Monday, June 18, 2018

Italy exiting the Eurozone could be more likely as time goes on

The arrival in power of a populist, Euroskeptic government in Italy has focused investors’ minds like few other events this year. The yield differential, or spread, between Italian and German bonds has widened sharply, indicating that investors view Italy as a riskier bet. And Italian equity prices have fallen – particularly in domestic bank shares, the best proxy of country risk – while insurance premia against a sovereign default have increased. There are even fears that Italy could trigger another global financial crisis, especially if a fresh election becomes a de facto referendum on the euro.

Even before Italy’s March election, in which the populist Five Star Movement (M5S) and the right-wing League party captured a combined parliamentary majority, we warned that the market was being too complacent toward the country. Italy now finds itself in more than just a one-off political crisis. It must confront its core national dilemma: whether to remain shackled by the euro or try to reclaim economic, political, and institutional sovereignty.

We suspect that Italy will compromise and remain in the eurozone in the short run, if only to avoid the damage a full-scale rupture would cause. In the long run, however, the country could increasingly be tempted to abandon the single currency.

Since Italy returned to the European Exchange Rate Mechanism in 1996 – after withdrawing from it in 1992 – it has surrendered its monetary sovereignty to the European Central Bank. In exchange, it has enjoyed much lower inflation and borrowing costs, resulting in a dramatic reduction in interest payments – from 12% of GDP to 5% – on its massive public debt.

Still, Italians have long been uncomfortable with the lack of an independent monetary policy, and that sense of lost control has gradually overshadowed the advantages of euro membership. The adoption of the euro has had massive implications for the millions of small and medium-size enterprises that once relied on periodic currency devaluation to offset the inefficiencies of Italy’s economic system and remain competitive.

The inefficiencies are well-known: labor-market rigidities, low public and private investment in research and development, high levels of corruption and of tax evasion and avoidance, and a dysfunctional and costly legal system and public bureaucracy. And yet several generations of Italian political leaders have cited “external constraint,” rather than domestic necessity, when pushing through the structural reforms required for euro membership – thereby reinforcing the sense that reforms have been imposed on Italy.

The loss of monetary sovereignty means there are effectively two chains of political command in Italy. One extends from the German government, through the European Commission and the ECB, down to the Italian presidency, treasury, and central bank. This “institutional” chain of command ensures that Italy meets its international commitments and maintains strict adherence to EU fiscal rules, regardless of domestic political developments.

The other chain of command starts with the Italian prime minister and extends through the government ministries that are responsible for domestic affairs. In most cases, the two chains of command are aligned. But when they are not, a conflict inevitably ensues. Hence the current crisis, which came to a head when the prime minister-designate tried to appoint the Euroskeptic economist Paolo Savona as Italy’s next economy and finance minister without first consulting the other chain of command. The appointment was duly rejected by the Italian president.

Let us return to the question of whether Italy will now choose to break free of its straitjacket. Despite the euro’s advantages, it has not delivered for Italy economically. Italy’s real (inflation-adjusted) per capita GDP is currently lower than it was when the euro experiment began in 1998, whereas even Greece has managed to register growth, despite its depression from 2009 onward.

Some would explain this poor performance by arguing that the eurozone is an incomplete monetary union, and that its “core” countries like Germany drain labor and capital from “periphery” countries like Italy. Others might counter that Italians failed to conform to the rules and standards, and to implement the reforms, upon which a successful monetary union is based.

But the real explanation no longer matters. The prevailing narrative in Italy holds the euro responsible for the country’s economic malaise. And political parties that have either openly or implicitly called for leaving the eurozone currently hold a parliamentary majority, and would likely retain it in another election later this year or in early 2019.

If Italians were confronted with the choice of retaining or abandoning the single currency, recent polls suggest that they would initially decide to stay, for fear of a run on Italian banks and public debt, as Greece experienced in 2012-2015. But the long-term costs of remaining in a club dominated by inherently deflationary, German-dictated rules might tempt Italians to leave. That decision could come in the midst of another global financial crisis, recession, or asymmetric shock that pushes several fragile countries out of the euro at the same time.

