Communications, Commerce, and Money as the High-Order Bit

Plus! Levered Pensions, eBay, Bankruptcy, Chip Wars, more...

At the limit, commerce and communications are the same thing. Prices  are very information dense, so they’re the first bidder for incremental  reach or lower latency. There’s abundant historical evidence for this:  some of the oldest written documents we have outline commercial  transactions, the Rothschilds used carrier pigeons to get information  (though, contra legend, not at Waterloo),  the first transcontinental telegraph was built to provide faster FX  quotes (that’s why GBP/USD is called “the cable”), and the information  that travels farthest fastest today is the current bid/ask spread on  futures contracts.[1]

Capital markets are usually the first use case for new kinds of  low-latency communications. The most informative bits need to arrive the  fastest. But retail is the strongest use case for new kinds of  high-breadth communications. One of the most striking examples of this  comes from the introduction of mobile phones to fishing villages in  Kerala. Almost instantly, price volatility disappeared.

In the last few weeks, there have been two stories that highlight broad communications tools as a tool for driving commerce.

Facebook, Jio, and Payments

Reliance Jio, an Indian mobile carrier with 386m subscribers, has raised money This year from Facebook, Silver Lake, Vista Equity  Partners, General Atlantic, KKR, Mubadala, the Abu Dhabi Investment  Authority, and TPG. These rounds, announced roughly weekly, have  totalled over $13bn.

When Facebook did their deal in April, I speculated  that Facebook wanted to subsidize the lowest-cost Indian data provider  to push down prices and indirectly subsidize Facebook usage.

Clearly, that was wrong. Facebook’s explanation is worth quoting:

Our goal is to enable new opportunities for businesses of  all sizes, but especially for the more than 60 million small businesses  across India. They account for the majority of jobs in the country…  One focus of our collaboration with Jio will be creating new ways for  people and businesses to operate more effectively in the growing digital  economy. For instance, by bringing together JioMart, Jio’s small  business initiative, with the power of WhatsApp, we can enable people to  connect with businesses, shop and ultimately purchase products in a  seamless mobile experience.

Investing in India is tricky, because the government is intermittently aggressively  protectionist, and sometimes launches sweeping crackdowns on previously-tolerated economic activity.  One good way to stay on the right side of India’s regulatory apparatus  is to invest with Reliance. (The firm is powerful enough to get an exposé banned, for example.) But another way is to make an investment that aligns with the state’s priorities.

When Facebook says that small business jobs are most of the jobs in the country, they’re omitting an important detail: India’s informal sector employs four fifths of the workforce. The government is trying to track these workers better, so there’s a regulatory tailwind for any company that can move transactions from paper to digital.

Facebook has payment plans elsewhere, too. Yesterday, they launched a WhatsApp-based payment product in Brazil. Brazil’s off-the-books economy is also sizable, albeit smaller than India’s, but Brazil has still-challenging pension obligations which makes it more important for the country to monitor and tax economic activity.

Communication, identity, and payments are all fundamentally tied  together. Any payment system that doesn’t involve hard currency has some  form of identity verification. Phone and messaging companies have an  incentive to do a moderate amount of identity verification in the course  of their business; someone who signs up for WhatsApp and spams a  thousand people but never gets a reply is probably a bad actor, whereas  someone who signs up and starts a series of back-and-forth conversations  is more likely to be real. The messaging product is its own  proof-of-work. Looking at WhatsApp today, you could imagine that this  was the plan all along: bootstrap a universal identity system and  communications network, and use to create smartphone-based payment rails  that skip legacy payment systems and enable more transactions.

That was not, of course, the original plan. But it’s halfway between  an opportunity and a necessity for Facebook. Since WhatsApp is  end-to-end encrypted, it can easily support wholesale commerce, and  coordinate engaging in such commerce without reporting it for tax  purposes. By making payments a feature of the app, Facebook switches  from a potential abettor of tax evasion to a part-time tax-collector.

