Macro Battleship with Christopher Wood

The issue of regulating the Silicon Valley titans has been back in the news recently. One trigger was a Wall Street Journal story quoting sources within Facebook that the company had uncovered emails that appear to connect Chief Executive Mark Zuckerberg with “potentially problematic privacy practices” at the company (see The Wall Street Journal article “Emails Stoke Worry at Facebook Amid Probe”, June 13, 2019 [paywall]).

 

A Smart Move by Facebook

Another story has reminded investors of a potentially hugely positive development for the same company. That is that Facebook has signed up more than a dozen companies, including Visa, Mastercard and PayPal, to back the new cryptocurrency that it unveiled on Tuesday (see The Wall Street Journal article“Facebook Crypto Coin Gets Backing”, June 14, 2019 [paywall]).

The plan, so far as I understand it, is to allow users to send money to their WhatsApp contacts across international borders. This would seem a clear rival to Bitcoin, whose transaction settlement network did more than US$410 billion in on-chain transaction volume last year, according to published data. But the difference is, of course, that Facebook will be running a closed network while the whole point of Bitcoin is that it is decentralized. Still, the coin initiative is a smart move on the part of Zuckerberg, as is the related announcement earlier this year that he is aiming to fundamentally shift Facebook’s core strategy from what he calls the advertising “public sharing” model to an encrypted system based on privacy, where only people sending and receiving messages will be able to sell them.

 

Facebook Bracing for Assault

These actions suggest that Facebook’s founder realizes that the risks are rising of a full-scale regulatory attack on the present model of what is aptly described as “surveillance capitalism” in a recommended recently published book (The Age of Surveillance Capitalism: The Fight for a Human Future at the New Frontier of Power, by Shoshana Zuboff, PublicAffairs, January 2019). This book chronicles in impressive detail how the model of exploiting users’ data for money emerged in the wake of the Internet bust of the early 2000s.

But for a much shorter more polemical version of the same argument it is also recommended to read an op-ed published in the New York Times earlier this month by Roger McNamee, the author of “Zucked: Waking up to the Facebook Catastrophe” (see New York Times article “A Brief History of How Your Privacy Was Stolen”, June 6, 2019). McNamee, interestingly, was also an initial investor in Facebook.

The last paragraph of that article is worth quoting in full. “The time has come to ban third-party exploitation of consumer data and to use anti-trust law to promote competing business models. This is not a matter of right or left; it is a matter of right and wrong.” Clearly, the calls for a break up of “Big Tech” on the antitrust angle have been led on the political left by the articulate Democratic presidential candidate Elizabeth Warren.

 

Hunting Season in Silicon Valley

She has also called for an unwinding of acquisitions where Big Tech has successfully identified potential threats to its winner-takes-all model and purchased them. The most obvious examples are Facebook’s acquisition of Instagram in 2012 for US$1 billion and of WhatsApp in 2014 for US$19 billion. But what is also interesting is that politicians on the Republican Right, such as Senator Ted Cruz, have made approving comments regarding some of Warren’s proposals. On this point, Cruz said at a Senate hearing in April: “By almost any measure, the giant tech companies today are larger and more powerful than Standard Oil was when it was broken up”.

Google, Amazon, Facebook and Apple, now account for 12.4% of the S&P500 market capitalization, up from 7% in 2014.

Meanwhile, in terms of the regulatory dynamic at play, the Wall Street Journal also reported earlier this month that the Justice Department is gearing up for a probe of Google and has authority to look into Apple, while the Federal Trade Commission has taken jurisdiction for possible antitrust probes of Facebook and Amazon. The House Judiciary Committee has also said it will open an investigation into competition in digital markets (see The Wall Street Journal article “Hunting For Giants”, June 8, 2019 [paywall]).

For such reasons, investors need to watch closely the ongoing debate regarding Big Tech regulation given the continuing importance of these stocks to the U.S. stock market. The so-called GAFA stocks, namely Google, Amazon, Facebook and Apple, now account for 12.4% of the S&P500 market capitalization, up from 7% in 2014, though down from a peak of 13.5% in September 2018 (see following chart).

