Commentary on Political Economy

Sunday 31 January 2021


Companies consider writing Hong Kong out of legal contracts

Hong Kong judges attending a ceremony to mark the new legal year. Concerns are growing over a degradation in the rule of law as Beijing tightens its grip over the city. © Reuters

Large international corporations doing deals in Asia are considering excluding Hong Kong from legal contracts over concerns China’s tightening grip may impact rule of law in the territory, according to interviews with corporate advisers across the region.

Senior lawyers at 10 large law firms in Hong Kong, Tokyo and Singapore told the Financial Times they had seen a surge in queries from clients, mostly headquartered in the US and Japan, about whether to write Hong Kong out of governing law and arbitration clauses when conducting business in the financial hub or entering into joint ventures with Chinese and other Asian counterparties.

“I’ve fielded this question four times so far this year,” said the head of an American law firm in Hong Kong, citing calls with large technology, pharmaceuticals and consumer products clients. “It’s a live issue. All sectors are asking the question and making an assessment.”

The managing partner of another US law firm in Hong Kong, who has worked in the territory for nearly a decade, said: “We are now getting a lot of questions from companies about this; it has never occurred before in my time. We have large private equity clients who never used to care about arbitration clauses coming to us with the simple question of ‘is it safe to leave Hong Kong as the seat [of arbitration]?’”

“For Japanese clients who have always had some concerns about arbitration in China, the questions are becoming more acute with respect to Hong Kong,” said Yoshimasa Furuta, a senior partner at Anderson, Mori & Tomotsune, one of Japan’s big four law firms. “We are now getting Japanese companies directly asking us whether we think it is safe to use Hong Kong as a seat of arbitration.”

He added that clients drawing up contracts “especially on a 10-20 year horizon” are increasingly thinking about alternative jurisdictions like Singapore for their arbitration.

A “governing law” clause allows companies entering into a contract to agree on which country’s laws will manage how they will conduct business. An arbitration agreement requires the parties to resolve any future disputes at an arbitral centre in a particular jurisdiction. Parties to a contract can choose any governing law or arbitration centre.

“At some of our clients, particularly wealthy Japanese clients, there is now a strong move not to have Hong Kong as the governing law or the seat of arbitration,” said the senior partner of a large law firm in the former British colony.

He said negative attention on Hong Kong’s judiciary, such as an announcement by Britain that it may pull its judges out of the territory’s highest court, as well as enhanced marketing by rival arbitration centres, “had twisted Hong Kong to look like an unfavourable jurisdiction” for business disputes.

Hong Kong’s legal system and judiciary have been under pressure since Beijing tightened control over the territory by imposing a national security law last year to crack down on anti-government protests. Arrests of pro-democracy campaigners, opposition politicians and journalists have led to questions over whether Hong Kong’s legal system may be compromised. In September, Australian judge James Spigelman resigned from Hong Kong’s Court of Final Appeal citing unspecified reasons relating to the security law. The move prompted a renewed debate about judicial independence.

Several of the lawyers interviewed rejected concerns. A number of lawyers said they had advised clients considering “writing out” Hong Kong from contracts to stick with the territory. They cited benefits including an enforcement agreement between Hong Kong and mainland China that means awards made by their respective arbitral centres will be upheld.

“Everyone is conducting the assessment but we are often [saying] not to deviate from Hong Kong, particularly on shorter contracts,” said one litigator. However, if a client was entering into an infrastructure contract that could last several decades “then they have got to be thinking about where Hong Kong will be by that time”.

For international companies and financial institutions operating in the territory, the city’s legal system has served as a guarantee that they can enforce contracts against Chinese state-owned enterprises and companies linked to mainland officials. In mainland China, the judicial system is subservient to the ruling Communist Party and its 92m members are often effectively above the law.

In 2019, the Singapore International Arbitration Centre received 479 new case filings, a record for the centre. The Hong Kong International Arbitration Centre held 503 cases that year, fewer than the previous two years but above 2016 levels. The number of contracts switching to using Singapore’s arbitration centre will not be seen in the statistics for several years. But safety fears during protests in Hong Kong in 2019 had already prompted some firms to shift arbitration hearings out of the city.

A Japanese lawyer said: “What has happened now is that the last 18 months have accelerated a trend towards Singapore, perhaps dramatically.”

Additional reporting by Stefania Palma and Mercedes Ruehl in Singapore

Saturday 30 January 2021


Inside a Pro-Huawei influence campaign

Adam Satariano

London | Edwin Vermulst, a trade lawyer in Brussels, did not think twice before he agreed to write an article for Huawei, the Chinese telecommunications giant, that would criticise a Belgian policy that threatened to box the company out of lucrative contracts. He had worked with the company for years.

After the article was published December 17 on a Dutch-language website, he moved on to other work. “That was the beginning and end of my involvement,” he said.

Tactics once used mainly for government objectives — like Russia’s interference in the 2016 US presidential election — are being adapted to achieve corporate goals. AP

Little did he know that the article would take on a life of its own. It soon became part of a covert pro-Huawei influence campaign in Belgium about 5G networks, the high-speed wireless technology at the centre of a geopolitical dispute between the United States and China.

