25/5/18: The Wondrous World of Cryptos Fraud: Profitable and Growing

One of the key promises of cryptocurrencies to their 'users'/'investors'/'gamblers' has been that of security of data stored on cryptos-backed blockchains and crypto 'assets' held by their owners. Yet, scandal after scandal, the myth has been deflated by the news flows, with security breaches, theft and fraud hitting the cryptos markets with frequency and impact not seen in traditional investment venues and asset classes.

Research by the Anti-Phishing Working Group released on Thursday shows that criminal activities have resulted in a theft of some $1.2 billion in cryptocurrencies since the beginning of 2017  (https://www.reuters.com/article/us-crypto-currency-crime/about-1-2-billion-in-cryptocurrency-stolen-since-2017-cybercrime-group-idUSKCN1IP2LU). Which is a significant number, but most likely an under-estimate to the true extent of theft and excludes fraud, especially fraud relating to the notorious ICOs.

In January-April 2018, ICOs raised some $6.6 billion, marking a 65% increase on 4Q 2017 ($3.9 billion in ICOs funding). Based on WSJ report that surveyed 1,450 ICOs, roughly 20 percent of the new offers raise major red flags for scams, including “plagiarized investor documents, promises of guaranteed returns and missing or fake executive teams”. Again, this is just a part of an iceberg. Ca half of all ICOs projects had no actual service or product offer behind them. In other words, investors in more than half of all ICOs were backing nothing more than a technological white paper, absent even a rudimentary business plan.

While there have been a lot of discussion in recent months about the potential Ponzi-game nature of the cryptos markets, irrespective of where you stand on the issue, there are two questions every investor must ask before dipping into the cryptos waters:
  1. Do I, as an investor, really comprehend the risks, uncertainties, complexities, and ambiguities imbedded in product offers I am considering investing in? and
  2. Do I, as an investor, have meaningful avenues for monitoring, hedging and/or ameliorating the above risks, uncertainties, complexities, and ambiguities imbedded in product offers I am considering investing in?
Now, without any sense of irony, when it comes to cryptos and ICOs, for any, even the most-informed and seasoned investor, the answers to (1) and (2) are 'No'. Which means that cryptos and ICOs are not a form of investment, but a form of speculative gambling. Nothing wrong with playing some chips at an unregulated casino, of course. Feel free to do so at own risk.

Update: A new research report (https://cointelegraph.com/news/ethereum-classic-51-attack-would-cost-just-55-mln-result-in-1-bln-profit-research) estimates that "it could take just $55 mln to hack a major cryptocurrency network for $1bln profit", providing yet more evidence that a "successful 51% attacks to control hashpower" previously deemed "too expensive and would result in making the attacked currency worthless" is no longer 'too expensive' and can deliver signifcantly higher profit margins than mining. So much for 'secure decentralized un-hackable' assets, thus.

President Trump actually has a point.

From Forbes:
“You know, they’ll let you think that they’re trying to stop this,” said Trump, referring to government officials in Central America. “They’re not trying to stop it. I think they encourage people from leaving. They don’t want the people. They don’t want the people that we’re getting in that country.”
President Trump actually has a point. The governments of Central America, by which I assume he is referring specifically to the Northern Triangle, have used the out migration of their people to reduce pressures on themselves to attain meaningful reforms and to bolster the region's economies through remittances. Migration has acted as a release valve to prevent social conflict from erupting and has prevented the region's economies from collapsing, as 15-20 percent of their economies are based on money from nationals living abroad.

What President Trump gets wrong, however, is his belief that the region is expelling its worst people - the people that they don't want and, therefore, that we don't want.

Often the people who leave are exactly the ones needed in Central America. Those who will no longer put up with corruption and poor governance. Those willing to make personal sacrifices by undertaking a treacherous journey north to an unknown land. Those willing to take jobs that most US citizens will not take because of low wages or danger. Those working overtime in order to send $15 billion in remittances to family members and friends left behind.

The Central Americans who leave are often those most needed in Central America. They also happen to be those most needed in the United States.

Where Did All the Young Adults Go?

We're about to go into a long holiday weekend, with something of a mystery to consider, in that it would seem that young adults between the ages of 20 and 24 are vanishing from the state of California.

That's according to population data that has been published by the state's Employment Development Department in its monthly Demographic Labor Force Summary Tables, where we find that after reached a peak of 2,992,000 in October 2015, the trailing 12 month average of the state's population of these young adults has been nearly decimated, falling to 2,715,000 in April 2018.

That's not the case for every other age demographic in California's population over the last two and a half years. The following chart shows the overall change the state's population by age group from October 2015 to April 2018.

