1. Facebook’s power play. Facebook
2. Europe caves on Russia -- again. European leaders have again appeased Russia, restoring Russia’s voting rights in the Council of Europe. That body was established to uphold norms of human rights, democracy, and the rule of law in Europe in the wake of the Second World War, and Russia’s voting rights had been suspended in 2014 after its invasion of Ukraine and seizure of Crimea. Germany in particular seems loath to pressure Russia, likely because of the country’s dependence on Russian natural gas, and perhaps because of corruption in deals made to bring Russian resources to western Europe. Long-term, this willingness to appease an illiberal regime will not be good for the unity of the continent, as countries in Russia’s shadow increasingly doubt that their western friends have their back.
3. Market summary. The U.S. stock market is having a modest pullback after touching old highs. Given the global backdrop of central banks and indebted governments with no appetite for higher rates or stronger currencies, we believe that stocks will have a long-term upward bias, supported by low interest rates from U.S., Japanese, and European central banks, albeit with volatility. Many other central banks in both the developed and developing worlds will be engaging in efforts to stimulate their economies and markets, and those efforts will likely go beyond low rates and could involve QE, stock buying, or other actions. There is potential in emerging markets, but the hoped-for resolution to trade conflicts may be some way off, and in the meantime, there will be volatility surrounding the negotiating process. Right now, the real activity is in cryptos and gold. FB’s announcement of its digital currency project has helped light a fire under the whole digital asset space. The rally was already underway before that announcement, however, and we note that this time, unlike the 2017 run-up, there is more infrastructure in place for institutions to buy and hold digital currencies. Of course, as we’ve observed, there’s still a lot lacking in regulatory oversight and market transparency. Gold continues to be attractive both technically and fundamentally. The fundamental supports for gold are the same as those mentioned above for stocks -- global central banks and governments are strongly disposed to lower rates and lower currencies. The trend in the U.S. is particularly important in this regard. In addition, many central banks, including Russia’s, China’s, and Turkey’s, are aggressive gold buyers. Globally, many government bonds still have negative yields; with zero yield, a small storage cost, and a long track record of wealth preservation, gold is attractive to more investors.
Facebook’s Power Play
Last week, Facebook finally announced its long-rumored digital currency initiative. Although bitcoin had been rallying since April, since the announcement it has risen almost 25%, as of this writing.
Why the boost for bitcoin? Won’t FB’s currency -- called “Libra” -- becompetition for bitcoin? Perhaps, but speculators are betting that the FB initiative will mean that this enormous, deep-pocketed tech company with global reach will now be doing the heavy lifting that creates an onramp into the digital currency space acceptable to the world’s financial regulators. Hundreds of millions -- eventually, billions -- of consumers who currently lack access to digital assets could now get it. They will buy Libra and then many of them could easily buy bitcoin (or any other of the thousands of digital currencies that now exist). That’s why FB’s announcement has had a galvanizing effect on bitcoin.
However, FB’s initiative is much more important than just a spark for the next run-up in bitcoin.
Libra: Vision and Problems
From a bird’s-eye view, Libra feels like such a natural fit for FB that it’s almost as if the whole point of creating the trio of Facebook’s core, Instagram, and WhatsApp applications was simply to make a social network where Libra could be launched.
In FB’s plan, Libra will be a global digital currency, available to anyone with a smartphone; making a financial transaction with Libra would be as simple and as cheap as sending a text message. Libra will be a so-called “stablecoin” -- every Libra coin issued will be backed by stable, liquid assets held in reserve (unlike most fiat currencies and cryptocurrencies, which have no tangible assets backing them). This will in theory insulate Libra from the kinds of wild valuation swings that have made other digital currencies more or less useless as media of exchange and stores of value.
FB obviously hopes to replicate the tremendous success that payment apps have enjoyed in China (where they have all but supplanted other payment methods), but on a global scale. The ease of transactions would allow them to accelerate the adoption of their apps for commerce, and also allow them (or their partners) to easily extend bank-like services to the world’s 1.2 billion unbanked Android phone users -- primarily poor people in the global south. If all goes well, that could win them accolades and build goodwill from governments and socially conscious citizens who now mistrust FB deeply.
As Libra becomes more successful, it would build up an increasing reservoir of reserves backing the issued digital coins. What happens to those? The governing body for the currency, a Swiss-based nonprofit called the Libra Association.
Although FB has led, and for some time, will continue to lead the Libra project, that leadership will ultimately pass to this nonprofit. Currently, it includes 28 members, including venture capital funds and global tech and payments leaders such as Visa [NYSE: V], Mastercard [NYSE: MA], PayPal [NASDAQ: PYPL], Stripe, Ebay [NASDAQ: EBAY], Lyft [NASDAQ: LYFT], Spotify [NASDAQ: SPOT], and Uber [NASDAQ: UBER]. (It’s an impressive list, but conspicuously lacks any representation from banks. Of course, this is because banks would like to build their own competing digital currency systems.)
Members of the Libra Association will operate nodes in the network which confirm transactions -- while bitcoin has no central authority, Libra will.
This makes the issue of Libra’s governance a key question, and you can be sure that global regulators are thinking about it too.
The Libra Association
The white papers describing Libra are not statements being made by a humbled and contrite company that is acknowledging its errors and seeking to regain the good graces of consumers and regulators. Rather, these documents are a bold statement of a future in which FB, having remade the landscape of global social interaction, goes on to remake the landscape of global finance.