Snapchat and Shopping

Payments don’t just tie into messaging in environments where existing  payment infrastructure is weak. It also works when messaging apps have  so seamlessly replaced in-person communication that they can recreate  real-world socialization remotely. Last week at their Snap Summit conference, Snap announced minis, apps that run inside Snapchat and enable group experiences like buying movie tickets and coordinating schedules.

Minis are essentially a Snapchat-specific implementation of WeChat’s Mini Programs, which (via Turner Novak’s excellent summary of the Snap summit) handled $115bn in GMV in 2019. For any kind of purchase that could  be a shared shopping experience—movies, sure, but also clothes, games,  and travel—Snap can create a Mini to handle the interaction.

And this is especially valuable because the prompt to start the purchase is mixed in with other social communications. Snap Minis let friends spam each other, and the shopping process has social proof upfront.

This is not a way to tap into a new, underbanked demographic. It is,  given Snap’s 75% market share in 18- to 34-year-olds, a way to reinvent  the mall.

Media and Message

The unsolved problem in mixing messaging and commerce is a good  problem to have: how do messaging platforms deal with the spam problem?  For a messaging app, the viral loop of notification-reply-notification  is their most cherished asset. When messaging platforms peak, their  daily- to weekly-active-user ratio takes a long time to fall—but  interactions per user drop fast. Any time an app goes from  being opened every hour to being opened once or twice a day, it’s  stopped being a messaging app and has turned into an email product with a  subpar UI. This makes it risky to bombard users with commercial messages, even if these messages are technically from their friends

Right now, Facebook and Snap are at opposite ends of the spectrum:  Facebook’s payments products are for harvesting demand, and Snap’s are  for creating it. But in the long run, they should converge: Snap will  want to capture a bigger piece of the economics it generates (not today,  but some day), while Facebook will have a hard time resisting the  integration opportunities. If someone uses Whatsapp to make a purchase,  it would be crazy not to use that purchase data to target ads on  Instagram and Facebook. Facebook is already moving down the funnel in  its traditional business through shops, and payments can meet halfway.

This fits in with the long-term visions of both companies. Snap wants to be a lens on the real world; Facebook wants to be an invisible, forgettable, indispensable utility.  (“Maybe electricity was cool when it first came out, but pretty quickly  people stopped talking about it because it’s not the new thing, the  real question you want to track at that point is are fewer people  turning on their lights because it’s less cool?”) Both views are  ultimately in conflict, because they each require users to filter their  view of the world through exactly one company’s products. And they both  start by converting the breadth of messaging platforms into an ad hoc  payments system.

[1] A friend of mine built one of the early microwave connections for high-frequency trading, and can now accurately claim that Salma Hayek played him in a movie.


Levered Pensions

Underfunded public pensions have been a Diff theme for the  last few months. The short story: pensions have unrealistic return  expectations, and are under-funded even relative to those. At some  point, they’ll run out of money and require some combination of higher  taxes, lower payouts, or a bailout. The first two create a slow-motion  run on the bank effect: if California’s taxes today are high to cover  pension underfunding for the last two decades, workers have an incentive  to work elsewhere. This shrinks the state’s tax base and forces taxes  higher.

Pensions have tried to solve this problem through the time-tested  approach of buying riskier assets, like private equity. Now, CalPERS  plans to layer debt on top of debt by borrowing $80bn (or about 20% of its assets) to double down on these investments.

When pensions are underfunded, and their sponsor lacks the political will to admit it, their natural strategy is to make Martingale bets:  if they lose, double-down and make it back. The classic Martingale  payoff is a series of small profits followed by a catastrophic drawdown  to zero.