California Working Age Population (Trailing 12 Month Average), October 2015 vs April 2018

And for the sake of filling in the gaps in between this 31 month span, the following spaghetti chart presents how the population of each of these major age groups has evolved from October 2015 to April 2018 as a percentage of its October 2015 population level, where you can quickly determine which age groups have grown and which have shrunk over that time.

Change in California Working Age Population by Age Group as a Percentage of October 2015 Population Level, October 2015 - April 2018

The same phenomenon is showing up in national population data for the U.S. Looking at national data for the Age 20-24 population and rounding to the nearest thousand, we find that there were 22,693,000 young adults in 1 July 2015, which decreased to 22,381,000 by 1 July 2016. Taking advantage of the available cohort population for 2017's Age 20-24 population, we can project that the numbers of this demographic group will continue to decline, with an early estimate of 21,774,000 that would apply for 1 July 2017.

That's a 919,000 decline over two years for the entire U.S., where if we limit California's Age 20-24 population change to an average 24 month period since October 2015, we find that its equivalent population decline over a two year period is 198,000, which would account for 21.5% of the national decline.

Overall, the population of California represents one out of every eight Americans (or 12.5%), so that 21.5% figure seems like a disproportionately large share of a seemingly vanishing population. Fortunately, there's a non-nefarious explanation for why so many Californians between the ages of 20 and 24 are disappearing from the state's population count: the population of this age group within California had been over-represented compared to the rest of the nation in previous years.

In 2015, Californians between 20 and 24 years old made up 13.2% of the nation's total in this age demographic, which has rapidly fallen in the period of time since, where April 2018's population of 2,715,000 young adults in California make up about one out of eight Americans in our early estimate for 2017's population of this group. This portion of the state's population is reverting back to its mean share within the national population.

Meanwhile, the age cohort that produced that over-representated share of Age 20-24 year old Californian among the national population in previous years has aged up into the Age 25-34 group, which is seeing a significant boost in its numbers, and is second only to the state's population of senior citizens (Age 65+).

But perhaps the most amazing thing is how fast the population of Age 20-24 year olds in California has been nearly decimated in such a short period of time. You might normally think of demographic change as something that takes generations to play out, but what's happened in California took place in the amount of time it takes a newborn to grow into a toddler ready to be toilet-trained!

Data Sources

California Employment Development Department. California Demographic Labor Force Summary Tables. [PDF Documents]. October 2015 to April 2018.

U.S. Census Bureau, Population Division. Annual Estimates of the Resident Population by Single Year of Age and Sex for the United States: April 1, 2010 to July 1, 2016. [Online Database]. Release Date: June 2017. Accessed 24 May 2018.

24/5/18: America, the Medici Cycle and the Corporate Powers in Politics

A recent paper by Luigi Zingales of the University of Chicago, titled "Towards a Political Theory of the Firm" (NBER Working Paper No. 23593, July 2017: http://www.nber.org/papers/w23593) deals with the issue of rent-seeking behavior by monopolistic firms through political influence. "Neoclassical theory assumes that firms have no power of fiat any different from ordinary market contracting, thus a fortiori no power to influence the rules of the game," writes Zingales. "In the real world, firms have such power. I argue that the more firms have market power, the more they have both the ability and the need to gain political power. Thus, market concentration can easily lead to a “Medici vicious circle,” where money is used to get political power and political power is used to make money."

In his opening to the paper, Zingales notes 2016 report by Global Justice Now showing that 69 of the world’s largest 100 economic entities are now corporations, not governments. Using "both corporation and government revenues for 2015, ten companies appear in the largest 30 entities in the world: Walmart (#9), State Grid Corporation of China (#15), China National Petroleum (#15), Sinopec Group (#16), Royal Dutch Shell (#18), Exxon Mobil (#21), Volkswagen (#22), Toyota Motor (#23), Apple (#25), and BP (#27). All ten of these companies had annual revenue in higher than the governments of Switzerland, Norway, and Russia in 2015. ...In some cases, these large corporations had private security forces that rivaled the best secret services, public relations offices that dwarfed a US presidential campaign headquarters, more lawyers than the US Justice Department, and enough money to capture (through campaign donations, lobbying, and even explicit bribes) a majority of the elected representatives. The only powers these large corporations missed were the power to wage war and the legal power of detaining people, although their political influence was sufficiently large that many would argue that, at least in certain settings, large corporations can exercise those powers by proxy."

