Jan 23, 2015

The Economics of Swiss Franc's Float

A Swiss watch or vacation in Zurich is going to cost you much much more.. The more I read, more I feel like I should have taken a Swiss trip before the this float decision
Much has been written about this. For a good introductory read, you can check the Mint article . Most of the literature of this decision has focused on the macro underpinnings. While it is true that the macro factors forced SNB to take this decision, I think it is important to understand the micro-economic implications of currency pegging & its aftermath
Switzerland is a country known for its political stability. It stood insulated from even the world-wars. Such a place , coupled with its banking laws naturally has an appeal for black & white money from risk averse people across the world.
The currency pegging was introduced by SNB to protect the economy from the global financial crisis. For a country, preventing appreciation of currency is quite easy -- Just print more money. The effect of this can be quickly assessed by checking a few numbers in SNB Balance sheet
If you look at period from 2010 - 2014, the total balance sheet size has approximately doubled ( CHF 269 billion to 525 billion ). If you look at where this has gone into, you would notice that bulk of it is  foreign currency investments ( 204 to 475 billion ) .  This is not accompanied by a proportional increase in economic activity or growth irrespective of which indicator you use to assess it ( GDP growth / consumer price / inflation ) .  This is best illustrated another two numbers in the same PDF. Bank notes ( value ) in circulation over the same time period has increased only by about 6%, whereas the deposits in domestic banks have grown about 9 times .  So, where this money has gone into ?  The obvious answer in all such economies is Real Estate
In such a situation, currency pegging ( i.e, capping appreciation ) makes matters worse for the local population.  Since the local economy has not really picked up, an average coffee-shop owner / farmer still sees his inflows largely the same in value ( CHF terms ). And when he goes to buy a home , he's kicked out of market by investors ( or, rather, risk-averse people ) who bring in Euros ( where, economic activity is much higher than CHF ) & convert it at a fixed rate to CHF.
The impact of this is lack of availability of affordable housing .Though the intention of currency peg was to keep the industry competitive, encourage investment, it ends up sidelining the local population.   At a micro-level, this drives huge resentment . Given the fact that ECB was about to take a cue from US Fed, currency peg would have left SNB with a very risky balance sheet - something which looks like a hedge fund betting on property & currency - and a disgruntled local population.   
In an increasingly connected economy, it is never a prudent decision to peg the appreciating exchange rate. Adam Smith's "Invisible Hand" or market forces would catch up with you sooner or later. 

Nov 26, 2014

Apple - Platform Thinking,Network Effects & Valuation

One of the electives that I took while in IIMK was this less fancied course - Complementary Products & Competitive Advantage  . The fundamental message in that course was in applying 'Platform Thinking' concept into a lot of situations . A platform could be thought of as an area where two or more types of consumers / producers join for their mutual benefit.  And the value of the platform grows as more and more consumers / producers join it.  Typical example of this is Card Payment networks - Visa & Mastercard.  So, if you are a card network provider,  merchants are forced to give that as a payment mechanism because consumers want that. And, more consumers joining the platform results in more merchants adopting it.  Like a domino / network effect. If executed well, it soon reaches a tipping point from where more consumers & merchants just adopt it.

This concept could be extended to a lot of situations - Currency is a platform  ( explains dollar's dominance  ) .. Amazon's kindle publishing is a platform..  Facebook is a platform ( you have users & advertisers ) , Airports could be thought of platforms connecting Airlines, Passengers & Retailers.    In a way, it is a kind of thinking that visualizes a business as a convergence point of different types of consumer - producer combinations

If there is a factor that has strongly differentiated Apple from Samsung in the smart-phone / tablet / field, it is internalizing this platform concept into their product strategy. In other words, platform thinking is Apple's competitive advantage. Product design, user experience, marketing strategies  - All can be copied.  But the game is no longer about producing a feature rich / perfect phone . It is all about enriching iPhone / iPad as a platform

This platform is much more than the App-Developing eco-system.  But it all started with it.  Apple took great care in nurturing the App-Developer eco-system.  Its entry barriers & tight quality checks resulted in attracting a well-paying user-base & a talented pool of app-developers adopt it as a platform.  It might be numerically less than the Android App store in terms of Apps or developers or consumers. But quality & experience-wise , I'd say Apple has nurtured it well.