First, at least 14 Twitter accounts posing as telecommunications experts, writers and academics shared articles by Vermulst and many others attacking draft Belgium legislation that would limit “high risk” vendors like Huawei from building the country’s 5G system, according to Graphika, a research firm that studies misinformation and fake social media accounts. The pro-Huawei accounts used computer-generated profile pictures, a telltale sign of inauthentic activity.

Next, Huawei officials retweeted the fake accounts, giving the articles even wider reach to policymakers, journalists and business leaders. Kevin Liu, Huawei’s president for public affairs and communications in Western Europe, who has a verified Twitter account with 1.1 million followers, shared 60 posts from the fake accounts over three weeks in December, according to Graphika. Huawei’s official account in Europe, with more than 5 million followers, did so 47 times.

The effort suggests a new twist in social media manipulation, said Ben Nimmo, a Graphika investigator who helped identify the pro-Huawei campaign. Tactics once used mainly for government objectives — like Russia’s interference in the 2016 US presidential election — are being adapted to achieve corporate goals.

“It’s business rather than politics,” Nimmo said. “It’s not one country targeting another country. It looks like an operation to promote a major multinational’s interests — and to do it against a European state.“

Twitter removes accounts

Graphika, which provided research for the Senate Intelligence Committee’s investigation of Russian disinformation, said there was not enough evidence to identify who was behind the pro-Huawei operation.

Huawei said in a statement that it had started an internal investigation “to try to find out what exactly has happened and if there has been any inappropriate behaviour”.

“Huawei has clear social media policies based on international best practice, and we take any suggestion that they have not been followed very seriously,” the company said.

“Some social media and online activity has been brought to our attention suggesting we may have fallen short of these policies and of our wider Huawei values of openness, honesty and transparency.“

Twitter said it had removed the fake accounts after Graphika alerted it to the campaign December 30.

“Platform manipulation is strictly prohibited under the Twitter rules,” the company said in a statement. “If and when we have clear evidence, we will take action on accounts associated with this practice, which may include permanent suspension.“

Target of Trump

Huawei, the crown jewel of China’s technology industry, has suffered from a sustained US campaign to keep its equipment from being used in new 5G networks around the world.

The Trump administration said the company posed a national security threat, arguing that the Chinese government could use Huawei’s communications technology for spying. Huawei has strenuously denied those accusations.

Prime Minister Scott Morrison says he has discussed the breakdown of the Australia-China relationship with John Howard “on many occasions”.

NBN caught in the middle of a geopolitical storm

The Trump administration took several steps to hobble Huawei, including an effort to cut off its supply of critical semiconductors — policies that the Biden administration hasn’t committed itself to retaining.

Britain announced a ban of Huawei products last year; Germany and other European countries are debating restrictions of their own.

The 5G contracts are expected to be worth billions of dollars.

Clumsily executed effort

Belgium, home to the headquarters of the European Union and NATO, illustrates the risk Huawei faces across Europe, the company’s biggest market outside of China.

Until now, Huawei and Chinese company ZTE had dominated Belgium’s telecommunications-equipment market, according to Strand Consult, a research firm. But as the Belgian government considers new restrictions, wireless operators in the country are shifting 5G deals to rival companies.

“They fear this could spread to other parts of the world,” said John Strand, founder of Strand Consult, which works with many wireless companies.

Nimmo said the pro-Huawei effort in Belgium had been clumsily executed and easy to identify. But it shows, he said, how underhanded internet campaigns try to launder seemingly legitimate material like Vermulst’s article through a mesh of websites and fake social media accounts to give it an air of impartiality and authenticity.

Bot followers

Graphika discovered the pro-Huawei effort after spotting suspicious posts about Belgium’s 5G policy from Twitter accounts used in an earlier pro-China operation. Belgian magazine Knack and Michiel van Hulten, director of Transparency International in Brussels, also identified suspicious efforts to spread pro-Huawei information.

The 14 fake accounts amplified by Huawei officials spread positive articles about the company and negative views of Belgium’s 5G policy. The three-week campaign appeared to be tied to a December 30 deadline in Belgium to review the country’s 5G policy.

To the casual Twitter user, the fake accounts looked legitimate. They included bland profile pictures along with career information. Many had more than 1000 followers.

But on closer inspection, investigators identified problems with the accounts. Many of their followers appeared to be bots. And the pictures had the hallmarks of being created by artificial intelligence software, with perfectly centred photos but small imperfections, like asymmetrical glasses.

Online businesses sell these kinds of photos of fake people, which can avoid the risk of detection that using pictures of real individuals can bring.

Disinformation commercialised

The fake accounts shared articles and commentary from different online publications, including EU Reporter, which publishes government news to its own website and affiliates like London Globe and New York Globe.

“If the Belgium government excludes specific suppliers, who will pay for it?” read the headline of one news story published on different EU Reporter websites.

Colin Stevens, publisher of EU Reporter, said in an email that he had “no knowledge of any fake Twitter accounts promoting our articles”. Stevens said that Huawei had paid EU Reporter to publish opinion articles in the past but that those were always labelled with disclaimers. The Belgian 5G stories were independently assigned without Huawei involvement, he said.

“EU Reporter would never knowingly be part of a disinformation campaign,” Stevens said.

