The London Brief - June 30th, 2021

The London Brief

June 30th, 2021

While Joe Biden was getting to know Vladimir Putin… at a distance, markets went through a tricky period intra-month due to changes in FOMC policy, quad witching in options and index rebalancing. The FOMC took out the language about the pandemic causing human and economic hardship and acknowledged that inflation is no longer “running persistently below [their] longer-run goal”. On a call hosted by an investment bank, Larry Summers noted that the FOMC change in language was real and that they are finally on the right side of the curve, in his opinion. Systemic and quant trading strategies repositioned. Index funds rebalanced. Given index funds and trackers can be as much as 20% of a stock shareholding these days, this repositioning had a dramatic impact on price movements.

Counterintuitively, inflation fighting is politically popular. A Harvard/CAPS Harris poll found that 88% of Americans are ‘somewhat’ or ‘very concerned’ about inflation. Only 18% were confident that the Biden administration would keep inflation at bay.

The Link with Crypto

This then makes cryptocurrency a riskier play. June saw a sharp melt-down in price, although Bitcoin still trades above $30,000, a strong price performance from the start of the year. American traders locked in $4.1 billion of profits last year trading Bitcoin according to Chainalysis. “Investors in nearly all countries saw the biggest increases toward the end of the year. That’s when U.S. investors really broke away from the pack, with most of their gains coming from activity on Coinbase.” China was second with $1.1 billion of profits.

The month’s first pressure point came from Beijing’s crack-down on cryptocurrencies. Fearing anything that it cannot control, the Communist Party has taken all sorts of measures to root out Bitcoin from the country. About 90% of China’s bitcoin mining capacity is estimated to be closed. This is significant as it is thought that 65%-75% of all mining occurs in China. The PBOC ordered the country’s largest banks and payment processors to take a more active role in curbing crypto trading and related activities. The financial firms were instructed to go through their systems and investigate and identify customers with accounts at virtual currency exchanges or that trade crypto in OTC markets. In these cases, the financial institutions were ordered to cut off the bank account’s ability to send or receive money for transactions.

A second challenge for crypto during the month was transparency. Apparently, Bitcoin fell 7% on June 8th, because U.S. regulators were able to recover most of the Colonial Pipeline ransom. This undermines the libertarian, free from government approach that Bitcoin people like. Hackers prefer newer cryptocurrencies such as Monero or Zcash, which are designed with more privacy in mind.

In Korea, cryptocurrencies account for 10% of trades according to industry estimates. Traders note the “kimchi premium” which refers to the extra value a leading cryptocurrency can achieve in the South Korea market. 90% of trading goes into altcoins rather than Bitcoin including offerings with murky origins. People in their 20s and 30s do the lion share of the trading and 2.5 million new accounts opened in the first quarter of 2021 according to Kwon Eun-Hee, representative for the conservative opposition People Power Party. 33% are in their 20s while another 31% are in their 30s. According to a survey of university students, released by Alba Heaven a job seeking portal, 53% of students were positive on investing in cryptocurrencies with 24% actually investing. 33% cited the high rate of return as their reason, and 15% said it offered the “last chance of escape” from their current social status. Many South Korean youth cannot buy a home, even ones on salaried income. Youth have criticized recent government efforts and comments to slow the investments into cryptocurrency. Legislation in March requires platforms to now partner with banks to ensure they are trading under real names to inhibit money laundering, but banks are reluctant to partner due to criminal ties and the negative policy action. There are 200 crypto-currency platforms in Korea. Household debt of those between 20-39 jumped 17% and it seems young people have been leveraging up to buy altcoins.

But the main driver to crypto weakness in June is probably the FOMC’s announcement that inflation was becoming more of a worry, signalling that the pessimists view of eternal money-printing may be off.

China’s Surveillance State Gets Worse

The Nikkei had a profile piece on Xi and his father for Father’s Day. They noted that there was a bond between father and son. The younger Xi respects his father, Xi Zhongxun, who was known for his integrity. The elder Xi stood up to Deng Xiaoping who sacked the reformist general secretary Hu Yaobang. However, Zhongxun’s disobedience led to his downfall and Xi felt integrity wouldn’t win political battles. Xi Jinping is now floating the idea of a “common prosperity” which departs from Deng’s “letting some people get rich first” philosophy. Xi is endeavouring to revive a new form of communist ideology, which could take China in a new direction.

At a study session in the communist party, a controversial scholar delivered a lecture saying China’s governance model is superior to the west. “Professor Zhang Weiwei has repeatedly preached that the success of China's development can be attributed to the one-party rule under which competent leaders are chosen based on merit, comparing it to the ineffectiveness of party politics and elections seen in the West.”