The Libra Association founding documents express hope for a future where Libra is governed in a decentralized way. But they note that there is currently no known path to this goal:
“To ensure that Libra is truly open and always operates in the best interest of its users, our ambition is for the Libra network to become [decentralized]. The challenge is that as of today we do not believe that there is a proven solution that can deliver the scale, stability, and security needed to support billions of people and transactions across the globe through a [decentralized] network.”
In short, don’t hold your breath. For the foreseeable future, Libra will be run by the Libra Association.
So who determines who is in the Libra Association? The answer is -- the Libra Association, until there is a “clear roadmap” to the network becoming decentralized, at which point anyone with the necessary hardware could operate a node in the network. But that’s a future towards which even FB says there is no visible path.
In short, don’t hold your breath. For the foreseeable future, the Libra Association will be a closed club which determines its own membership.
These technical and governance issues will be in the foreground as FB continues to engage with regulators around the world in the leadup to Libra’s anticipated launch next year. FB will meet a lot of skepticism -- especially because its past behavior has often seemed to hide a fierce expansionary drive under a veneer of savvy public relations. The socially positive aspects of the Libra project -- such as the beneficial effects of expanding inexpensive financial services to a wide swath of the world’s poor -- will probably encounter a wall of public and regulatory cynicism. FB’s leaders have not yet convinced the world that they can be trusted.
FB has successfully persevered through such troubles in the past. We will be watching the reaction to Libra as the project moves forward.
Investment implications: In a “blue sky” scenario where FB overcomes public skepticism and regulatory concerns, the Libra project could represent a profound expansion of FB’s presence in e-commerce and financial services, providing wholly new revenue streams, deepening the company’s strength as an advertising powerhouse, and creating public goodwill. However, there are many clouds on the horizon, and we believe that in the face of regulatory concerns and likely competition from globally significant banks, the timeline for Libra adoption proposed by FB is extremely aggressive. In the near term, the vicissitudes of the approval process could cause volatility for FB, though, in our view, not as severe as those which accompanied the revelation of the company’s privacy missteps. The progress of the project could also continue to provide support for cryptos, as speculators anticipate a new influx of cash into the digital asset space in general.
Europe Caves on Russia Again
True to form, the Council of Europe has fallen into appeasement of the illiberal regime that lies on the European Union’s eastern flank. Russia had been suspended from the continent’s human rights watchdog council in 2014 as a result of its annexation of Crimea in neighboring Ukraine, and its ongoing covert war in Ukraine’s eastern oblasts of Donetsk and Luhansk in which more than 13,000 have died. This ongoing war, as well as Russia’s constant aggressions against its other small neighbors, may have fallen out of mainstream news coverage, but they should not have escaped the attention of the European body which was allegedly established to “uphold human rights, democracy and the rule of law across the continent.” Nevertheless, with the approval of German Chancellor Merkel and French President Macron, the Council reinstated Moscow’s voting rights in the body.
The irony was not lost on Ukraine’s new president, Volodymyr Zelensky, since the reinstatement occurred on the very day that Russia exceeded a UN deadline to return 24 kidnapped Ukrainian naval personnel.
Sadly, this behavior from Europe is typical and expected. In March we told you about the approval given under German pressure for an expanded pipeline to ship Russian natural gas to Europe, and some of the compromised and possibly corrupt interests at work in that deal. While Europe fails to stand up for human rights in Russia, and to hold Russia’s leaders accountable for their aggression against their neighbors, it does not bode well for the future -- and especially, it will stoke divisions within Europe between the cavalier, self-interested western Europeans, and the eastern Europeans who live in Russia’s shadow.
Investment implications: In the long term, Europe’s unwillingness to stand up to Russia is bad news for the political cohesion of the continent, which is one more reason we are not long-term bulls on Europe.
The U.S. stock market is having a modest pullback after touching old highs. Given the global backdrop of central banks and indebted governments with no appetite for higher rates or stronger currencies, we believe that stocks will have a long-term upward bias, supported by low interest rates from U.S., Japanese, and European central banks, albeit with volatility. Many other central banks in both the developed and developing worlds will be engaging in efforts to stimulate their economies and markets, and those efforts will likely go beyond low rates and could involve QE, stock buying, or other actions. Many analysts believe that the U.S. stock market has further appreciation ahead in 2019 -- perhaps after a (relatively) quiet period until later in the year.
Emerging Markets and China
Here our opinion remains the same -- there is potential in some emerging markets, but the hoped-for resolution to trade conflicts may be some way off, and in the meantime, there will be volatility surrounding the negotiating process. Nimble traders could try to exploit that volatility, but we believe investors would be better served by adopting a considered long-term view and sticking to it.
Gold and Digital Currencies
FB’s announcement of its digital currency project has helped light a fire under the whole digital asset space. The rally was already underway before that announcement, however, and we note that this time, unlike the 2017 run-up, there is more infrastructure in place for institutions to buy and hold digital currencies. Of course, as we’ve observed, there’s still a lot lacking in regulatory oversight and market transparency. Our recent observations are that cryptocurrencies trade with risk assets, and so if the overall market environment remains benign, the crypto rally could continue.
Gold continues to be attractive both technically and fundamentally. The fundamental supports for gold are the same as those mentioned above for stocks -- global central banks and governments are strongly disposed to lower rates and lower currencies. The trend in the U.S. is particularly important in this regard. In addition, many central banks, including Russia’s, China’s, and Turkey’s, are aggressive gold buyers. Globally, many government bonds still have negative yields; with zero yield and a small storage cost, gold is comparatively attractive. With gold having broken out above long-term resistance, we see the possibility of continued appreciation.
Thanks for listening; we welcome your calls and questions.
Equities Contributor: Guild Investment Management
Source: Equities News
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