In a few instances, investigators found articles like Vermulst’s, which Huawei paid for and included disclaimers about the financial arrangement. Other articles critical of the 5G policy appeared on websites that accept user-generated content without review, alongside author pictures that were the same as the computer-generated images in the fake Twitter profiles.

Phil Howard, director of the Oxford Internet Institute, said operations like this would become more common as disinformation became increasingly commercialised.

In a recent report, Oxford University researchers identified 63 instances in which public relations firms were involved in online disinformation operations in 2020. The work is typically on behalf of political figures or governments, he said, but can be applied to businesses.

Follow the money

“The flow of money is increasingly there,” Howard said. “Large-scale social media influence operations are now part of the communications tool kit for any large global corporation.“

In Belgium, the campaign appeared to have little effect beyond drawing unwanted attention to Huawei’s lobbying efforts. Policymakers have shown no signs of backing away from plans to limit Huawei’s access to the 5G networks. The draft legislation must now be considered by the country’s Parliament.

Vermulst, the trade lawyer, said he hadn’t known about the fake social media campaign until being contacted for this article. And while he called the effort “silly” and “stupid”, he hoped to continue working for Huawei.

“Lawyers get paid for legal opinions,” he said. “Once that article is in the public domain, anybody can do with it what they want.“

The New York Times

Friday 29 January 2021

Words of Wisdom from Authers


GameStop Isn't a History Lesson, It's a Syllabus

The trading frenzy surrounding the video-game retailer is a prism for a range of epochal issues.

Updated on 
And they took to the streets, crying “liberty, equality, liquidity...”
And they took to the streets, crying “liberty, equality, liquidity...” Photographer: Les Lee/Archive Photos/Getty Images

Winning the GameStop Game

When this week started, I had a long “to do” list of topics to cover.

    These are all important issues. If you have thoughts about any of them, drop me a line.

    Beyond that, you’ll have to discuss these topics amongst yourselves because I’m writing a fourth newsletter in a row about a small video-game retailer in the U.S., which was worth less than $1 billion at the beginning of last month. And yes, GameStop Corp. really is the most important issue for markets.

    It’s an extraordinary saga. I am linking here to a selection of pieces my colleagues and others have been writing; I won’t waste time in recounting what is now a familiar narrative. But to bring you up to date, this is the performance of GameStop’s share price over the last month:

    Despite its Thursday 70% fall, GameStop is up almost 900% this year

    It’s hard to believe this won’t become a pivotal event in the history of finance. Here are some of the biggest questions it raises:

    Libertarianism vs Paternalism

    This is an eternal debate. Freedom means the freedom to mess things up. But governments have a responsibility to citizens, and companies have a responsibility to clients, to reduce the risks that the actions of some will harm others. Driving is the most popular analogy. Paternalism demands that manufacturers fit cars with seat-belts, but libertarianism permits people to take the risk of not wearing them.

    There is a line to be drawn. Within markets, it is best to set a few simple rules, enforce them, and leave everyone as free as possible. That way the invisible hand can work its magic. But if the invisible hand really thinks that GameStop is worth $25 billion, something has gone wrong. The Securities and Exchange Commission is considering what to do, and there is plainly a regulatory issue here. Meanwhile, the decision by Robinhood Markets Inc., the main broker used by the Redditors, not to accept trades in GameStop on Thursday has already prompted class-action lawsuits from clients. For arguments against paternalism, look at the comments below the piece by my colleague Conor Sen arguing that Robinhood did the right thing. 

    As day traders are the Davids in this drama, up against hedge-fund Goliaths, their supporters in Congress include progressive Democrats such as Representative Alexandria Ocasio-Cortez, and Senator Elizabeth Warren. The politics will be unpredictable. But a few points seem clear:

    • The issue of whether Robinhood and others really engaged in “gamification” — making trading more like a game, and helping to get people addicted to it — needs to be addressed. I think they have a case to answer

    The Future of Shareholder Capitalism

    What was intended to be one of the week’s biggest stories disappeared in the vortex of excitement caused by the sub-redditors. Laurence Fink, chief executive officer of BlackRock Inc., the world’s largest fund manager, released the startlingly assertive letter he had sent to the CEOs of every company in which his firm invests. His demands notably included:

    Given how central the energy transition will be to every company’s growth prospects, we are asking companies to disclose a plan for how their business model will be compatible with a net zero economy – that is, one where global warming is limited to well below 2ºC, consistent with a global aspiration of net zero greenhouse gas emissions by 2050. We are asking you to disclose how this plan is incorporated into your long-term strategy and reviewed by your board of directors.

    BlackRock is trying to come up with a more palatable model for shareholder capitalism, which can guide the economy and society to better long-term outcomes, even if they don’t bring immediate returns. Viewed cynically, this is a public relations effort to make Wall Street look more virtuous; less cynically, it is an attempt to live up to the demands of stewardship. Not only do BlackRock and other big fund managers need to provide a pension for their clients in retirement, the argument goes; they also need to ensure that they have a world with a breathable atmosphere in which to retire. The truth lies between these poles and includes a realization by Fink and others that capitalism is widely seen to be failing, and that they need to do what they can to reform it from within, before having reforms imposed on them.

