NFTs hook the greatest fools ever

Plus repos crack, oil surges, China plans

Welcome to the latest edition of Contention! Get ready for just about six minutes of non-fungible dissident business news. This week we cover:

  1. Powell’s SLR silence roils repos

  2. NFTs hook the greatest fools ever

  3. Rapid Round: Oil soars, Greensill nears insolvency, China finalizes the 14th Five-Year

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Powell’s SLR silence roils repos

Markets had a volatile week, ending mostly on an up note with high-tech “growth” names hammered again by rising interest rates. The Dow gained 1.8%, the S&P 500 0.8%, and the tech-heavy Nasdaq lost 2.1%. 

Now a new set of problems deep in the financial system’s plumbing could be driving market fears far more than any “overheating” concerns, with much more drama to come.

End of week numbers hide the true story, as investors “bought the dip” on Friday, prompting a sharp rally in stock markets. They caught a tailwind Friday morning as February employment numbers blew past expectations: 379,000 new jobs vs. 210,000 forecast.

Before Friday, however, fast-rising interest rates prompted major price drops across the market. Thursday alone the Nasdaq lost 2.9%

The jobs numbers actually “complicated” things by implying rising wages and spending, with markets not necessarily happy about new gains for workers. Investors hoped that Federal Reserve Chairman Jerome Powell would say something at Thursday’s Wall Street Journal Jobs Summit to calm markets down, but Powell did not deliver. Markets expressed their disappointment in a broad-based selloff in stocks, bonds, gold, and cryptocurrency. 

What did Powell not say that freaked investors out so much? The answer starts with what may have been the most important, least reported news of the week: “repo” rates on 10-Year Treasury bonds hit an all-time low: -4.25%. 

Repo markets provide extremely short-term loans to major financial institutions -- typically overnight -- and arise from a peculiar fact: wealthy individuals and institutions do not like cash. Cash offers zero returns, and so wealthy non-financial capital holders put their cash into money market funds, investment vehicles that can be turned back into cash quickly, but which provide small, steady returns until then. 

They generate these returns by lending to banks and hedge funds who also don’t want cash, but who need it to complete trades and fund depositor withdrawals. Financial institutions give the money market funds government bonds as collateral for these loans.  Last week’s negative repo rates meant that the funds had to pay banks for the right to lend them money.

This bizarre situation arose because demand for 10-Year Treasury bonds so outstripped supply that investors had to pay a premium for access to them. Funds would pay just to get access to the collateral they usually flip back to the banks in a day. 

But isn’t everybody selling off their 10-Year notes, hence rising interest rates? Yes, but that very price plunge means record short selling, and the short sellers need bonds to bet against. The Fed responded to the supply crunch by lending out $8.7 billion of its own hoard of 10-Years, bringing repo rates up to -0.5%. 

Markets aren’t just shorting bonds because of inflation expectations. Last March, the Fed gave banks an emergency exemption to its “supplementary leverage ratio," or SLR, and these exemptions expire at the end of the month. The exemptions say that banks don’t have to hold capital as insurance against two extremely safe sorts of assets: Treasury bonds and interest-bearing accounts kept at the Federal Reserve. 

Raising new capital would dilute existing shareholders or require the banks to hoard earnings instead of reinvesting them.

As of April 1, however, banks will have to either raise new capital against their Treasury bond holdings, or sell off those bonds. That will accelerate rate increases, hence the short selling. Powell said nothing about the SLR exemption on Thursday, and markets freaked out in anticipation of the coming selloff. 

Escalating contradictions in our system mean more and more state intervention into markets. But the contradictions arise from the internal dynamics of capital itself, so each intervention just exacerbates the crisis, piling each on top of the other until you’re left with a fiasco like the one shaking markets.

Next up: more interventions up to and including the effective nationalization of the world’s largest investment market. If last week is any indication, this will likely have some ugly consequences too. 


NFTs hook the greatest fools ever

Last Monday, Canadian musician Grimes made $5.8 million off of 10 works of art. This would not be especially newsworthy except for how she made the money -- selling “non-fungible tokens” (NFTs) associated with the digital works depicting her and husband Elon Musk’s child as a sort of god on Mars.

Twitter founder Jack Dorsey also last week began auctioning off an NFT associated with his first tweet ever from 2006, with bids hitting $2.5 million. This is nothing compared to digital artist Beeple, who sold one NFT for $6.6 million two weeks ago and another now going for at least $3.5 million.

What are NFTs? The answer: a sign that the speculative mania gripping our economy has reached unprecedented proportions, where even the concepts of assets and ownership are getting shaky.

More concretely, NFTs are a specific application of the blockchain technology behind cryptocurrency, where token owners can register “ownership” of digital assets. NFT owners don’t have exclusive access to the property, they own the right to say they own the associated media. 

Historically, there are two basic reasons to buy an asset:

  • Utility: it meets a need or desire, like a surfboard enabling you to surf.