GAFA Stocks as % of S&P500 Market Cap

GAFA stocks as %of S&P500 market cap

Note: GAFA = Google (Alphabet), Amazon, Facebook and Apple. Source: Bloomberg

Two Potential Outcomes for GAFA

These stocks have risen by 89% since the beginning of 2016, compared with a 44% gain in the S&P500 over the same period (see following chart). My longstanding view is that some form of regulation is coming sooner or later, regardless of which party controls the White House or Congress. One obvious risk is that these companies are simply deemed monopolies, as a result of the “network effect”, and turned into regulated utilities. That means they will no longer be able to own the platform and also participate in it.

Another risk is already fast becoming a reality. That is that these companies, which for years were, in many respects, media platforms posing as tech companies ‒ be it Facebook with Instagram or Google with YouTube ‒ will increasingly be held responsible for what appears on their platforms. The problem is, of course, that, being run by geeks or marketing types, they have no editorial competence in this area, while the attempt to monitor content involves spiraling costs.

GAFA Stock Index and S&P500

GAFA stock index and S&P500

Note: GAFA = Google (Alphabet), Amazon, Facebook and Apple. Source: Bloomberg

The conclusion is, therefore, that Zuckerberg is smart to try to be pre-emptive in terms of changing the model before it is regulated out of existence. It is entirely another question whether he will get away with it.

Reference must also be made this week to the phenomenal rebound in Bitcoin, which broke above US$10,000 last week after having made a low of US$3,100 late last year, down 84% from the peak of US$19,500 reached in December 2017. It ended the month of June at US$10,769. It must also be admitted that the long-term chart of Bitcoin now looks extremely positive again (see following chart). It looks like the noise over Facebook’s coming plan to launch a digital cryptocurrency has helped to revive interest in Bitcoin.

Bitcoin Price

Bitcoin Price - Jul 2019

Source: Bloomberg

The Growing Strength of Bitcoin

One of the many interesting aspects of Bitcoin is that it reflects distrust of the current fiat paper system, a system that has had no discipline attached to it since Richard Nixon broke its last link with gold back in 1971. In this sense, Bitcoin and physical gold share similar characteristics. Indeed, grounds for distrusting the fiat paper system would seem to be growing ever clearer as it has become evident from central bankers’ recent chatter that the G7 economies cannot tolerate any level of positive real interest rates whatsoever.

Meanwhile, the interesting question is whether Bitcoin has now replaced gold as the best way of playing distrust in the system, particularly as so-called “Modern Monetary Theory” (MMT) is now being debated on the political left as a real policy option (see Macro Battleship – Modern Monetary Theory: Socialist Economic Quackery akin to Quanto Easing, March 19, 2019). Two points are clear on this issue: first, Bitcoin has massively outperformed gold since the gold price peaked at US$1,921/oz in September 2011 (see following chart); second, Bitcoin has much greater appeal to digitally enabled millennials, and they are growing in number as boomers are declining.

Bitcoin/Gold ratio

Bitcoin-Gold price ratio

Source: Bloomberg

I was reminded of this watching a debate recently between a veteran gold bug and a millennial Bitcoin enthusiast in a libertarian forum. It has to be admitted that the Bitcoin advocate was the more credible though, interestingly, he also liked gold, whereas the gold bug was trashing Bitcoin. This is the point. It makes sense to own both for those who, like myself, believe the U.S. dollar paper standard is on borrowed time ‒ particularly as both physical gold and Bitcoin are in limited supply.

Meanwhile, government coercion is the biggest risk to owning Bitcoin in the sense that there is an attempt to regulate it out of existence. But that has also always been the biggest risk to owning gold. For those millennials who may not know it, it is worth recalling that former U.S. president Franklin Roosevelt, the hero of interventionists, banned Americans from owning gold in 1933.