U.S. economy of the 2020s in not the U.S. economy of the 1970s. Unions are weaker. Competition is more global. Technology fosters more consumer price transparency. Services, like health care and IT, are more prevalent.
Also becoming more prevalent by the day: Vaccinated Americans—almost half of the country’s adults have now received at least one shot. Sure enough, leisure companies of all types are benefitting; Six Flags for one, which owns amusement parks, said last week that demand is strong as summer approaches. Texas Roadhouse, a restaurant chain, said people are returning to its dining rooms and trading up to larger and higher priced steaks (though it did add: “It’s never been more difficult to attract and retain employees.” And yes, it is raising wages. And yes, it is raising menu prices).
Other takeaways from last week’s earnings calls: Shippers are still doing brisk business: UPS said revenues spiked 27% y/y. The housing market remains hot. Oil companies are breathing easier after a dreadful 2020. Aerospace remains troubled, based on reports from Boeing and one of its leading engine suppliers GE. Ford offered more insight on the semicon shortage, which will likely last into 2022. Warren Buffet’s Berkshire Hathaway said something like 85% of the economy is running in “super-high gear.”
This week, attention turns to pharmaceutical earnings, with vaccine champions Pfizer and Moderna slated to report. General Motors and Stellantis will keep the auto sector front and center. The health insurer Cigna is one to watch. Keep an eye on PayPal, CVS, T-Mobile and Uber as well.
- Big Tech’s Big Five: Amazon, Apple, Microsoft, Google and Facebook all reported Q1 earnings last week. And man were they good. Extremely good. As the chart below shows, the Big Five collectively earned more than $81b in operating profits during just the January-through-March period. This was a hearty 25% margin on their $321b in revenues. Perhaps even more astounding is how fast these companies continue to grow—y/y revenues collectively rose 42%. Wow. Make no mistake: In financial terms, the Covid pandemic was an enormous boon for Big Tech, making their technologies and services ever more central and necessary to everyday life and commerce. Almost like utility companies. With stores closed, more people shopped on Amazon. Stuck at home, more people communicated, learned, shopped and entertained themselves on iPads. They played more Xbox. They spent more time searching on Google and reading conspiracy theories on Facebook. Ouch. O.K., maybe that’s unfair. But you get the point. It’s no less important to highlight the role these companies are playing in research and development, a role reminiscent of AT&T’s Bell Labs in a previous era. Perhaps most importantly, all are investing heavily in artificial intelligence, which promises to make the entire economy more productive. Some are leaders in developing autonomous driving, some in cloud computing, some in semiconductors, some in 5G, some in virtual reality… and so on. Their tools are helping large and small businesses alike, while fostering a new “creator economy” of individuals connecting with their fans and followers. They’re also among the U.S. economy’s leading job creators. But they’re controversial, too. Microsoft, once a corporate Bad Boy, is mostly out of the doghouse today. The others, however, are criticized and even under federal investigation for one alleged transgression or another. Do they adequately protect privacy? Do they unfairly charge for access to their platforms? Do they spread misinformation? Do they play fairly with business that use their platforms? Do they treat their workers fairly? Do they illegally collude with each other? These are questions of national importance, not unlike past questions about the influence of Vanderbilt’s railroads, Rockefeller’s oil trust, J.P. Morgan’s banking and indeed, the Bill Gates software empire.
- Tesla: Unlike the giants of Silicon Valley, Tesla is a Silicon Valley company that generally loses money, on its almost quixotic quest to upend the notoriously labor- and capital-intensive auto sector. The mission is starting to look somewhat more achievable as the company reports modest profits. But again in Q1, profits came only thanks to selling regulatory credits to other automakers, plus a gain on the sale of some Bitcoin. There’s no questioning Tesla’s popularity—demand for its cars is strong. There’s no questioning its technological prowess—it’s the worldwide leader in electric vehicle (EV) sales. But a history of overpromising and under-delivering reflects recurrent setbacks in production, even more so right now due to global supply chain bottlenecks affecting companies nationwide. CEO Elon Musk, a figure so iconic and famous that Tesla doesn’t even need to advertise, emphasized just how difficult producing cars can be. The company, he said, once had to stop production because of something so minor as a shortage of carpets for the cars’ trunks. There’s of course the semicon shortage now weighing on automakers. At its new factory in China, Covid restrictions left its engineering teams short-staffed this winter. Other recent troubles in China include complaints about product quality and allegations that its cars are collecting sensitive data perhaps useful to U.S. intelligence agencies. Back home, meanwhile, it’s under scrutiny for an accident involving one of its self-driving cars. Tesla, however, for all its past losses and production headaches, remains an investor magnet. The aura of Elon perhaps explains some of that. But it legitimately does hold the potential to become a dominant force, not just in autos but in energy as well. Some think Tesla’s technology is so far ahead that it will remain the leader in EVs, at a time when the world is unequivocally shifting to EVs, literally to save the planet. The company’s self-driving technology positions it to potentially command a worldwide fleet-of robotaxis that can do what Uber does, but without the labor costs. Production should improve with newly opening factories in Austin and Berlin. New products are coming too, including the sporty Roadster, the Cybertruck and a Semi for trucking companies. Musk insists that Tesla isn’t so much a car company or an energy company as an AI robotics company, employing some of the world’s best software and hardware engineers.