Despite this reality, economic theory largely ignores the issue of political power of the firms despite the fact that throughout modern history, "the largest modern corporations facilitated a massive concentration of economic (and political) power in the hands of a few people, who are hardly accountable to anyone." And despite the well-established fact (including through the precedent of the U.S. sanctions), that "...many of those giants (like State Grid, China National Petroleum, and Sinopec) are overseen by a member of the Chinese Communist party." Worse, as Zinglaes notes, "In the United States, hostile takeovers of large corporations have (unfortunately) all but disappeared, and corporate board members are accountable to none. Rarely are they not reelected, and even when they do not get a plurality of votes, they are coopted back to the very same board (Committee on Capital Market Regulation, 2014). The primary way for board members to lose their jobs is to criticize the incumbent CEO (see the Bob Monks experience in Tyco described in Zingales, 2012). The only pressure on large US corporations from the marketplace is exercised by activist investors, who operate under strong political opposition and not always with the interest all shareholders in mind."

So Zingales argues "that the interaction of concentrated corporate power and politics it a threat to the functioning of the free market economy and to economic prosperity it can generate, and a threat to democracy as well." Which, of course, is simply consistent with existence of the set of market-linked trilemmas, such as The International Relations (Order) Trilemma that implies that in the presence of perfect capital mobility, the nation states can either pursue a democratic sovereign political set up or an objective of international stability/order, as well as. (see more on these here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2786660).

Logically, thus, economics need to be asking the following questions, largely ignored in the neo-classical theory of the firm: "To what extent can the power firms have in the marketplace be transformed into political power? To what extent can the political power achieved by
firms be used to protect but also enhance the market power firms have?"

As Zingales notes correctly, "US economic patterns in the last few decades have seen a rise in the relative size of large companies," as also documented in a number of posts on this blog:
for example, the rise of monopolistic competition here:

monopsonistic power here:

effects on regulatory enforcement efficiency here:

effects on democratic institutions here:

As the result, Zinglaes calls "attention to the risk of a “Medici Vicious Circle.” The “signorias” of the Middle Ages—the city-states that were a common form of government in Italy from the 13th through the 16th centuries--were a takeover of a democratic institution (“communes)” by rich and powerful families who ran the city-states with their own commercial interests as main objective. The possibility and extent of this Medici Vicious Circle depend upon several non-market factors. I identify six of them: the main source of political power, the conditions of the media market, the independence of the prosecutorial and judiciary power, the campaign financing laws, and the dominant ideology. I describe when and how these factors play a role and how they should be incorporated in a broader “Political Theory” of the firm."

The driver for this 'Medici Circle' dynamic is market concentration or monopolistic competition. Product differentiation and market regulation can bestow onto a firm a degree of market power that translates into market concentration (rising and significant share of market activity captured by the firm). While in the environment of continued innovation, such competitive advantage generates only temporary abnormal profits, the degree of market power can be significant enough to provide the firm with substantial resources (profits) to engage in lobbying activities, corruption and other rent-seeking activities. There are also symmetric incentives for the firms to engage in rent seeking. As Zinglaes notes: "If the ability to influence the political power increases with economic power, so does the need to do so, because the greater the market power a firm has, the greater the fear of expropriation by the political power". This sounds strange, but it is quite intuitive: as a firm gains market power, it's prices rise above the marginal cost, yielding abnormal economic profits to the firm at the expense of consumers. The Governments can (and do) claim political mandate to limit these profits by taxing the market dominant firms' profits (either through regulation or direct taxation), thus expropriating part of the abnormal profits.

In simple terms, "Most firms are actively engaged in protecting their source of competitive advantage: through a mixture of innovation, lobbying, or both. As long as most of the effort is along the first dimension, there is little to be worried about. ...What is more problematic is when a lot of effort is put into lobbying. In other words, the problem here is not temporary market power. ...The fear is of what I call a “Medici vicious circle,” in which money is used to gain political power and political power is then used to make more money. ...In the case of medieval Italy, it turned Florence from one of the most industrialized and powerful cities in Europe to a marginal province of a foreign empire. At least the Medici period left some examples of great artistic beauty in Florence. I am not sure that market capitalism of the 21st century will be able to do the same."

Zingales relates the Medici circle concept to the modern day U.S. economy. "In the last two decades more than 75 percent of US industries experienced an increase in concentration levels, with the Herfindahl index increasing by more than 50 percent on average. During this time, the size of the average publicly listed company in the United States tripled in market capitalization: from $1.2 billion to $3.7 billion in 2016 dollars... This phenomenon is the result of two trends. On the one hand, the reduction in the rate of birth of new firms, which went from 14 percent in the late 1980s to less than 10 percent in 2014. On the other hand, a very high level of merger activity, which for many years in the last two decades exceeded $2 trillion in value per year... The market power enjoyed by larger firms is also reflected in the increasing difficulty that smaller firms have in competing in the marketplace: in 1980, only 20 percent of small publicly traded firms had negative earnings per share, in 2010, 60 percent did... Barkai (2016) ...finds that the decrease in labor share of value added is not due to an increase in the capital share (that is, the cost of capital times amount of capital divided by value added), but by an increase in the profits share (the residuals), which goes from 2 percent of GDP in 1984 to 16 percent in 2014. ...By separating the return to capital and profits, we can appreciate when profits come from (non-replicable) barriers to entry and competition, not from capital accumulation. Distinguishing between capital and share allows Barkai (2016) also to gain some insights on the cause of the decline in the labor share. If markups (the difference between the cost of a good and its selling price) are fixed, any change in relative prices or in technology that causes a decline in labor share must cause an equal increase in the capital share. If both labor and capital share dropped, then there must be a change in markups—that is, the pricing power firms to charge more than their cost."

