Virtual Reality


By Monish Chhabra ǀ 31st May 2016

The largest coal company in the world – Peabody Energy – filed for bankruptcy in April. It is the fifth American coal company to go bust. Other than the rise of renewables, the second big reason behind these demises is the fall in demand from China.

In 2012, China alone was using as much coal as the rest of the world combined. Coal companies extrapolated that demand growth to perpetuity, and acquired more and more capacity.

Since then, the Chinese coal demand has come off and now seems firmly on a downward trajectory, both due to environmental reasons as well as less industrial growth.

By the time the coal prices fell to the 2007-level (which was not a bad year), 90% of the coal industry got wiped out.

Imagine that – mere 8 years of price reversal wipes out most of the value of an industry that is 300 years old.

It is not just coal, the damage extends to the entire mining sector. US mining losses in 2015 wiped out the total earnings over the previous 8 years. A single bad year eliminated 8 years of profits.

What could stop this train-wreck? More growth. The central bankers are hard at it. They are acting like the parents, who believe that if they make their kid’s life miserable enough at home, the youth would somehow become more productive at school.

Since 2008, the central banks around the world have cut interest rates almost 700 times to discourage saving and prompt spending. In many places, interest rates have already been cut to negative levels. More than 20% of the bonds in the world are now trading at negative rates.

Recently, the Japanese government sold 10-year bonds at negative interest rate. Imagine that; invest in a supposedly safe thing for 10 long years, to get back less than the principal at the end.

So how low can the rates go? How negative can they get?

One argument is about the alternative to keeping deposit at the bank i.e. hold cash. Based on how much it would cost to safely store large amounts of currency, it seems the lower bound of rates is about -0.5%. Below that, depositors might hold cash rather than pay interest.

Another argument is that banks are not likely to lend to borrowers at negative rates. In many developed markets, banks lend at 1% above some benchmark rate. In fact in Japan, the interest rate spread (lending rate minus deposit rate) for the entire banking sector is below 1%.

In such places, if the benchmark rate falls below -1%, the banks would have to pay interest to the borrowers, which is quite unlikely. Thus, -1% could be the lowest the rates can go. Most of the developed world is already quite close to that level.

The next option for the central banks is quantitative easing (QE). That’s the parent who thinks that by buying enough computers at home, the kid would somehow learn to code and become a great programmer.

Since 2008, the central banks have bought assets equivalent to 20% of the world’s GDP, in their bid to stimulate the markets.

Yet the demand refuses to budge.

In the US, capital investments by the businesses are at historical low. The companies would rather spend their cash on buying back their shares (a mini-QE of their own), than installing new capacity. In February, the companies bought back their own shares worth more than $100 billion; the highest monthly figure on record.

In China, the size of receivables of all public firms combined have grown to 6% of the country’s GDP. Collecting payments for the sales has become rather difficult. On average, it takes 100 days to collect these receivables now. It used to take only 50 days in 2007.

Standard Chartered – a bank that derives most of its earnings from Asia, Africa & Middle East - posted a loss for the year 2015. This was the first yearly loss for the bank since 1989.

Mind, Body & Soul

Donald Hoffman, a cognitive scientist, posits that what we perceive is not the reality itself but our brain’s best guess of it; a guess that gives us the best chance to survive. Our perceptions are tuned to provide us the fitness for survival, not necessarily the truth.

Evolution itself has created the magnificent illusion, as it maximizes fitness by driving truth to extinction. It has shaped our perceptions so that we know only what improves our odds of survival.

Part of that involves hiding from us what we don’t need to know. And that – Hoffman argues – is pretty much all of the reality, whatever that reality might be.

The Last Word

Money itself – for the lack of any real asset supporting it - is based on the perceptions; of its issuer and the mechanism behind it. What central banks are doing, is to use the monetary perceptions to influence the economic perceptions. Hoping something real comes out.

However, if they push their efforts to penalize money too far, and fail to get it used, they may just succeed in getting it substituted.

‘Negative rates on the money they create’ is akin to raising prices of their own product, in the face of new competition.

If people get a virtual currency that they can trust (backed by blockchain or some other technology), they may adopt it faster when pushed by the punitive cost of holding traditional cash or deposits.

Cash is already under the threat of cards, and cards of mobile apps.

At half of the bank branches in Sweden, no cash is available for withdrawal, nor is cash accepted for deposits. Many markets in Africa transact only through mobile payments; no cards, no cash.

The bid to make the ‘demand’ real, might make the ‘bid’ itself virtual.

This write-up is for informational purpose only. It may contain inputs from other sources, but represents only the author’s views and opinions. It is not an offer or solicitation for any service or product. It should not be relied upon, used or construed as recommendation or advice. This report has been prepared in good faith. No representation is made as to the accuracy of the information it contains, nor any commitment to update it.