- Verizon, which competes with AT&T and T-Mobile in the wireless phone market, says 14% of its customers are now using a 5G-enabled device (the latest iPhones, for example). That number is expected to grow sharply in the coming years, which raises hopes for major productivity gains throughout the economy. Simply put, 5G, or fifth-generation technology, moves data at faster speeds than 4G. Much faster. And that heralds breakthroughs in areas from autonomous vehicles to drones to virtual and augmented reality. It will also enable the advancement of IOT, or the “internet of things” in which nearly every type of device—from factory machines to refrigerators—becomes connected to the internet. Verizon, for its part, borrowed tens of billions of dollars from the bond market to help fund its $45b purchase of 5G-capable C-Band spectrum, secured during an FCC auction in February. AT&T bought $23b worth of new spectrum. T-Mobile, which already had a lot of the spectrum it needs, bought just $9b worth. Verizon, by the way, also competes against cable companies with its Fios product, delivering broadband internet, telephone service and television channels to peoples’ homes via fiber optic cables. Last year, the company purchased Bluejeans, a videoconferencing service competing with the likes of Zoom, Microsoft Teams, Google Meet and Cisco Webex. But even amid its acquisitiveness, it might be poised to divest all or part of its disappointing media business, the Wall Street Journal reports. It owns, for example, the once-vaunted brands of Yahoo and AOL.
- Pulte Group: One of the nation’s top homebuilders gave an update on the tight-supply, booming-demand U.S. housing market. In the company’s words: “Covid-19 has also resulted in a growing desire for single-family living and has changed what the homebuyers want and need from their homes.” This desire, meanwhile, is turbocharged by supportive demographics, low interest rates and an improving economy. And voila: “You get the tremendous demand environment we are experiencing today.” High lumber prices, on the other hand, was a negative factor that Pulte called out in its earnings call.
- CSX: The Jacksonville, Florida-based railroad recounted the ups and downs that many companies must have felt during 2020. Talking about its shipment of autos, CEO James Foote recalled his sentiment in January 2020, just before the pandemic: “Forecasted car sales are going to be very, very strong… Three months later, I looked on the morning report about how much auto traffic we were moving. It was zero. And then we thought, well, this will never start back up. This is going to be a very slow start-up. How are we going to handle this?… And the next thing we know, we get a call saying all the manufacturers are going back to restart their plants three shifts a day. We were able to move, respond and be able to serve that customer segment in a manner that had very, very little disruption. We all geared up into January of this year figuring, all right, it’s going to be another great year. And then guess what? All the plants are shut down again because they can’t get a computer chip.” For the record, CSX saw its auto shipments decline 16% y/y in Q1. On the other hand, overall intermodal shipments rose 11%. Management says it’s well-placed to handle higher traffic volumes at a time when the entire global supply chain is stressed. It wants to be a bigger player in the rapid transition to e-commerce, trying for example to win more longer-haul freight business from trucking companies, especially for metals, plastics, steel and cardboard. Trucking companies, it says, are disadvantaged right now by a driver shortage. Trains, it adds, are also cleaner than trucks in terms of their environmental impact.
Tweet of the Week
Inflation first happens without raising prices Costco paper towels. Same price as the previous several times buying them. Now with 20 fewer sheets. 140/160= .875 Inflation rate: 8.75%
Big Tech’s Big Five’s Big Profits
- Amazon a lower-margin business with immense scale
- Apple saw the sharpest y/y growth
- Facebook earned the highest operating profit margin
source: Econ Weekly analysis of company reports
- Autos: KPMG’s Gary Silberg shared his thoughts on the Daily Drive podcast, specifically about the “tsunami of investment” (roughly $200b worth) in electric vehicles. “King ICE,” he said, referring to the internal combustion engine, “will be dethroned.” But not without great risk that’s often underestimated. Silberg underscores the enormity of the bets that companies, investors and entrepreneurs are making, which are hardly guaranteed to succeed. The future will include not just pure EVs but also hybrids, probably hydrogen vehicles and maybe even natural gas or solar vehicles. And ICE vehicles themselves aren’t going away completely. The giant investment in EVs separately raises questions about what happens with all the ICE assembly plants that exist today. EV plants will require fewer workers and might wind up in different locations. What happens with the huge ecosystem of ICE vehicle suppliers? How to ensure sufficient demand for electricity? What about all the EV infrastructure that will be needed? And don’t forget the question about cost—EVs remain more expensive than ICE vehicles, which begs the question of how the developing world will afford them.