They had a few more platform experiments -  iBooks  , Newsstand , Passbook .. All these are nothing  but interesting variants of platform concept that brought a distinct user-base & producers / sellers towards iPhone / iPad . With the latest entry  - Apple Pay -  I think Apple has virtually killed the competition . True, Samsung has Google Wallet  -  But its not about being first in the market. It is about properly launching it & marketing it to reach that Platform Tipping point from where the platform would itself grow.

The value of iPhone today is not about electronics / features / UI alone.. It is about access to these platforms that it provides you.  And it is this valuation that Corporate Finance often misses
In a networked world, if a company of Apple's size manages to make a 20%+ Jump in Stock in a month or two -  largely on account of the Apple Pay announcement - I've to say that it is being truly successful in internalization & execution of this Platform Strategy

See the Graph Below on Apple's Stock 



I've to say, Carl Icahn is spot-on in asking for share-buy backs. Because present valuations does not account what new platform ingredients can Apple innovate - and the network economy benefits that it can add to the company.

Nov 14, 2014

Brent Crude - An index detached from the fundamentals ?


To Hedge or Not to Hedge - That's the billion dollar question puzzling everyone from industry heads to govt policy makers in the wake of crude oil collapse . Before even attempting to answer that, it may be prudent to to look at the way indices work - and the economics behind it.

What should a market index reflect ?  It should be a consistent & fair representation of the underlying supply & demand. Is that the case behind petro price indices ? Lets look at a few data points first.

Globally, there are two main crude indices  - Brent & WTI . Brent crude index is computed as a mathematical function of spot & future prices of North Sea oil ( Click for details ) . Similarly, WTI or West Texas Intermediate is function of primary crude contracts settled in Cushing, Oklahoma . Both have different Sulphur content, density etc - which means there are different costs to refiners, though the end - market - Consumers is largely the same

For most part of the last 5 years, Brent has been higher than WTI. If you look at the Brent - WTI spread ( http://ycharts.com/indicators/brent_wti_spread   ) , you will see a few interesting points. The spread has been highest ( $20+ ) at the peak time of quantitative easing.  Or in other words, loose money often tends to flow into easily accessible commodity markets.  The intermittent spikes have largely coincided with the political flare-ups. And, as of today, the spread stands at $3.09.

Suppliers naturally tend to lean to higher indices as it suits them.  A large portion of oil purchase agreements are ( were ? ) based on Brent. But, is Brent, a fair representation of the market ? Most of the Brent Crude flows to Europe  ( Of late, Russian oil also has a sizable market share there ) . When the market is largely limited to a region,  is it really prudent for a consumer - in say China / India - to strike a contract based on an index that is not really favorable to them ?

The geo-political realities today are much different from the last decade.  ONGC & CNPC - which represent two large consumer nations today have taken stakes in a lot of African / Russian oil fields. And these are driven by large volumes - which dwarf North Sea capacity ( It is depleting as well ) .

What this essentially means is that, in terms of producer - consumer combinations, the oil market has become a bit more fragmented / decentralized . In a decentralized market, centralized indices that predominantly cater to the demand of a region will lose relevance.   Imagine, LIBOR being used as a standard to price securities world-wide.  Using Brent to price crude is in some ways equivalent to that  .  As more and more consumers realize that, a large number of them will move away into different modes of pricing  -  Governments will tend to take stakes in oil fields  ,  Companies will tend to rely on more localized & independent indices .

Another problem with these indices is that it is kind of self-reinforcing. Suppliers strike contracts based on indices - & indices take those contract settlements to recalculate themselves.  It is somewhat debatable as to how quickly the demand signals get reflected in such a mechanism. What gets easily reflected are the speculative positions taken based on external political events.

How can indices stay relevant ?  Can we imagine a world in which a consumer strikes a petrol contract with a next door petrol pump based on XYZ index ? I would say, fuel market will be truly deregulated only on such a day.