    The Redditors — or at least some of them — also plainly believe that they are part of a democratization of finance that will allow them to help make capitalism fairer. Rather than leave this process to big fund managers using “ESG” investing, their idea is to force a more “just” outcome. That includes, in the case of some of the companies they are now buying, the notion that it is unfair to starve them of capital. This is in part a well-intentioned attempt to rescue some companies; it sounds much like governments’ old practice of saving lame ducks and picking winners, rather than letting the market ensure that capital doesn’t go where it cannot be well used.

    Share ownership is now largely a business for institutional managers using other people’s money, who don’t have the incentives that direct owners would. The new breed of retail investors hope to reform capitalism by returning to direct ownership and breaking the hold of what they see as the corrupt institutions that now control the market. Many seem to delight in the label “anarcho-capitalist.”

    The common thread is, of course, an acceptance that the current model isn’t working. I’m far from convinced that either the BlackRock or the WallStreetBets model is the answer. But the debate over what the new model of capitalism should look like, which should have happened at least a decade ago, can be delayed no longer. 

    Accountability for the Global Financial Crisis

    Many Redditors involved in the insurrection see this as belated justice, or revenge, for the global financial crisis. Melvin Capital, the hedge fund whose bets against GameStop triggered the conflict, didn’t exist back in 2008, and as far as I’m aware nobody working there has any responsibility for the behavior that caused the crisis. But that isn’t how many of the Redditors feel about it. This is taken from a manifesto written by one of them, a teenager at the time of the crisis whose family went through considerable privations. It was sent in by several people:

    We have a once in a lifetime opportunity to punish the sort of people who caused so much pain and stress a decade ago and we are taking that opportunity… Your ilk were rewarded and bailed out for terrible and illegal financial decisions that negatively changed the lives of millions.

    There are two issues. One is legitimate; there was no personal accountability for the many people whose behavior contributed to the crisis. The other is less so; we can exact a measure of justice by punishing other people who now do things in some ways similar. Personally, I would say that short-sellers, and hedge funds in general, were quite a long way down the list of culprits for the 2008 disaster.

    The central point is that the failure to hold people to account has poisoned the body politic for the last decade. That was a scandalous failing of the Obama administration. The story of how it omitted even to attempt to prosecute the worst miscreants can be found in Jesse Eisinger’s The Chickenshit Club. There was nothing inevitable about this. Plenty of people went to jail after the Great Crash; only a generation ago, Rudy Giuliani made his name sending the likes of Michael Milken to jail; and only a few years before Lehman, the leading figures in the Enron, Tyco and WorldCom scandals (some of them revealed by short-sellers) did jail time. 

    It is presumably too late to prosecute crimes more than a decade old. To some extent, that error is now impossible to remedy. It is also important to resist the temptation to find scapegoats; nobody should be punished unless they deserve it. But somehow the legal authorities, led by the U.S., need to demonstrate that white-collar crime will be punished. Otherwise, we can expect efforts at vigilante justice to intensify.

    Inter-Generational Conflict

    It is no longer acceptable to insult people on the basis of their race, sex, or sexuality, which is as it should be. However, it now appears to be OK to attack people because of their age. Look through WallStreetBets traffic and disparaging references to boomers come thick and fast. This incident is an opportunity to get one over on a generation who have houses, guaranteed pensions, subsidized healthcare, and paid off their college bills decades ago.

    The demonization of boomers is growing alarming. One WallStreetBets post with 27,000 likes starts “All you ****king Boomers enjoyed the golden age of America...” If that seems reasonable in a way, just imagine replacing the word “Boomers” with a racial term. The level of inter-generational distrust is terrifying. 

    While personal animus isn’t justified, the same cannot be said for the notion that there is generational injustice. Plainly, the Baby Boomers had a great deal, and the Millennials and those who follow them have a terrible one. (Full disclosure: I’m in Generation X and my children are in Generation Z). Generational conflict is set to be a critical fissure for the decades ahead, particularly as the number of retirees swells relative to the number in the working population. 

    In particular, there is the intractable issue of pensions. Many defined-benefit plans appear to be in real danger of failing to meet their guarantees, at least in the U.S.; defined-contribution plans the world over appear likely to leave people with inadequate income in retirement. Does society do everything it can to honor commitments to retirees (and thereby widen the generational gap still further)? Or are we on course for some reckoning in which older people surrender some of the benefits they have been expecting? This question is central to the next book club selection — The Great Demographic Reversal by Charles Goodhart and Manoj Pradhan — which we will be discussing in a live blog on the terminal on Feb. 3.


    China is exploiting U.S. capital markets and workers. Here’s what Biden should do.

    Chinese President Xi Jinping during a virtual meeting of the World Economic Forum on Jan. 25.
    Chinese President Xi Jinping during a virtual meeting of the World Economic Forum on Jan. 25. (Pascal Bitz/Wef Handout/EPA-EFE/REX/Shutterstock)

    Marco Rubio, a Republican, represents Florida in the U.S. Senate.

    For decades, establishment elites in our nation’s two major political parties ignored — and oftentimes furthered — the Chinese Communist Party’s efforts to undermine our national security, industrial capacity and the well-being of American workers.

    The greatest example of this is China’s exploitation of U.S. capital markets and Wall Street’s role in facilitating the transactions that transfer American investment to malicious Chinese companies.