- Foreign Exchange: The Fed said its three-month currency swaps with other central banks will end on July 1, though weekly operations for shorter-term swaps (with a seven-day maturity) will continue. Sounds esoteric, but the Fed’s swaps with foreign central banks played an instrumental role in calming overseas financial markets both in 2008 and 2020. The U.S. central bank was essentially operating as a last-resort provider of dollars to foreign countries, whose companies need them to conduct international trade and repay international debts. In total, more than $1 trillion was swapped, mostly to the Eurozone and Japan. For more on this mysterious ‘Eurodollar” market for U.S. currency used outside the U.S., take a deep breath and read on…
- Eurodollars: Appearing on the Macro Musings podcast, Boston University’s Robert McCauley discusses his new paper on the “Global domain of the dollar,” a topic critical to understanding the realm of global trade and finance. First of all, don’t get caught up in the prefix “euro.” The Eurodollar market refers to all U.S. dollars owned and owed outside the U.S. It’s a giant market that first got started in the 1950s. The Soviet Union, for one, received dollars for the oil it sold on world markets, depositing much of them in London bank accounts, out of Washington’s reach. Before long, U.S. banks themselves were taking dollar deposits in London, from U.S. companies eager to avoid domestic regulations on how much interest they could receive. The U.S. banks themselves avoided regulations like how much in reserves they were required to hold. The 1970s oil boom saw Saudi Arabia deposit massive sums of dollars in London bank accounts. Today, non-U.S. governments and companies routinely borrow money in dollars though global bond issuances, taking advantage of the low interest rates championed by the Federal Reserve. Such foreign entities now have something like $12 trillion in liabilities to banks and investors, McCauley estimates. The figure roughly doubles if you include commitments to buy dollars in foreign exchange swap markets. O.K., what’s the big deal? So what if all these dollars are being borrowed and loaned between two non-U.S. entities? Well, some say it’s an inherently unstable system for the world economy, never mind the enormous global influence it affords the Federal Reserve and the U.S. more generally. These days, every financial crisis seems to involve a mad scramble for global dollars by foreign entities. This was the case in 2008. It was the case again in 2020. McCauley’s paper, however, downplays the risk. In both cases, the Fed managed to quickly stabilize the run on dollars with the swap lines to foreign central banks discussed above, providing the global economy all the dollars it needed. Sure, this gives the Fed a lot of influence, McCauley concedes. But foreigners also benefit from Fed policies—to lower rates for example. The 2008 crisis, he adds, was more about big runs on 1) nonbank finance companies like GE, which has since exited the financial realm and 2) money market funds, which he describes as essentially “banks without capital” and an “accident waiting to happen.” If anything threatens the dominance of the dollar in global trade, he argues, it’s non-economic factors like the overuse of sanctions or the politicization of Fed swap lines—these could encourage foreign nations to develop dollar-alternative infrastructure.
- Here’s another point from McCauley’s paper: Despite all the dollar liabilities foreign entities have, they hold an even greater amount of dollar assets—think of all the dollars foreign central banks hold in their reserves. Given this situation, one would think that a rise in the dollar’s value would be good for the rest of the world—it means their assets are appreciating. But for some reason, dollar appreciation always seems to trigger financial trouble outside of the U.S. McCauley’s explanation is that there’s a big difference between what foreign governments own and owe, and what foreign companies own and owe. For companies, most of their revenue is in local currency but most of their costs are in dollars. So a stronger dollar spells trouble. Think of a Korean airline that suddenly finds its dollar-denominated debts to bondholders more expensive, never mind its fuel bill. Another way to look at it, McCauley writes, is that “corporate sector dollar debts seem to make dollar appreciation akin to a global tightening of credit.”
- Still another point about the giant dollar market outside the U.S.: Keep in mind that lending money is equivalent to creating new money. So a lot of dollar money expansion happens without any involvement from the Fed, a U.S. bank, or any other U.S. entity. Just one foreign entity lending to another foreign entity. McCauley again: “The implication is that the rest of the world does not depend solely on the U.S. economy to produce U.S. dollar assets to hold.”
