In my first macroeconomics class, the lecturer wrote on the board the following equation:
Y = C + I + G + (X – M)
GDP (Y) is a function of consumption (C), business investment (I), government fiscal spending (G) and X and M represent a nation’s exports and imports respectively. Few equations in academia apply in the real world but, ironically, the first one was the most relevant.
Output remains low in many advanced economies because the effects of the crisis are still being felt today. Stock markets have roared back, but such valuations have yet to validate the real economy. Monetary policy aims to act on the output equation above by increasing asset prices which in turn creates a wealth effect boosting consumption, C. This has not happened. Furthermore, by lowering the cost of capital via interest rate cuts, was supposed to encourage firms to borrow and invest (I), increasing capital expenditure (CAPEX).
Rather this easy money has meant equity values have risen causing large-scale share buybacks. Net exports, the difference between X and M, can rise off the back of a weaker currency, but that cannot be an indefinite solution because other countries get moody when you steal trade competitiveness. Markets were shaken last summer because China devalued the renminbi creating concerns that China was attempting to steal exports from Japan and the wider ASEAN region.
That leaves government spending. The US has a national debt of circa $16trn and continues to raise the ceiling which seems to get through congress unbelievably fast compared to any other fiscal proposal. One wonders why. Fiscal policy is restrained both financially and socially but one policy which does seem to appeal to both polar opposite parties is the idea of infrastructure bonds.
The Fed Decisions
A stronger dollar has caused havoc over recent months but until recently with the Brexit debacle, the Fed has decided to wait a little longer on its hiking cycle, causing emerging markets to all of sudden be a popular asset class. Sit tight for the 2017 rate tantrum, but that is another story for another day. If the government issued infrastructure bonds, it would not spark inflation in the usual QE fashion. The reason is because the Fed would buy the bonds directly from the government so the selling wouldn’t have an effect on interest rates and thus an impact on the dollar index.
The money would never hit the open market to boost asset prices but would be bought at a very low-interest rate, with the Fed simply holding them until maturity – say 30-50 years, maybe longer. The government would then have money to spend on infrastructure projects around the country boosting employment, but more importantly economic activity and wage growth. Inflation would be the indirect goal, with the primary being GDP growth. With rates at recent lows, the authorities should take the opportunity to set up spending for the next few years.
The Corporate Sector
Corporations have borrowed significantly with total debts rising, while the more important aspect, debt service costs, have not risen. When rates rise, the private sector needs to be aware, but given the markets expectations for rate levels over the next few years, no one should be too concerned. Rising rates are irrelevant for the government because the holder of these bonds would be the Federal Reserve and will likely just let them expire, or the government will roll over the debt by issuing more.
Such a project is necessary and could be the key to unlocking US growth potential. Emerging markets, beware.
Breakfast Briefing: Space Race, Google in China and Zuckerberg
Google to Open in Beijing
Alphabet announced that it will open an AI research facility in the Chinese capital yesterday.
Editor’s Remarks: Under CEO Sundar Pichai, Google has been recommitting itself to China after it had most of its services blocked in 2010 when it refused to censor search content. In recent months, the tech giant has been marketing its new TensorFlow AI tools to the Chinese market, which aligns with the state’s ambitions to become a world leader in AI by 2030. Google’s new facility will consist of a small number of AI researchers, supported by hundreds of Chinese engineers. Google expects to face stiff competition for talent given how local tech giants, Baidu and Tencent, are ramping up their own AI efforts.
Telegram Is Not for Sale
Telegram’s elusive founder, Pavel Durov, insists that his messaging service will remain non-profit.
Editor’s Remarks: Durov and his brother Nikolai founded VK, Russia’s answer to Facebook, before they were forced to sell their stakes to a Kremlin-friendly oligarch. The pair has since relocated and built Telegram, an encrypted messaging service that they insist will never be sold. A libertarian – having enabled Telegram users to even send messages that will self-destruct – Durov and his product have gained popularity among cryptocurrency enthusiasts. Durov himself is bullish about the prospects of cryptocurrencies and owns at least 2,000 bitcoins. Pundits, meanwhile, reckon that Telegram is worth in the region of $5bn.