    Thankfully, a growing bipartisan consensus has emerged that recognizes we must address the clear risk to U.S. economic and national security this poses. Congress and the Trump administration made considerable progress over the past four years in laying a marker that future U.S. policy must correct profound imbalances in the U.S.-China relationship.

    The foremost policy choice facing President Biden is whether his administration will continue those efforts in ending this exploitation or return to the naive consensus that allowed China’s rise at America’s expense.

    A number of Chinese companies and their subsidiaries that operate in U.S. capital markets actively support the Communist Party’s programs to supplant the United States. Such companies benefit from Beijing’s espionage and human rights abuses, as well as government programs such as the “military-civil fusion strategy” and “Made in China 2025” industrial policy. As a result, Americans are investing in Chinese companies that bankrupt American competitors and build weapons that may be used against U.S. service members.

    President Donald Trump took several actions to ban such companies from our markets. He also signed bipartisan legislation to protect American retail investors and retirees from risky investments in fraudulent, opaque Chinese companies listed on U.S. exchanges and that trade on over-the-counter markets but do not comply with our transparency laws.

    I urge Biden to build upon — not undo — the critical work the previous administration took to address China’s exploitation of U.S. capital markets.

    For starters, Biden should keep or improve Trump’s executive order to prohibit U.S. investments in Chinese firms on the Defense Department list of Communist Chinese military companies. The decision of whether to side with American workers, service members and mom-and-pop investors or Beijing and payouts for Wall Street investment bankers should be easy.

    Leaving the executive order in place would make Biden the second president in history to convey to the CCP that it will no longer be able to exploit our financial system. It would also put Wall Street on notice — campaign donations do not buy a free pass to sell out U.S. workers and industry.

    Wall Street became “too big to fail” after the financial crisis. Now, its firms are signaling to Beijing that if China can steer enough American investment into CCP-affiliated companies — which Wall Street would gladly facilitate — the U.S. government will view these Chinese companies as “too big to sanction.”

    Where the Trump administration erred, Biden’s administration should correct course.

    One glaring example is the financial services section of the so-called Phase 1 agreement then-Treasury secretary Steven Mnuchin negotiated with China. Instead of holding the Chinese Communist Party accountable for exploiting U.S. investors and our markets and addressing Wall Street’s role as the facilitator, the agreement ensures U.S. capital will continue to directly fund China’s state-run economy. For the first time ever, American financial companies are authorized to purchase Chinese nonperforming loans, the overwhelming majority of which go to state-owned enterprises controlled by the CCP.

    In other words, China can finance its industrial ambitions with the deepest, most liquid capital markets in the world — our own.

    In Congress, we must continue our bipartisan efforts to stop China’s exploitation of U.S. finance. I will soon be reintroducing my American Financial Markets Integrity and Security Act, which would ban malicious Chinese companies from operating in U.S. capital markets.

    Opponents of this effort argue these companies will flee to foreign exchanges abroad, a move that would be bad for America’s economy and our investors. But these opponents fail to explain how the current status quo is good for America at all. I will never support allowing American investors to put their hard-earned money into opaque, Chinese Communist Party-controlled companies that flout U.S. investor protections laws, extend the CCP’s reach globally and corrode democratic governance.

    The United States cannot afford to keep supporting the CCP and its state-led economic model, whether inadvertently or deliberately, through misguided economic and financial policies. It is high time that we realigned our economic activities with our national interests and political values.

    Biden will have to make many tough choices. But when it comes to China’s exploitation of U.S. capital markets, the choice facing him is simple: support American workers and our national security, or side with Wall Street and the CCP.


    The GameStop-Stock Saga Is Dangerous and All Too Familiar

    The sign for a GameStop store.
    The surge of speculative investing in GameStop stock is just one example of how the U.S. markets are currently in the grip of the “the madness of crowds.”Photograph by Victor J. Blue / Bloomberg / Getty

    After the stock market closed on Wednesday, there was a good deal of celebrating at r/WallStreetBets, the Reddit message board favored by small investors who have been bidding up the shares of GameStop, a video-game retailer that has been hit hard by the coronavirus pandemic. A couple of weeks ago, the stock was trading below twenty dollars. It’s been rising sharply since, and on Wednesday it shot up more than a hundred per cent, to close at $347.51 on news that a number of short sellers—Wall Street traders who bet on stock prices falling—had closed out their negative wagers and suffered big losses. “Tards this is bigger than all of us. Once we’re done with GME”—the stock symbol for GameStop—“we take down the whole fuxking Wallstreet! Get Fxked!,” one Reddit user wrote, employing a shorter version of the derogatory label that many Reddit contributors apply to themselves ironically. Another wrote, “Market is closed guys, get some fresh air and eat some veggies. We have a big day tomorrow.”

    There are two stories here. The one that has drawn the attention of everyone from Elon Musk to Representative Alexandria Ocasio-Cortez is a David and Goliath yarn, in which the buyers of GameStop are viewed as underdogs battling the Wall Street giants. By banding together, the day-traders have recently managed to ramp up some beaten-down stocks, such as GameStop, Blackberry, and AMC Entertainment Holdings, besting some short sellers in the process. “Individual investors are winning big—at least for now—and relishing it,” the Wall Street Journal reported.