- Jeff Snider, Head of Global Research at Alhambra, has a lot to say about the Eurodollar market, and no less to say about the Fed’s quantitative easing strategy of buying bonds to artificially inflate demand (which in turn boosts their prices and lowers their interest rates). Snider says it’s more than just not helpful. It’s harmful, because of the mechanism by which the Fed executes the strategy. By buying bonds from banks, in exchange for reserves, the Fed is merely conducting an asset swap that removes bonds, much needed for use as collateral, from the dollar-based global trading system. “More bonds for the Fed, more bank reserves for the banks, less collateral out there in the world overall,” he wrote in an April 21st blog post. Snider is a vocal proponent of Milton Friedman’s interest rate fallacy idea, which says low interest rates paradoxically signal money is tight, not loose. The Fed’s removal of Treasuries reduces the quantity of money, Snider insists, creating a shortage of money globally. Put another way, there’s so much demand for so few Treasuries that their price keeps rising—and by extension, their rates keep falling. He goes even further to say that much of the decades-long GDP sclerosis seen in places like Europe and Japan have a lot to do with limits on economic opportunities linked to this shortage of U.S. Treasuries.
- Alright, you’ve read enough about the safe asset shortage. Just one more thing to hammer home the point, courtesy of David Andolfatto of the St. Louis Fed, who spoke about the topic with Macro Musings in 2019. Even then, demand for Treasuries was already growing a lot, driven by usage as collateral in the shadow banking sector, usage as a store of value for foreign central banks and usage by commercial banks to comply with post-2008 regulations. As for supply, the 2008 crisis destroyed a lot of what were previously considered safe assets used for collateral, like asset-backed securities and certain forms of government-backed mortgage debt. Demand for Treasuries up. Supply of Treasuries down. So Treasury prices up, and yields correspondingly down—a deflationary force, says Andolfatto. Again, the tricky thing here is answering the riddle of how Treasury supply can be down with so much new government borrowing. For economists like Snider and Andolfatto, the explanation lies with forces like quantitative easing and post-2008 changes in risk tolerance.
- Fiscal Policy: To some Americans, from Thomas Jefferson to Mitch McConnell, expansive federal influence in the economy is a force for ill. President Biden is not one of those people. Instead, channeling Franklin Roosevelt and Lyndon Johnson, he’s championing a sharp increase in federal spending to address a vast array of challenges, from rebuilding infrastructure to reducing income and wealth inequality. After a $1.9 trillion aid and investment package passed by Congress in March, followed by a $2.3 trillion infrastructure plan proposed later that month, President Biden last week presented a separate $1.8 trillion plan to boost the economic fortunes of lower- and middle-income American families. The plan features $800b in tax credits, $225b for childcare, another $225b for paid medical and family leave, $200b for universal preschool, more than $100b for community college tuition, $80b for IRS tax collection and so on. The previous infrastructure proposal, remember, included $400b for at-home care for seniors and people with disabilities, in addition to money proposed for transportation, housing, utilities, education, broadband access, scientific research and support for the strategic semiconductor industry. To be clear, both the infrastructure and family support proposals need to get through Congress, which won’t be easy given Biden’s ultra-slim majorities in both chambers. For critics, just as unappealing as the big spending is Biden’s intent to raise taxes—on corporations to pay for the infrastructure part and on wealthy Americans to pay for the family support part. Biden also wants to improve tax collection by closing loopholes.
- Monetary Policy: At the latest Fed FOMC meeting last week, chief Jerome Powell announced… well, nothing really. While acknowledging the economy’s improving health, the improvement isn’t yet sufficient, Powell believes, to start the process of reversing the ultra-dovish policies first enacted when the Covid crisis began this time last year. So no changes to the federal funds interest rate—the target remains essentially zero. No changes to the practice of buying at least $120b a month of government and government-backed debt. And no changes to the Fed’s goal of seeing inflation exceed 2% for a while, to balance a recent history of falling below that mark. The bottom line: Powell still isn’t convinced that the labor market—especially for low-income and minority workers—is healthy again. Not with millions fewer Americans working now than before the crisis started (see employment chart below). Not with labor participation rates still low. Yes, employment data for March looked strong. But one month, he insisted, doesn’t make a trend. The Fed’s inaction, unsurprisingly, further alarms those concerned about inflation, a debilitating economic disease that’s hard to cure once ingrained in people’s expectations. But Powell again rebuffed such worries, in part because rising prices now evident are normal as industries revive following a pandemic. Naturally, inflation readings will show a substantial increase when compared to last year when things were shutting down. The other chief reason for recent price spikes, Powell said, involves supply chain bottlenecks which are temporary, or “transient” in Fedspeak. Besides, there are big areas of the economy like information technology and health care where spikes aren’t so pronounced. As for labor costs and labor supply, Powell points to many Americans still unable to work due to school closures and health concerns. He said many older workers have elected to retire early (helped by the booming stock market) but could reenter the workforce. Others will surely return as bonus unemployment benefits expire in September. Pre-crisis experience, furthermore, showed that many Americans who dropped out of the workforce will return as job opportunities increase. Put another way, there’s still plenty of slack in the labor market to provide a check on labor cost inflation. In sum: “During this time of reopening, we are likely to see some upward pressures on prices.” But it’s likely to be temporary, not persistent.