To be fair to CalPERS, they have made the responsible decision to buy  longer-dated treasury bonds. The main macro risk pensions take is that  they’re massively short duration: their liabilities are fixed and in the  distant future, while their risk assets' prices tend to move inversely  to interest rates most of the time. By buying long-term treasuries,  they’re partially hedging this risk out—but unsustainably. A pension  fund that’s 71% funded at a 7% expected return can’t justify putting  much of its assets into 30-year treasuries yielding 1.5%—but the  fundamental reason for that is that a portfolio whose mandate is to  deliver low-risk long-term yields should not be promising returns 550  basis points above long-term interest rates. (For comparison, in the  year 2000 most public pensions were in pretty good shape, and had  expected returns of 8% or so—which was about 200 basis points above  comparable treasuries.)

Bankrupt Stocks: Not a Great Bet

Verdad crunches the numbers  and finds that investing in the equity of companies whose bonds trade  at a discount to face value is a terrible strategy. It is, in fact, one  of the worst strategies I’ve seen in any published research that omits  transaction costs: buying shares of companies whose bonds trade at 20  cents on the dollar or less has -94% annualized returns. (Transaction  costs will mitigate most of the edge from shorting these, as the cost to  borrow these stocks can be quite high. But the retail investors  speculating in shares of bankrupt companies are generally not earning  the borrow fee when they do so.)

Chip Wars

Steve Blank speculates that China will impose retaliatory sanctions on Taiwan Semi, which would certainly represent an interesting turn of events given TSMC’s planned US investments (covered in The Diff here and here).

Blank suggests that China won’t invade Taiwan, but might launch  missiles(!) at Taiwanese foundries. This is a bit extreme, but sanctions  and political pressure from China are likely. There’s an extension of  the Golden Arches Theory of Conflict Prevention  which holds that close economic ties between countries preclude  military conflict. This was the argument for what became the EU: if  enough of Germany’s coal was exported to France and enough of France’s  steel was exported to Germany, neither country could afford a war. But a  corollary to that theory is that the marginal cost of total war  compared to limited war is lower: all-out conflict is unpopular because  it leads to material deprivation, but if material deprivation is going  to happen anyway, there’s an incentive to get things over with. Taiwan’s  anomalous position—essential to China’s economy but nominally a  rebellious province, but effectively guaranteed by the US—limits many of  the bad outcomes close to the middle of the bell curve. But the tails  of that distribution are fat and hard to model.

Elsewhere in US/China news: the US has adjusted sanctions  after realizing that broad rules against working with Huawei prevented  American companies from participating in 5G standards committees, which  gave Huawei a monopoly on setting those standards.

The Fame Market

I once called Cameo the “dollar store for used fame.” They’re moving upmarket, and now sell Zoom calls with celebrities for $1,000 to $15,000.  It’s an interesting way to disaggregate the market in fame. Normally, a  famous person is an input to a bundle of mass-market products—a movie, a  show, a book, etc. But the hard-to-model economics of Hollywood make it  unclear who’s underpriced. For the top tier of famous people, the scale  advantage of a big media production prevails over the pricing power of a  one-on-one encounter, but there’s a long tail of semi-famous,  micro-famous, or formerly-famous celebrities who can’t carry a feature  film but can carry on a ten-minute video chat.

Inflation and Missing Prices

Covid-19’s economic impact has registered as deflationary, but that’s in part an artifact of using old purchase baskets:  the goods people buy more of are rising in price, while the goods we’ve  stopped buying are cheaper. Also notable: “[T]he share of products with  missing prices in the US CPI rose from 14% in April 2019 to 34% in  April 2020.” This out-of-stock issue is partially caused by online  retailers who are reluctant to raise prices in response to supply  shocks, demand shocks, or pretty much anything. As I  noted in May:

Since retailers are very reluctant to raise prices, the  visible effect will be deflationary: for products that were  overproduced, retailers will want to get rid of them; for the ones that  were underproduced, they’ll just show up as out-of-stock. Whether you  treat that as inflationary or deflationary depends on whether you treat  out-of-stock as a null entry or infinity.