    There are plenty of good reasons to be outraged at Wall Street. But what sort of victory was this? On Thursday morning, GameStop’s shares plunged fifty per cent after TD Ameritrade and Robinhood, the popular trading app, restricted investors’ ability to trade in certain stocks. The stock continued to trade on other platforms, and it subsequently rebounded—at noon it was trading above two hundred and fifty dollars. Still, some people who had bought in on Wednesday were sitting on significant losses, which could well get larger if they don’t sell out soon. (Prior to the past couple of weeks, GameStop’s all-time high was about sixty dollars.) One Reddit poster commented: “I’M OUT OF CASH, DOWN 50%, AND HOLDING TIGHT. THE LINE IS OURS BOYS!!”

    The larger story is that the U.S. stock market is in the grip of what Charles Mackay, a nineteenth-century historian of financial manias, called “the madness of crowds.” The GameStop short squeeze didn’t happen in isolation. For almost a year now, investors have been bidding up shares in companies like Tesla, Shopify, and Snap to prices that bear little relation to the actual earnings prospects of the underlying companies. And it’s not just small investors who have been participating in this frenzy. Looking past the short sellers, who are relatively few in number, many professional investors have been playing the speculative game, even though they know that it’s likely to end badly.

    Nearly twenty years ago, I published a book titled “Dot-Con: How America Lost Its Mind and Money in the Internet Era.” Between January, 1998, and March, 2000, hundreds of new Internet startups held initial public offerings of stock, and many of them saw their stock prices skyrocket. In the same period, the Nasdaq exchange, where many of these stocks were listed, rose by about two hundred and twenty per cent, and large numbers of ordinary Americans took up day trading as a way to make money. Things haven’t progressed as far this time. Make no mistake, though: we are pretty far along. Since the middle of this past March, when the first wave of the coronavirus was raging, the Nasdaq has risen by almost a hundred per cent, despite a deep recession. (On Thursday, the Commerce Department announced that the Gross Domestic Product declined by 3.5 per cent in 2020, the biggest fall since 1946.) During the past twelve months, there have been more I.P.O.s than in any period since 1999, and day trading has once again become popular. In the latter respect, the main difference this time is a technological one. Thanks to trading apps like Robinhood, and the abolition of commission fees for many online stock trades, people can speculate from minute-to-minute while sitting on their own couches, instead of using commercial trading facilities, which was the case in the late nineties.

    Building on the work of the economist Hyman Minsky and the economic historian Charles Kindleberger, we can say that almost all speculative manias happen in four stages: displacement, boom, euphoria, and crash. A displacement happens when something changes people’s expectations about the future. In this case, the pandemic created the stay-at-home economy and prompted the Federal Reserve to slash short-term interest rates to near-zero and pour trillions of dollars into the financial markets through a policy known as quantitative easing. Since March, we’ve been in the boom period, with prices soaring, skepticism giving way to greed, and more and more people flocking to an inflated market.

    Video From The New Yorker

    Copycat behavior is at the heart of speculative bubbles. There is nothing like the sight of others making seemingly easy money to persuade people to take risks that they don’t fully comprehend. “At a late stage, speculation tends to detach itself from really valuable objects and turn to delusive ones,” Kindleberger wrote in his book, “Manias, Panics and Crashes,” from 1978. “A larger and larger group of people seeks to become rich without a real understanding of the processes involved.” Some of the people who have bought stock in GameStop exhibited a sophisticated grasp of the mechanics of a short squeeze. But all the publicity has also pulled in a lot of newbies. “Just bought 2 shares, my first investment ever and I feel sick but excited I need support,” one Reddit user wrote on Wednesday. Two others replied, “Hold and enjoy,” and “I’m here for you brother.” This type of hand-holding is one of the novel aspects produced by the current technology. But there is absolutely no reason to believe it will prevent this episode of speculation from most likely ending in a costly bust.

    One of the lessons we learned in the dot-com era is that this reckoning can be delayed for longer than one might think. As that historic bubble inflated in the late nineties, some Wall Street analysts warned that stocks were overpriced, and some professional investors placed short bets. But as prices kept going up, many of the skeptics lost their jobs or fell silent. Eventually, many investors, including some big hedge funds, switched sides and also tried to surf the bubble. Something similar appears to be happening now—and I’m not referring merely to the hedge funds that have closed out their shorts in GameStop. For months now, many big institutional investors have been riding the remarkable rise of mega-cap tech stocks like Amazon, Apple, and Tesla—despite the obvious risks of concentrating their portfolios on a small number of winners.

    Over the past fifty years, the average price-to-earnings ratio for stocks in the S. & P. 500 index has been about nineteen. At the market opening on Thursday morning, Amazon was valued at ninety-five times its trailing earnings; Apple was at thirty-eight times trailing earnings; and Tesla was at about thirteen-hundred-and-seventy times. Do all those handsomely paid fund managers really believe these are safe investments? Quite possibly not, but the momentum behind such stocks has been phenomenal. If you are in the game of trying to beat the market index on a quarterly or annual basis—as many professional investors are—it can be a career-ending move to avoid the high-flyers, regardless of how overpriced they may seem based on sounder conventional metrics. So you keep buying in the hope that you will be able to get out before everything goes to hell. This is the peculiar logic of collective action that I have called, in the past, “rational irrationality.”