- Macro-prudential Supervision: Beyond monetary policy and bank supervision, the Fed is also charged with monitoring systemic financial risks. Are there any that elicit concern? Not really, Powell repeated. He did use the word “froth” when talking about the stock market and financial asset markets more generally. Rising house prices, he added, reflect a supply shortage, not another risky lending bonanza like in the mid 2000s. In any case, asset prices are only one of four key areas the Fed is watching. The others are household finances (which are strong), leverage in the financial system (which appears healthy; the largely uneventful Archegos affair kind of proved that) and funding risks for companies (which isn’t a problem, notwithstanding specific concerns about the functioning of short-term money markets). The U.S. Treasury market, more generally, needs reform as dealers commit less capital at a time when Treasury supply is growing sharply. The Treasury market, Powell said, is “probably the single most important market in the economy.”
- Monetary Policy: Count Mohamed El-Erian as one of the most prominent figures expressing concern about the Fed’s ongoing dovishness. The former CEO of Pimco, a giant investment management firm specializing in bond funds, shared some of his views in a January discussion with the Center for the Study of Financial Innovation. He’s not necessarily a monetary hawk. But he worries that financial markets are overinflated, not so much because of irrational exuberance but because of rational decisions to buy assets based on expectations that the Fed will continue to buy as well. Markets are essentially becoming conditioned, at every small signal of distress, to expect the Fed to support financial markets. Investors, always asking the question “who will buy this after me,” look at the Fed right now and see “a printing press in the basement.” What to do? It’s not an easy question to answer, El-Erian concedes. If the Fed retreats from its dovish stance, there really could be a stock market crash. If it they continue to do more, it only makes the problem worse, like feeding a drug addition. Even by doing nothing, risks are inflating as markets are already conditioned to buy. Chair Jerome Powell, he says, has behaved “too much like the market’s BFF.” Don’t like that metaphor? How about his quip that “the marketplace [is] like a spoiled kid being given sweets.” Well before the Covid crisis (in 2017), El-Erian authored a book entitled “The Only Game in Town,” warning then that world economies were becoming too dependent on central bank support.
- Delaware: They call it the “First State” for a reason. Delaware was the first of America’s original 13 colonies to ratify the U.S. Constitution in 1787. Going even farther back, its largest city Wilmington started as a Swedish colony in the 1600s. But fast forward to 2021, and Americans are becoming acquainted with the First State for another reason. It’s the home state of the current U.S. President Joe Biden. Biden’s election, sure enough, made Wilmington a busy place this winter, serving as the headquarters of his presidential transition. Incidentally, this helped struggling local hotels, shops and restaurants hurt by the Covid crisis. It helped the city’s convention center as well. But Biden works from Washington now, and Wilmington is back to being what it’s always been: A niche financial hub. Well, maybe not always. Delaware’s rise as a banking haven began in the 1980s, as deregulation swept through the industry. In 1980, South Dakota pioneered an end to laws capping interest rates, prompting Citicorp for one to establish a big presence there (which remains today). Delaware followed with its own state laws to attract banks, adopting what it called its “Luxembourg” strategy. The Federal Reserve chief at the time, Paul Volcker, wasn’t happy. A 1983 Washington Post article quoted him thus: “I am seriously concerned about the possibility of widely divergent and inconsistent laws governing both banks and thrift powers, with deposit-taking organizations shopping for the most permissive rules, and states competing to pass such laws in order to enhance local employment.” Delaware got its way though, and quickly became a hub for credit card lending most importantly. JP Morgan Chase has its credit card division in Wilmington. So does the British bank Barclays, which purchased the Delaware lender Juniper in 2004. Bank of America acquired Wilmington’s MBNA in 2006. And so on. According to Delaware Prosperity Partnership, the state’s economic development agency, Goldman Sachs—a recent convert to consumer lending—will add up to 150 new jobs on Wilmington’s waterfront. Barclays is adding hundreds of jobs as well. Overall, finance, including lots of