My Uber rant and the Gold Standard…

If a man has good corn or wood, or boards, or pigs, to sell, or can make better chairs or knives, crucibles or church organs, than anybody else, you will find a broad hard-beaten road to his house, though it be in the woods.

– Ralph Waldo Emerson
“I landed in this country with $2.50 in cash and $1 million in hopes, and those hopes never left me”
Charles Ponzi

As someone who has predicted 9 of the last 0 housing crashes in NZ I like to think I know an investment bubble when I see one… and nothing gets me more confused than the valuation of Uber at a cheeky USD 69bn. I should point out a clear conflict of interest here: I own a taxi license: Auckland Coop 466 is mine, a legacy and one I am reluctant to give up mainly for historical reasons (my father left it to me rather than economic reasons).

But Uber does my head in… I don’t think I am a Luddite, but it’s just so transparently not what it says it is: namely I don’t see any innovation just regulatory arbitrage and the collision of money and politics. The main thing they seemed to have achieved is to avoid the classification of a smartphone as a taxi meter, and therefore any of the regulatory costs that come with that. Taxis have always been defined by the meter, which enabled them fairly and transparently to show people how they were charging, combined with a host of regulations (including safety) they pushed the costs up far above what anyone with a private license and car could offer their services at. It was seen as collectively better for society to ensure that you knew a safe and regulated car was turning up, that was insured etc. Uber drivers also don’t get the same levels of insurance as licensed hire cars, nor undergo the same sort of licensing checks.

In other words, Uber’s costs are cheaper not because they have invented a better mousetrap but because they operate in an environment where the smartphone that catches the mouse is not called a mousetrap (with apologies to Emerson) even though it catches mice. I am not sure any of the reductions in regulations and insurance are in the long-term interests of consumers, but I may be biased, but then again I also know someone who lost their private hire license after a stroke and considered driving for Uber instead as he only needed a normal drivers license without a health check.

The constant need of Uber to fight it out in court, where they seem to be losing a number of battles such as Denmark, Brazil, and cities like Prague, show this isn’t minority view. And maybe that is what grates the most, the whole corporate mien of Uber. I read this today from INET (please read the whole thing):

In one of these countries live members of what Temin calls the “FTE sector” (named for finance, technology, and electronics, the industries which largely support its growth). These are the 20 percent of Americans who enjoy college educations, have good jobs, and sleep soundly knowing that they have not only enough money to meet life’s challenges, but also social networks to bolster their success…

Politicians increasingly influenced by the FTE sector turned from public-spirited universalism to free-market individualism. As money-driven politics accelerated (a phenomenon explained by the Investment Theory of Politics, as Temin explains), leaders of the FTE sector became increasingly emboldened to ignore the needs of members of the low-wage sector, or even to actively work against them.

When David Cameron was Prime Minister he claimed to be looking after the little guy. But the little guy was a tax paying guy from Essex who had done three years training to get “the knowledge” who then found his income dramatically cut by a fleet unregulated and unregistered drivers. Coincidentally his head of strategy, Steve Hilton, was married to Rachel Whetstone, who headed up Uber’s PR department in London… and behind closed doors… Which explains why a traditional group of self-employed business, traditional Tory voters were hung out to dry. It’s why Travis Kalnick can yell at an Uber driver… I could go on…

I get it: Uber is cheap, and in the new gig economy we all like cheap. But is it economic? For a thorough demolition of the business model read Naked Capitalism. I really like this part:

By contrast, in the hundred years since the first motorized taxi, there has been no evidence of significant scale economies in the urban car service industry. That explains why successful operators never expanded to other cities and why there was no natural tendency towards concentration in individual markets. Drivers, vehicles and fuel account for 85% of urban car service costs. None of these costs decline significantly as companies grow. As the P&L data above demonstrates, Uber has not discovered a magical new way to drive down unit costs.

The whole thing is worthy of a read. Nothing beats a good bit of iconoclasm when it’s grounded in fact.

I especially like the revelation that two investment banks passed on marketing the private company to their high-net-worth customers after reviewing a prospectus with no revenue or profitability data (at 290 pages!). Not all did: caveat emptor!