Like the United Kingdom’s Brexiteers, Italians might convince themselves that they have what it takes to succeed on their own in the global economy. After all, Italy has a large industrial sector that is capable of exporting worldwide, and exporters would benefit from a weaker currency. Italians might be tempted to think: Why not escape the euro before those industries fold or end up in foreign hands, as is already happening?

If Italians do eventually go down this path, the immediate costs will be borne by domestic savers, whose nest eggs will be redenominated in depreciated liras. And the costs would be still greater if an Italian exit precipitated another financial crisis with bank holidays and capital controls. Faced with these possibilities, Italians – like the Greeks in 2015 – might blink and stay. But they also might decide to close their eyes and take the plunge.

Though Italy would be better off staying in the eurozone and reforming accordingly, we fear that an exit could become more likely over time. Italy is like a train whose engine has derailed; it might be only a matter of time before the cars behind it start coming off the track.

Tuesday, March 6, 2018

Blockchain technology might be the most over-hyped technology

Predictions that Bitcoin and other cryptocurrencies will fail typically elicit a broader defense of the underlying blockchain technology. Yes, the argument goes, over half of all “initial coin offerings” to date have already failed, and most of the 1,500-plus cryptocurrencies also will fail, but “blockchain” will nonetheless revolutionize finance and human interactions generally.

In reality, blockchain is one of the most overhyped technologies ever. For starters, blockchains are less efficient than existing databases. When someone says they are running something “on a blockchain,” what they usually mean is that they are running one instance of a software application that is replicated across many other devices.

The required storage space and computational power is substantially greater, and the latency higher, than in the case of a centralized application. Blockchains that incorporate “proof-of-stake” or “zero-knowledge” technologies require that all transactions be verified cryptographically, which slows them down. Blockchains that use “proof-of-work,” as many popular cryptocurrencies do, raise yet another problem: they require a huge amount of raw energy to secure them. This explains why Bitcoin “mining” operations in Iceland are on track to consume more energy this year than all Icelandic households combined.

Blockchains can make sense in cases where the speed/verifiability tradeoff is actually worth it, but this is rarely how the technology is marketed. Blockchain investment propositions routinely make wild promises to overthrow entire industries, such as cloud computing, without acknowledging the technology’s obvious limitations.

Consider the many schemes that rest on the claim that blockchains are a distributed, universal “world computer.” That claim assumes that banks, which already use efficient systems to process millions of transactions per day, have reason to migrate to a markedly slower and less efficient single cryptocurrency. This contradicts everything we know about the financial industry’s use of software. Financial institutions, particularly those engaged in algorithmic trading, need fast and efficient transaction processing. For their purposes, a single globally distributed blockchain such as Ethereum would never be useful.

Another false assumption is that blockchain represents something akin to a new universal protocol, like TCP-IP or HTML were for the Internet. Such claims imply that this or that blockchain will serve as the basis for most of the world’s transactions and communications in the future. Again, this makes little sense when one considers how blockchains actually work. For one thing, blockchains themselves rely on protocols like TCP-IP, so it isn’t clear how they would ever serve as a replacement.

Furthermore, unlike base-level protocols, blockchains are “stateful,” meaning they store every valid communication that has ever been sent to them. As a result, well-designed blockchains need to consider the limitations of their users’ hardware and guard against spamming. This explains why Bitcoin Core, the Bitcoin software client, processes only 5-7 transactions per second, compared to Visa, which reliably processes 25,000 transactions per second.

Just as we cannot record all of the world’s transactions in a single centralized database, nor shall we do so in a single distributed database. Indeed, the problem of “blockchain scaling” is still more or less unsolved, and is likely to remain so for a long time.