activity in areas like student loans and insurance, accounts for nearly 10% of the state’s jobs, more than any other sector. Delaware, however, is more than just a haven for credit card lenders. It’s more broadly a haven for all of Corporate America, offering business-friendly courts, flexible rules on corporate governance and favorable tax laws. Believe it or not, nearly 70% of America’s Fortune 500 companies are incorporated in Delaware. And a third of the state government’s revenue comes from fees these companies pay. Even more controversially, Delaware’s corporate friendly rules extend to privacy—often no need to disclose the names of people associated with a newly-formed business. As a result, Delaware is often accused of facilitating tax avoidance and even elicit activities (see item below). Historically, Delaware followed a similar path to other northeastern cities, growing wealthy with industry but struggling as industry moved to lower-cost places starting around the 1970s. For many years, the state’s most important company by far was Dupont, a chemical company which produces a diverse array of things like semiconductors, printer ink, dietary supplements and water purifiers. But as a recent Wall Street Journal report explained, years of downsizing and a giant merger with Dow Chemical led to nearly 10,000 lost jobs in the state. Today, the Journal wrote, Dupont is Delaware’s twelfth largest employer, down from number one 20 years ago. Consistent with much of today’s American economy, the state’s largest employer is now a health care network. JP Morgan is number two. Other big employers include the Dover Air Force base and the University of Delaware. Poultry farming is a major industry. A Delaware Business Times report last month highlighted the scarcity of land in neighboring Pennsylvania and New Jersey, encouraging real estate developers to consider Delaware. None are doing so with more zeal than Amazon—the report cites Newmark Research showing Delaware ranks number two for the company—behind only San Antonio, Texas—in terms of square footage under development. You can see why Amazon finds it attractive as a distribution hub. It’s surrounded by areas with lots of people and lots of wealth. The U.S. Census, in fact, considers Wilmington a part of the Philadelphia metro area, with many Delaware residents commuting to jobs there. Places like Rehoboth Beach, meanwhile, long a vacation spot for federal employees from Washington, DC, is now a popular retirement community for people in New Jersey, fleeing high property taxes. To be clear, Delaware certainly isn’t a sunbelt-like growth story in terms of population, retiree migration and GDP expansion. Nor is Wilmington a millennial magnet like Boston, New York and Washington. But going forward, the presence of so many bankers and chemical engineers, plus the easy Amtrak access to other Northeast Corridor mega-cities, makes the state—and Wilmington more specifically—a place to watch for fintech and STEM-related startups.
- The Hustle takes a deeper dive into why so many U.S. corporations register their documents in Delaware. Even more specifically, they’re registered at one of two nondescript Wilmington offices run by the obscure registration agency firms CT Corporate and CSC. Nearly 1.5m businesses, in fact, are incorporated in Delaware, including 68% of the Fortune 500. Amazon, Apple, Facebook, Walmart, Tesla, JPMorgan Chase, American Airlines, Starbucks… all are Delaware-registered companies. It’s a story about moving where regulations are friendliest—some would call it a “race to the bottom.” In 1899, inspired by New Jersey’s pioneering laws to shield corporations from taxes and other burdens, Delaware passed its General Corporation Law which “reduced restrictions upon corporate action to a minimum.” As The Hustle poetically writes: “It promised to maintain the most hospitable business enclave in the nation—a place where corporations could frolic in the open fields of capitalism, unencumbered by income tax, bureaucratic policing and shareholder litigation. Companies save millions by using tax loopholes like exemptions for intangible assets (i.e., trademarks, copyrights, and leases). Delaware, furthermore, has almost Swiss-like secrecy laws, making it a favorite place to hide money for overseas drug cartels, arms dealers, sex traffickers and Ponzi schemers. It doesn’t hurt that Delaware’s courts are corporate friendly. Will things change? Delaware understandably doesn’t want to surrender all the money it makes from registration fees. President Biden, who hails from Delaware, might be reluctant as well. A law passed last year by Congress, however, outlaws anonymous shell companies, which could eliminate at least part of the shenanigans happening in Delaware.