And fresh from the presses today: "US IG Chart of the Day: Global M&A deal flow has doubled YTD for a total of $1.5 trillion of announced deals. US-only deals account for about 37% of the global total, for $555 billion of transactions."

While firms require market power to acquire political power, access to political power is required to protect abnormal profits arising from market power. Which, in a highly polarised society (aka, the U.S. system of politics dominated by two mainstream parties) can result in political representation concentrated in the hands of minorities (e.g. Trump Presidency, gained absent major corporate support), and in ineffectiveness of lobbying monitoring (As Zinglaes notes: "Even when it comes to lobbying, the actual amount spent by large U.S corporations is very small, at least as a fraction of their sales. For example, in 2014 Google (now Alphabet) had $80 billion in revenues and spent $16 million in lobbying".) Which is, of course, quite ironic, given that the ongoing Robert Mueller probe of the Trump campaign is focusing almost exclusively on the violations in the legal or declared channels of lobbying, instead of the indirect forms of political influencing.

I will quote Zingales' conclusion almost in full here, for it is a powerful reminder to us all that we live in a world where corporatism (integration of State and corporate powers) and monopolisation / concentration of the markets are two key features of our environment, not only in the economic sense, but in the political / democratic domains as well.

"In a famous speech in 1911, Nicholas Murray Butler, President of Columbia University, considered the practical advances made by large corporations in the late 19th and early 20th century and stated: 'I weigh my words, when I say that in my judgment the limited liability corporation is the greatest single discovery of modern times, whether you judge it by its social, by its ethical, by its industrial or, in the long run, ...by its political, effects.' Butler was right, but this discovery of the modern corporate form – like all discoveries – can be used to both to foster progress or to oppress. The size of many corporations exceeds the modern state. As such, they run the risk of transforming small- and even medium-sized states into modern versions of banana republics, while posing economic and political risks even for the large high-income economies. To fight these risks, several political tools might be put into use: increases in transparency of corporate activities; improvements in corporate democracy; better rules against revolving doors and more attention to the risk of capture of scientists and economists by corporate interests; more aggressive use of the antitrust authority; and attention to the functioning and the independence of the media market. Yet the single most important remedy may be broader public awareness."

The latter bit is still woefully lacking in the Fourth Rome of Washington DC, where the usual, tired, unrealistic narrative of American Exceptionalism reigns supreme, and where the U.S. flags at the 4th of July picnics are still confused for meaningful symbols of the U.S. meritocracy and the American Dream, the native entrepreneurialism and the social mobility. Wake up, folks, and smell the roses.

Jesuit Migration Network on Capitol Hill

Along with other members of the Jesuit Migration Network, I spent last Friday on Capitol Hill meeting with staff from three Senate offices. We discussed the importance of tackling the root causes of violence in Central America that are forcing thousands of men, women, and children to flee the region.

In particular, we advocated for continued U.S. support for the region. We've followed an enforcement heavily policy for much of the last two decades, and it seems to have only gotten worse under President Trump. At this point in time, I urged public support for Guatemala's new attorney general and the International Commission Against Impunity in Guatemala (CICIG). I can't say that any of the staff members from the three offices were familiar with what is going on in Guatemala. See Kate Doyle and Elizabeth Oglesby's take on what is happening in Guatemala in Why Guatemala’s Anti-Corruption Commission Faces a New Wave of Efforts to Derail It for World Politics Review.

We also discussed the awful policy of separating children from their parents at the border and holding migrants in custody rather than releasing them before their hearings,. The staff seemed to overplay concerns about how some of these children could be released into the hands of human traffickers.

Finally, we discussed the damage that is being done to families and communities by deporting long-term members of our society and people from families of mixed immigration status.

The staff were clearly concerned about the plight of migrants. They also seemed to indicate that each of their Senators supported paths to citizenship for long-term undocumented migrants, even though I thought what they were willing to accept in return for sensible reform was too much. Finally, they were at a loss to understand what the administration would or would not accept on immigration reform.