Although we can be fairly sure that blockchain will not unseat TCP-IP, a particular blockchain component – such as Tezos or Ethereum’s smart-contract languages – could eventually set a standard for specific applications, just as Enterprise Linux and Windows did for PC operating systems. But betting on a particular “coin,” as many investors currently are, is not the same thing as betting on adoption of a larger “protocol.” Given what we know about how open-source software is used, there is little reason to think that the value to enterprises of specific blockchain applications will capitalize directly into only one or a few coins.

A third false claim concerns the “trustless” utopia that blockchain will supposedly create by eliminating the need for financial or other reliable intermediaries. This is absurd for a simple reason: every financial contract in existence today can either be modified or deliberately breached by the participating parties. Automating away these possibilities with rigid “trustless” terms is commercially non-viable, not least because it would require all financial agreements to be cash collateralized at 100%, which is insane from a cost-of-capital perspective.

Moreover, it turns out that many likely appropriate applications of blockchain in finance – such as in securitization or supply-chain monitoring – will require intermediaries after all, because there will inevitably be circumstances where unforeseen contingencies arise, demanding the exercise of discretion. The most important thing blockchain will do in such a situation is ensure that all parties to a transaction are in agreement with one another about its status and their obligations.

It is high time to end the hype. Bitcoin is a slow, energy-inefficient dinosaur that will never be able to process transactions as quickly or inexpensively as an Excel spreadsheet. Ethereum’s plans for an insecure proof-of-stake authentication system will render it vulnerable to manipulation by influential insiders. And Ripple’s technology for cross-border interbank financial transfers will soon be left in the dust by SWIFT, a non-blockchain consortium that all of the world’s major financial institutions already use. Similarly, centralized e-payment systems with almost no transaction costs – Faster Payments, AliPay, WeChat Pay, Venmo, Paypal, Square – are already being used by billions of people around the world.

Today’s “coin mania” is not unlike the railway mania at the dawn of the industrial revolution in the mid-nineteenth century. On its own, blockchain is hardly revolutionary. In conjunction with the secure, remote automation of financial and machine processes, however, it can have potentially far-reaching implications.

Ultimately, blockchain’s uses will be limited to specific, well-defined, and complex applications that require transparency and tamper-resistance more than they require speed – for example, communication with self-driving cars or drones. As for most of the coins, they are little different from railway stocks in the 1840s, which went bust when that bubble – like most bubbles – burst.


Wednesday, February 14, 2018

Blockchain technology has not achieved much

"Conventional wisdom that Cryptocurrencies may crash but that the underlying technology, blockchain, is great & useful is still unproven. Most overhyped & underachieving new technology ever; it still has to deliver a single killer app."

"Blockchain is the most over-hyped technological innovation ever : a shaky solution looking for a problem that may not exist as intermediaries are necessary and evolving to sharply reduce transaction cost even without blockchain."

via twitter

Monday, February 12, 2018

Bitcoin the mother of all bubbles

"Bitcoin is THE biggest bubble in human history by a factor of 10X." 

"And the US Hearing on cryptoscams is only a day away. So a $5K handle looks highly likely unless the crypto-manipulation gangs starts pumping and dumping or wash trading again. So HODL nuts: be ready for a 75% loss from recent peaks."

"HODL nuts will hold their melting Bitcoins all the way down to ZERO while scammers and whales dump and run..."

"I have ZERO financial stake in any crypto-currency, ICO or blockchain business, either short or long or otherwise. Not talking my book like the thousands of conflicted, manipulative self-serving crypto insiders do."

via twitter

Wednesday, January 17, 2018

Nouriel Roubini slams Bitcoin and Gold

"At a typical Bitcoin exchange BTC is sold at a price 2% higher than market rates; then they charge u another 2.5% as a purchase fee; then they charge u another 5% as a credit card transaction fee. So total fees are 9.5%. So much for cryptos reducing transaction costs to 0%. Scam!"

"Gold is another scam with scammers peddling it all day long on Fox TV commercials to clueless retails investors - granpas & granpas -  & charging them prices above market + gouging fees.  And now all the fanatic lunatic gold bugs have become Bitcoin bugs. Gold & BTC: two scams."

via twitter