    The ringmaster of this circus is the Federal Reserve, which is primarily responsible for the monetary and regulatory environment in which investors—amateur and professional—operate. But today, as in the late nineties, the Fed is trying its best to look like a bystander. During a press conference, on Wednesday, following a meeting of the central bank’s policymaking committee, Jerome Powell, the Fed chair, refused to comment on GameStop specifically. Speaking more broadly, he said, “If you look at what’s really been driving asset prices, really in the last couple of months, it isn’t monetary policy.” Powell also said that the Fed wasn’t considering raising margin requirements, which limit the amount of money investors can borrow from brokerage firms, to quell speculation.

    To be sure, Powell has persuasive-sounding reasons for adopting a hands-off policy. With the country still poleaxed by the virus, and many people out of work or otherwise suffering financially, he and his colleagues want to provide as much support as they possibly can for hiring and spending. If they were to say or do anything to tank the stock market, their actions could conceivably have a negative effect on the rest of the economy, at least in the short term.

    Powell’s intentions may be honorable, but his claim that the Fed’s policies haven’t been feeding speculative activity isn’t credible—and it’s likely not sustainable either. As Powell’s predecessor Alan Greenspan discovered in the dot-com era, speculative bubbles tend to take on a life of their own. The longer they are allowed to inflate, the bigger the eventual bust, and the more negative fallout there is for the economy—and for Americans, as a whole. If the Fed chair doesn’t want to store up more trouble for all of us in the future, he would be well advised to pay more attention to Reddit.


    The battle ahead: war is coming for your money

    The US Navy went through war games for a Japanese attack on Pearl Harbor for a decade and a half before it happened. Yet in the event navy commanders were surprised © AP

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    War risk is consistently underestimated by money people. Yes, investors now understand that pandemics can happen and disrupt business and holiday travel.

    Somehow, though, Wall Street, the City of London and their counterparts appear to believe that once vaccines are distributed to most of the developed world’s population, the problem ends. The 1990s assumptions of peace and free financial flows will work once again.

    They are wrong, unfortunately. That is not peaceful clicking you hear out there, that is the sound of reloading. The pandemic encouraged governments to believe the wartime-model production of testing kits and vaccines created a great precedent for state-directed investment and state-restricted trade.

    But state-directed economies become war economies, and war economies tend to move on to use their products. Before the wars, typically, capital controls are imposed, and most global investors are not taking that probability into account.

    They think that currencies will always be hedge-able, tradeable, and portable as they more or less have been since the 1980s. No. I believe the coming generation of policymakers want to demote the financial class, and one of their methods will be the imposition of controls on capital flows. Even in the US.

    Most people, including me, think of the Biden administration as a moderate government. Yet the president’s policy speech about economic revival held up the Roosevelt administration’s “Arsenal of Democracy” recapitalisation programme as a model. The new US president imposed the requirements of the WWII Defense Production Act on vaccine and medical supplies makers.

    The most immediate financial and economic shock would probably come from an Israeli-UAE attack on Iran . . . I think it is more likely than not

    He talked of creating more “stockpiles”, as the Department of Defense held from before WWII until the early Nineties. Trusting foreigners and markets — no! The lack of trust in foreigners and markets is now more subtle but more direct than Donald Trump’s crude, open belligerence and anti-multilateralism.

    Maybe Mr Biden and those who wrote that language for him have a point. Periods of big wars are preceded by domestic instability and smaller international wars. People with money have paid little notice to the interconnected wars across northern Africa, from Western Sahara to the growing conflict between Egypt and Ethiopia. Not to mention the Azerbaijan-Armenia war.

    The latter conflict in particular has been closely watched by international militaries as a testing ground for the use of drones in conventional war, much as the Spanish civil war proved the utility of ground and air attacks co-ordinated by radio.

    The most immediate financial and economic shock would probably come from an Israeli-UAE attack on Iran. This has been floated for so long that people are numb to the idea, but I think it is more likely than not. The Iranian leadership is more desperate, and Israel is far more independent of any restraining US opinion.

    The US Navy had gone through war games for a Japanese attack on Pearl Harbor for a decade and a half before it happened. Yet in the event the commanders were surprised. The all-time low in US equity markets was reached six months later.

    On a slightly longer timescale than the Iran conflict threat is the Chinese national commitment to incorporating Taiwan. Business and financial people (including those in China itself) apply rational commercial calculation to conclude that a hostile Chinese blockade of the island, never mind an outright attempt at a military takeover, would be economically wasteful and unnecessary.

    But in the classical analysis of the causes for war, fear and honour come before interest. The Americans say they must have strategic supremacy in semiconductor chips. How can they have that without Taiwan, the Ruhr of the electronic age? And in China’s conception, reunification with Taiwan is a generational imperative, you could say a matter of honour.

    The market volatility caused by sudden conflict in an over leveraged world would lead to the mother of all un-meet-able margin calls by the financial clearing houses (CCPs) that were supposed to solve the problems of the last global financial crisis. The US, UK and other governments would bail out the CCPs — once — and then, I believe, impose international capital controls.