The words Ponzi scheme are used, and the Uber valuation clearly is one. Not because there is any fraud involved, but because the last people in depend on more people coming into ever show a profit. With a 2bn operating loss those people will get harder to find… eventually… The cynic would argue the investment banks have gone through the institutional money making small portfolio bets, then moved on to individuals who are much less astute…

I prefer the arbitrage comparison. Charles Ponzi’s original scheme  had the basis of sound economics (more so than Uber after reading the Naked Capitalism posts), if it worked; but it was also based on regulatory arbitrage and the slow adaptation of international systems to economic change. In 1906, in the classical Gold Standard era , by agreement at the Universal Postal Congress (held in Italy) , world postal organisations agreed to a system of International Reply Coupons to make it easy to send funds abroad: as exchange rates were fixed to a pre-agreed formula the prices for the coupons were pre-agreed and locked in as well. When in 1919, under the interwar gold standard (where there was some exchange rate flexibility), someone sent Ponzi an IRC from Spain that cost 30 centavos that could be exchanged for US 5c and Charles Ponzi realised there was a riskless profit to be made as the Spanish currency had recently devalued.

And Ponzi was right, but like Uber part of the economic problem rested with scale, and Ponzi simply couldn’t organise to purchase enough of these coupons to make the profits he had promised investors. The mistake, the fraud,  he then made was to claim he had a network of agents buying IRCs in various countries and that there was a viable business underpinning this that could go on indefinitely; he then hired a network of agents in the US, paid them more than the arbitrage profit levels to collect “investments”, and collected the money coming in paying out those who wanted to be cashed out with the money coming in. (One could also add the stupidity of investors was not realising that riskless profits would be traded away).

Uber does appear to be a business that takes advantage of regulatory arbitrage on a global scale and it obviously, based on five years of operating performance and financial results, requires massive scale if it is ever going to work at all.   I buy the argument that actually the industry structure and economics don’t work that Naked Capitalism make so eloquently so I won’t bother doing anything other than quoting some more of it:

If rapid growth could not drive major margin improvements between 2012 and 2016, there is no reason to believe that Uber will suddenly find billions in scale economies going forward. Fundamentally digital companies like Amazon, EBay, Google and Facebook had massive operating scale economies because the marginal cost of expanded operations was close to zero. Aggressive pricing fueled the growth that drove major margin improvements and also created major consumer welfare benefits.

What all the other big names like Google, Facebook and Amazon achieved were increasing returns to scale where fixed costs remain virtually unchanged even as revenue grew massively and hence dramatically lowered unit costs. Unless Uber could find some way of changing this equation they simply cannot trade forever on at the same price level as a company that does this as they require dramatically more cash (mainly in subsidies by the look of it). The next pricing round promises to be extremely interesting because if Naked Capitalism is right it’s not simply that it should be done at a lower number it’s clearly that there is no inherent economic value in the business at all… which is also like Ponzi…

Macro, gold, and private credit

Like most economic historians I get the gold standard was a bad idea and we shouldn’t go back to it. But I think the hankerings for it really reflect a deeper desire for some sort of control on the monetary base. As Bordo et al ., note:

We find that [financial and banking] crisis frequency since 1973 has been double that of the Bretton Woods and classical gold standard periods and is rivaled only by the crisis-ridden 1920s and 1930s. History thus confirms that there is something different and disturbing about our age.

The problem is credit. Specifically privately created credit and frankly clearly linked to housing and commercial property lending.

bank-lending-1870-2013

The Bretton Woods agreement controlled the capital account and acted as a brake on the pro-cyclicality of asset price inflation (unintentionally) by making it harder to fund these transactions from offshore borrowing. In some ways it linked the domestic asset base to a trading value of the currency. Now land values have gone crazy because capital is international and property has simply become an international asset class.

And as part of this change tThe banking system has been transformed:

The share of mortgage loans in banks’ total lending portfolios has roughly doubled over the course of the past century—from about 30% in 1900 to about 60% today. To a large extent the core business model of banks in advanced economies today resembles that of real estate funds: banks are borrowing (short) from the public and capital markets to invest (long) into assets linked to real estate.

The driving force in this has been lending to households as the article makes clear.

In the modern economy fractional reserve banking is a myth although it may have functioned like that under the gold standard. But now we understand that banks create money via deposits and there is no theoretical limit on money supply creation other than the monetary policy of the central bank, and there are questions as to the effectiveness of this given the openness of the modern international monetary system and banks ability to fund themselves in the wholesale market. In a modern economy, where home ownership is exalted above almost all other policy goals, combined with open bank funding on a international scale,  I struggle to see a limit on the creation of private credit to property and thus it is a system with a self-induced propensity to pro-cyclicality with a put option on the state. Anything less would imperil the banking system itself.

To me, the question isn’t whether we should be going back to the Gold Standard but really could the Bretton Woods agreement be improved and tried with Bancors? Like the Chicago Plan for domestic money, I am too cynical to believe an institutional mechanism that requires so much change is likely to occur, but it is clear that the link between credit and the macroeconomy is the crucial variable that needs to be understood better and be the driver of economic models. A fundamental model of understanding the modern macroeconomy needs to be the driver of credit, something Minsky well understood.