- Puerto Rico: As devastating as the pandemic has been to poorer parts of the U.S., the giant Washington stimulus money now getting spent gives these same communities a big boost. Puerto Rico, a U.S. territory that’s experienced depression-like economic conditions for a decade, is among the beneficiaries. In its earnings call last week, San Juan’s First Bancorp indeed mentioned the “significant stimulus flowing into the island through the CARES Act and subsequent programs.” In fact, the island’s fiscal board estimates the aid amounts to some $45b, which is more than half of the island’s annual GDP. Puerto Rico’s chronic government fiscal problems are now easing too. Tourism is coming back. And 27% of the island’s eligible population is now vaccinated. First Bancorp itself, like other banks, is struggling with weak loan demand as people receive more government money. But on balance, an improving economy is good for business. It also by the way has a sizable presence in Florida, where economic conditions are particularly strong thanks to a thunderous housing market and rapidly recovering tourism.
- Coeur D’Alene, Idaho: “In the U.S. alone, the total value of owner-occupied real estate is roughly $32 trillion, nearly as much as the value of the entire U.S. stock market.” That’s the lead sentence of new report by the Wall Street Journal and Realtor.com ranking the hottest emerging real estate markets in the country. On top: Coeur D’Alene, an Idaho resort town just across the Washington state border. A few hours to the west is booming Seattle. A few hours northeast is Glacier National Park. Just a half hour away is Spokane, Washington, which also made the top ten. The ranking is based on various economic data, housing market dynamics and quality of life measures. Austin was an unsurprising number two on the list. The lesser-known Springfield, Ohio ranked third. So why are people moving to Coeur D’Alene. Real estate agent Kristen Johnson tells the WSJ that “buyers from other Western states are moving to northern Idaho in droves, seeking a more rural and less expensive place to live. Workers able to work remotely are also choosing to relocate.
- Raleigh-Durham, North Carolina: Apple said it would build a new engineering base in the Research Triangle, the name given to the area covering Raleigh, Durham and Chapel Hill, home to several prominent universities including Duke. The firm pledges at least 3,000 new jobs at the site, in areas like machine learning, artificial intelligence and software engineering. Apple is planning to hire some 20,000 new U.S.-based workers overall in the next five years, many in the areas of 5G and silicon chip development. Raleigh-Durham, make no mistake, is a winner in the tech-heavy economy of the 2020s, joining other IT hubs like Austin, Seattle, Los Angeles, San Diego, Boulder and Apple’s home city Silicon Valley. The company is hiring in all these places. By the way, Apple claims to be the largest taxpayer in the U.S., based on the $45b in domestic corporate income taxes it’s paid during the past five years. Critics, though, say it uses overseas shelters to skirt its rightful obligations.
Here’s the biggest reason why the Fed is not yet tightening policy: A job market not yet fully recovered
source: Bureau of Labor Statistics, Congressional Research Service
- R&D: Britta Glennon of the Wharton School at the University of Pennsylvania shares her research about the internationalization of research and development, part of a book she helped write on multinational firms called “Global Goliaths.” Speaking on Dollars & Sense, a Brookings Institution podcast, she highlights a trend toward offshoring R&D. U.S. multinationals still conduct about 83% of their R&D at home. But that figure was 95% in the 1990s. For some sectors like professional services, meanwhile—think software—about 40% now happens abroad. Another change is whereS. companies are doing their overseas research. Most activity used to happen in just five countries: the U.K., Germany, France, Japan and Canada. Much more now happens in emerging markets, with China, India and Israel taking on greater importance. In China’s case, low labor costs and sheer market scale are factors. One of India’s big advantages is an English-speaking workforce. For Israel, attractions include an IT startup culture and many workers who learn IT skills in the military. All three countries, incidentally, have a large diaspora of business leaders working in the U.S. for U.S. companies. Why do R&D abroad? Sometimes to help develop localized products for a specific market. Sometimes to save money. Sometimes to learn from best practices (i.e., having teams in Germany working on advanced auto manufacturing). But importantly, U.S. immigration rules that started tightening in the 2010s make it impossible to find enough skilled IT workers at home. Glennon said the U.S. IT workforce grew 112% from 1993 to 2010 compared to 70% for the entire workforce. As visa laws grew restrictive, maintaining that level of growth became impossible without finding workers elsewhere. Of course, IT itself, and the internet more specifically, makes cross-border collaboration easier and more productive, with firms now commonly having teams of people cooperating on innovation from different locations around the world. The development of Covid vaccines is a case in point. A final stat to share: Glennon says 40% of all U.S. patents today are for software.