    So it makes geopolitical sense, if not necessarily financial-model sense, for large asset managers to more closely match assets and liabilities by country or currency area. Free international capital flows, and associated financial hedges, have become politically fragile.

    War comes faster than you expect and costs more freedom than you thought possible.

    Thursday 28 January 2021


    Philippines Says U.S. Vowed to Help If There’s a Maritime Attack

    The Philippines said U.S. President Joe Biden’s government vowed that America would help the Southeast Asian nation if there was an armed attack in the South China Sea, repeating an earlier pledge made by former President Donald Trump’s administration.

    U.S. Secretary of State Antony Blinken told Philippine Foreign Affairs Secretary Teodoro Locsin in a call the 1951 Mutual Defense Treaty between the two nations “will apply to armed attacks against the Philippines,” Manila’s envoy to Washington Jose Manuel Romualdez said at a virtual forum organized by the foreign correspondents’ association.

    The U.S. State Department, in a separate statement Wednesday, said Blinken spoke with Locsin about the treaty’s application “to armed attacks against the Philippine armed forces, public vessels, or aircraft in the Pacific, which includes the South China Sea.”

    The reassurance comes amid Beijing’s continued assertion of its South China Sea claims which overlap with those of Manila and other nations in the region. China recently passed a law giving its coast guard more freedom to fire on foreign vessels, a move that could raise the risk of miscalculation in disputed waters and which the Philippines protested.



    The Reddit Wolves of Wall Street

    A social-media stock bubble is a new version of an old phenomenon.

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    The GameStop stock mania has captivated market speculators, spectators, politicians and even morning TV. It’s certainly high financial drama to see armies of retail investors on Reddit hunting the so-called wolves of Wall Street. This may be a new example of the power of social media, but it isn’t a crisis of capitalism or the stock market.

    There are two broad theories of how equity markets work. One is to focus on fundamentals like the growth path of the U.S. economy and the prospects and earnings of companies. You buy and hold a stock, or you invest in a fund that tracks an index like the S&P 500 or Russell 2000. This is what most people do.

    Opinion: Potomac Watch

    Yet we market fundamentalists have to admit that more than a few people have become very rich betting on the famous phrase “popular delusions and the madness of crowds.” Stock manias are common—and wonderful until they become panics. This is where we seem to be this week as investors used online brokerage platforms like Robinhood Markets to bid up shares in companies hyped on social media that may or may not deserve their soaring market capitalization.

    The drama was heightened as the Reddit pack pumped up stocks like GameStop and the movie-theater company AMC that were shorted by hedge funds. Most are hoping to make a quick buck by riding the roller-coaster up and selling before shares crash, though some also want to squeeze the hedgies.


    Short sellers have to deliver real shares when their short contracts expire, which means buying shares and raising the price even more. The losses can be high. Some in the Reddit pack triumphed this week when Citadel LLC and Point72 Asset Management had to rescue Melvin Capital Management from its short bet against GameStop. Hedge funds are sophisticated investors and know the risks.

    As for the Reddit investors, many may soon learn Herbert Stein’s Law that if something can’t continue, it won’t. If GameStop’s future earnings don’t warrant a valuation of $28 billion, which it reached this week, it will eventually fall back down to earth.

    That process has already begun as Robinhood and other online trading platforms first raised margin requirements for investors and then put restrictions on buying shares like GameStop and AMC. GameStop shares fell 44% Thursday. Many Robinhood customers are angry, and so are politicians who want to speak up for small investors.

    New York Rep. Alexandria Ocasio-Cortez and Texas Sen. Ted Cruz lambasted Robinhood’s restrictions. “Gotta admit it’s really something to see Wall Streeters with a long history of treating our economy as a casino complain about a message board of posters also treating the market as a casino,” AOC tweeted. “Tax the Rich.” Naturally.

    Politicians are calling on financial regulators to investigate the GameStop rally. But investor platforms and brokerage firms have every right to police their own sites with borrowing limits or other rules to protect customers. Robinhood hopes to go public this year and doesn’t need an investor bloodbath.

    The focus of regulators should be fraud or those who might be coordinating a pump-and-dump scheme. It’s possible someone nefarious is driving the mania in one or more stocks. But the Occam’s razor explanation is the madness of crowds rather than market manipulation.

    The government body that should come in for more introspection is the Federal Reserve. The central bank may be feeding the asset frenzy as it holds interest rates near zero and crushes the long bond yield curve so it doesn’t send accurate price signals. As investors search for yield, they have moved into commodities, real estate, junk bonds, foreign currencies—and stocks.

    We don’t profess to know if stock prices are overvalued, and perhaps investors are right that Tesla deserves its price-earnings ratio of 1,600 based on future sales of its electric cars. But in the Federal Reserve’s current world of negative real interest rates, there is also plenty of speculative money chasing higher returns.

    Many young people can’t go to Las Vegas or even a bar, so they are playing roulette on Robinhood. Asked about the craze, White House press secretary Jen Psaki said Wednesday that Treasury Secretary Janet Yellen was “monitoring the situation” and “it’s a good reminder, though, that the stock market isn’t the only measure of the health of our economy.”

    How about reminding people that investments carry risk, that stocks fall and rise, and that the GameStop losers won’t be bailed out?

    Copyright ©2020 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8

    Appeared in the January 29, 2021, print edition.