  • Cashflow: ownership gives you rights to claim money generated by the asset.

As for cashflow, there are two basic ways an asset generates returns:

  • Return on capital: buying the asset gives someone else capital to purchase materials and labor-power, make and sell value-added products, and return some of the surplus to the asset owner.

  • Rent: title to the asset gives the owner the right to control access to it, and they can charge a premium to those who want to use it too.

NFTs do not grant any special access to their owners -- it appears Dorsey could delete his tweet even after someone pays millions for it, for example. They also do not confer any exclusive right to the asset’s utility. They obviously do not generate returns on capital, so what exactly are buyers paying for?

They are buying the other source of returns on ownership: speculation, the right to sell it to someone else later at a higher price. But with NFTs this right is devoid of any other utility or material scarcity -- at least tulip bulbs delivered flowers and Beanie Babies could be a paperweight. This speculative frenzy has people speculating on speculation itself.

Shrinking returns on investment mean a frantic search for profits, bidding up all sorts of bizarre “asset” classes. More than a decade of interest rate suppression has only thrown gasoline onto this simmering crisis. Now “ownership” itself has become a speculative asset even though the concept no longer has any concrete meaning. 

There’s no way to time when reality will set back in -- it could take years -- but when it does the self-justifications peddled today will look even more inane, if that’s even possible. 


Rapid Round

OPEC+ surprises, oil rises 

Oil had one of its best weeks in months with West Texas Intermediate (WTI) crude trading toward $70/barrel after OPEC+ announced it would not relax production cuts. The cartel of oil-producing states voluntarily agreed to limit production with the onset of the COVID pandemic last year, an attempt to balance plunging demand. OPEC+ surprised commodity investors by staying the course even as global demand recovers. Sustained cuts are helping fuel an oil “supercycle,” alongside inflation in production costs, driving prices higher.

The winners include Saudi Arabia’s state coffers. Saudi oil minister Abdulaziz Bin Salman dismissed concerns the oil market could overheat, and dismissed U.S. shale oil producers -- who depend on higher prices to fund their capital requirements. “Drill, baby, drill is gone forever,” Abdulaziz said.

Meanwhile, ExxonMobil appointed climate-minded activist investor Jeff Ubben and ex-Comcast vice chairman Michael Angelakis to its board following investor criticism of the oil titan’s environmental record and dwindling financial performance. The 2020 plunge in oil prices caught ExxonMobil exposed following years of elevated spending on new oil and gas operations.

Greensill fails, miners may pay

London-based supply-chain financing company Greensill Capital is on the brink of declaring insolvency after Credit Suisse suspended $10 billion worth of the firm’s investment funds last Monday. Greensill specializes in a complex form of shadow banking called “reverse factoring,” paying manufacturers’ suppliers earlier than normal for a discount and pocketing the difference. This financing method is decades old, but has seen new demand in the era of just-in-time inventorying. Greensill went a step further by repackaging these debts into securities, which it then sold to Credit Suisse among others.

Germany’s banking regulator BaFin froze Greensill’s operations in the country and filed a criminal complaint over improper accounting methods between the firm and mining and steel consortium GFG Alliance, which owes £3 billion to Greensill. The complaint has sent a shockwave through GFG, and now thousands of steel jobs in the United Kingdom are at risk.

Bluestone Resources, the coal mining company owned by West Virginia Gov. Jim Justice, has borrowed $850 million from Greensill. Seven board members have now resigned from Greensill. Credit Suisse investors, meanwhile, stand to lose up to $7 billion still locked up in the now defunct funds. 

China finalizes the 14th Five-Year Plan 

On March 4, more than 5,000 Chinese political officials gathered for the annual “two sessions.” The Chinese People’s Political Consultative Conference and the National People’s Congress -- the country’s top legislature -- meet through March 11 to hammer out a budget and the 14th Five-Year Plan. 

At the top of the agenda, this year’s Government Work Report reintroduced China’s annual growth target, setting a minimum of 6% in GDP growth in 2021, although 8-9% growth is more likely. China had scrapped this target in 2020 due to the pandemic. Beijing is also emphasizing a shift from quantity to quality of growth, boosting spending in research and development by more than 7% per year by 2025. 

This is part of a longer-term strategy to build self-sufficiency and reduce China’s dependency on Western technology in seven specific areas including artificial intelligence, quantum computing and integrated circuits -- particularly “third generation” semiconductors critical to electrical vehicles and renewable energy. Those technologies, in turn, are a springboard into the 2030s when China plans to emerge as a fully developed advanced production economy.

Crucial to the strategy: boosting domestic demand, part of what the Communist Party calls a “dual circulation” development model. To this end, the Five-Year-Plan committed to specific targets in key areas, including:

  • Improving urban-rural logistics

  • Speeding up e-commerce

  • Extending express delivery services to rural areas

  • Promoting new infrastructure and new urbanization

  • Investing more to improve public services


Disclaimer

Our only investment advice: NFTs, really? 

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