Japanese Space Startup Raises $90m
Ispace Inc raised $90m from Japan’s largest corporates in a bid to reach orbit by 2019.
Editor’s Remarks: Ispace is backed by Japan Airlines, Tokyo Broadcasting System Holdings and also government-backed Innovation Network Corp. of Japan. The company plans to sell advertising space on its spacecraft, which will then feature prominently in distributed images. However, Ispace also envisages the use of rovers that will offer a “projection mapping service”, which will essentially produce a tiny billboard on the surface of the moon. This is the latest announcement in what is rapidly shaping up to be a wider commercialisation of space exploration. Elsewhere, SpaceX and Blue Origin are developing reusable rockets, while Planetary Resources intends to mine asteroids.
Roy Moore Loses Alabama
Moore, who was backed by Trump, narrowly lost to Doug Jones, a largely unknown Democrat.
Editor’s Remarks: Moore’s election efforts appeared to have succumbed to allegations of child abuse that were made against him last week. Newcomer Jones won 49.9% of the vote against Moore’s 48.4% in deeply conservative Alabama, marking the Democrats’ first Senate victory in the state since 1992. Moore is a household name in Alabama but the accusations recently levelled against him have ruined his once impeccable reputation. Reluctant to concede defeat in his home state, Moore has said that Alabama must “wait on God and let the process play out”. Meanwhile, Democrats are jubilant that they have managed to reduce the Republican majority in the Senate to 51-49, which could impact Trump’s tax reform.
Zuckerberg Backs VR Firm
Dreamscape Immersive, a virtual reality (VR) company, is backed by 21st Century Fox, Warner Bros. and Mark Zuckerberg.
Editor’s Remarks: Dreamscape is developing new VR arcades for shopping centres and has just closed a $30m Series B funding round – 50% more than planned. Among its initial backers were Steven Spielberg, 21st Century Fox and Warner Bros. The company has now added to that impressive list the likes of Mark Zuckerberg and Nickelodeon. Dreamscape is capitalising on Hollywood’s interest in VR, which the film industry reckons will draw in greater numbers of viewers and provide an opportunity to raise margins. Dreamscape intends to open seven VR centres in locations across North America and the UK.
Google to Open Artificial Intelligence Centre in China
Google will be opening its first artificial intelligence (AI) research centre in China, despite many of its services being blocked there.
Fei-Fei Li, Chief Scientist of Google Cloud, said:
“I believe AI and its benefits have no borders. Whether a breakthrough occurs in Silicon Valley, Beijing or anywhere else, it has the potential to make everyone’s life better for the entire world. As an AI first company, this is an important part of our collective mission. And we want to work with the best AI talent, wherever that talent is, to achieve it.”
The research centre will focus on basic AI research, and will consist of a team in Beijing, who will be supported by Google China’s engineering teams.
Google’s search engine and its Gmail are banned in China. However, the country has 730 million internet users, making the market too large to ignore.
Google is not the only tech giant facing restrictions in China. Facebook is also banned, while Apple’ App Store has been subject to censorship. In order to comply with government requests, Apple removed many popular messaging and virtual private network (VPN) apps from its App Store in China earlier on this year.
China has recently announced plans to develop artificial intelligence, and wants to catch up with the US. However, human rights groups are concerned by China’s use of artificial intelligence to monitor its own citizens.
Europe Warns Trump on Tax
Finance ministers from Europe’s largest economies have said that Trump’s tax plans breach global agreements.
Europe’s leading finance ministers, including UK chancellor Philip Hammond, penned a letter to the White House in which they raised the possibility of retaliation if the Republicans push on with their tax reforms. Europe is worried that Trump’s “America First” doctrine will undermine global trade patterns and escalate ongoing tensions between the US and its key allies. With the UK looking to its closest ally for support post-Brexit, it is unlikely that Hammond’s latest move will sweeten any future US-UK trade deal. Meanwhile, Trump is unlikely to care about shaking up current trading arrangements, given that he ran for office on the platform of making the US more competitive.
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