The Nikkei says China is blaming after school operators for cut-throat competition. They are planning on drawing up regulations to oversee course structures, pricing and teacher recruitment. The school operators will have to set up a Communist Party chapter within their organizations, a practice designed to ensure the CCP’s control over every facet of society. The People’s Daily said, “For some time, the mushrooming of tutoring services that serve the compulsory primary and middle secondary school education has turned unruly to the point of becoming a stubborn malady.” However, the reason these firms exist is the annual gaokao test, which determines a student’s admission into universities and shapes career prospects.

The pressure doesn’t stop once you get a good job though. China has a piece of surveillance software called DiSanZhiYan or “Third Eye”. The system is on the laptops of most tech companies to track screens in real time, record chats and browsing activity; and examine every document edit they make. Hundreds of employees at tech companies know the Third Eye is watching. If they visit a job search site or video-streaming platform, an alert goes up to their supervisor. Efficiency reports are generated weekly. Cameras are there to check on the length of lunch breaks.

One problem with authoritarian governments is that they can’t admit mistakes. In democracies, leaders are accountable, but in a dictatorship, admitting mistakes is an existential risk. So, when the Taishan nuclear plant started to report higher than normal radiation levels this month, the authorities did not want to shut it down because they would look bad and panic people in the area. The nuclear plant has a foreign operator, and CNN reported that Framatone asked the U.S. government for a waiver to provide technical assistance using U.S. technology to the nuclear plant, which sits 84 miles west of Hong Kong. According to the EDF letter (parent of Framatone), “Chinese safety authority was raising the acceptable limits for radiation detection outside the Taishan Nuclear Power Plant in Guangdong province in order to avoid having to shut it down.” On Weibo, Wang Yigang, member of the Institute of Industrial Economics, said, “American imperialism hyping up opposition to nuclear power forcing China to develop wind and solar only.”

Perhaps China can spin its nuclear problems away. CGTN, the state media agency, is targeting British influencers and vloggers as part of a new journalistic recruitment scheme. Its Media Challengers scheme will give job prospects and a $10,000 prize to social influencers. One applicant hopes to “help eliminate the bias western media has towards China.” China now allows for three children and by 2025 may remove all child restrictions. Hopefully one of the extra ones will say maybe it’s best to shut down the nuclear plant when you don’t know why the radiation is rising. Carrie Lam, leader of Hong Kong, is at least

“concerned”.

In other China news, China’s top regulator instructed creditors of China Evergrande Group to conduct a fresh round of stress tests around the developer. Regulators are scrutinizing a bank it has a major stake in and the company has been making late payments on short-term debt. But there are now three corporates with very large debt burdens struggling. This could have a significant impact on China’s bond markets as the party attempts to stamp out moral hazard risk.

Don’t You Have Better Things To Do?

While Japan’s Prime Minister Suga was enjoying the atypical sunny weather of England at Cornwall, his name was being mentioned in the press as supporting Toshiba’s efforts to disenfranchise shareholders. Toshiba is a storied company that was mired in accounting scandals and still refuses to address its inefficiencies. Because it needed to raise extraordinary amounts of emergency capital, foreigners ended up owning over half the share capital. When shareholders grew frustrated with management, who refused to shut down, seek alternatives or restructure underperforming businesses, the management turned to the government to help see off activist proposals. Harvard Fund Management seemed to have faced some ‘advice’ from a Japan advisor to support the company. And management and METI attempted to use the new Foreign Exchange and Foreign Trade Act, which was supposedly to protect Japanese companies from Chinese influence, to suppress activist’s shareholder rights. One Toshiba manager met Suga when he was cabinet secretary and allegedly received his support. All of this was detailed in report, 139 pages long.

I had a conversation with a political advisor to a major investment bank this month and he thinks that this may be a positive for Japan corporate governance. Many Japan government agencies are frustrated with METI and its parochial way of looking at the world. There are calls for reform. This past week, the Chairman of Toshiba was ousted by shareholders and board members proposed by foreign shareholders seem to now dominate the board. Toshiba even said it would consider strategic alternatives for its businesses.

End Note

Some of Trump’s top lawyers are having trouble finding new jobs. Ken Cuccinelli, who was the number two in Homeland Security, said, “they decided they didn’t want Trump people. It was just flat out – you can call it Trump discrimination.” Is it the start of the TLM movement?

Meanwhile, neuroscientists at the University College of London (UCL) believe their research have allowed them to discover the formula for happiness. “Contentment depends, apparently, not on achieving more than others but on doing rather better than we anticipated.”

Omar Sayed

Cobham, June 30th, 2021