- Media: In 2011, just as companies like Google and Facebook were starting to attract attention for their influence on the information Americans consumed, law professor Tim Wu wrote a book called “The Master Switch” about the rise and fall of information empires in the 20th It covers the history of the film industry, the radio and television industries and the telecommunications industry, the latter dominated by the monopoly AT&T. A typical pattern is that these sectors started out with lots of competition and entrepreneurial energy. Eventually, though, one or a handful of firms came to dominate, often working with government regulators to stifle challenges to their reign. In film, Paramount would take control of most theaters, wiping out independent producers and distributors. This had an impact that was as much cultural as economic, for Paramount now largely controlled what movies people saw. RCA played a similar role with radio, even working to stunt the development of television, a potential competitor. AT&T did the same with many nascent technologies, including the use of magnetic tape to record sound—it was devised as early as the 1930s but suppressed until arriving in the U.S. via Germany in the 1990s. Wu, now working on antitrust policy in the Biden administration, celebrates the breakup of the AT&T Bell monopoly in the 1980s. “The breakup of Bell,” he writes, “laid the foundation for every important communication revolution since the 1980s onward.” Most importantly, that meant the internet, which like its predecessor industries, began with lots of competition and entrepreneurial spirit. Sure enough though, media conglomerates of the sort pioneered by Warner’s Steve Ross would look to seize control. Warner, which later became Time Warner, famously acquired American Online, or AOL, then the primary gateway to the internet for most Americans. The deal just as famously flopped, with AOL’s usefulness swept away by web browsers and search companies like Google. Nevertheless, conglomerates remain a powerful force in the battle to control information and its distribution, the internet included. The seven Baby Bells themselves rebuilt parts of the old AT&T empire, none more so than Southwestern Bell of Texas, or SBC, which in 2005 bought AT&T itself, the long-distance phone company left intact after the breakup. Today’s AT&T is really SBC using the more recognizable name. And it happens to include three other former Baby Bells acquired over the years. Two others are now part of Verizon, best known for cellular telephony. A third is now part of CenturyLink, a cable company.
- Cryptoeconomy: Visa, the Silicon Valley-based company best known for its credit cards, talked at length about the opportunities its sees in the Crypto space. And indeed, said CEO Al Kelly, “this is a space that we are leaning into in a very, very big way.” For one, it’s enabling people to buy cryptocurrencies with their Visa cards. Working with exchanges like Coinbase, customers can now convert their cryptocurrency to dollars or other real-world “fiat” currencies, which can then be used to shop with any of Visa’s 70m merchants. It’s separately working with central banks to help them develop digital currencies. It’s working with private-sector financial institutions too, to help them enable their customers to purchase, hold and trade digital currencies. Less comfortably for established financial institutions, Visa sees great potential in stablecoins (see item below) and their usefulness for cross-border payments. Today, fees on such payments are handsome revenue generators for banks in particular. Are Visa’s ambitions an early prelude of crypto’s looming decentralization of finance? Or are Defi dreams overhyped?
- Cryptoeconomy: Rune Christensen is the founder of MakerDAO, which issues a stablecoin (called Dai) on the Ethereum network. Dai was in fact the world’s first stablecoin, which is simply a digital currency whose value (unlike Bitcoin) is tied to the dollar or some other established real-world currency. That theoretically makes it more practical for buying and selling things online. Christensen’s focus these days is developing the vision and organizational structure of MakerDAO, a mission he discussed on the Fintech Blueprint podcast. For starters, he explained the “DAO” part of MakerDAO. The initials stand for “decentralized autonomous organization,” which is a whole new blockchain-based way to run an economic entity, distinct from traditional corporations. Maker issues “MKR” tokens whose holders form a community spread throughout the world, with voting rights on everything the organization does: Should it adopt new protocols? What should its budget be? What new financial products should it offer? And so on. There’s no central authority, just an online forum where the community can discuss, debate and vote on matters regarding how the organization is governed. Will DAOs replace corporations as the preferred structure for running a business? Probably not anytime soon given questions ranging from their legal status to their effectiveness. Christensen himself acknowledges uncertainties about the scalability of the Ether network and the risks of it being a single point of failure. But he also says that people—though they often overestimate what can happen in two years—often underestimate what can happen in five.
- Virtual Reality: Tech investor Josh Buckley has an interesting thought that he shared on the Invest Like the Best podcast: He increasingly sees today’s reality as akin to living in a giant online multiplayer video game. For many people, especially younger people, two parallel worlds exist side by side: the physical world and the digital world. And the boundaries are blurring. “We are already in the matrix,” he says. “More than half of our waking hours are on a screen.” More than half a billion people on earth, he continues, are currently living a big part of their lives in digital worlds through games like Roblox, Minecraft and Fortnite. What’s more (echoing a theme often mentioned by the investor Peter Thiel), he sees an outsized portion of the world’s money, time and talent flowing to the digital world, in part because innovation and productivity has been much slower in the physical world. “Imagine if we’d invent, say, a teleport machine. We’d spend so much less time online.”