Sunday, 19 August 2018

Twitter and the coming crisis

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James Saft on the wider implications of the latest irrational exuberance.

James Saft

James Saft, Reuters Columnist

The bad news is: we are going to have another crisis.

The good news is that by then promoted messages on Twitter will make it easy to find bankruptcy attorneys.

Yes, this was the week that Twitter went public at a stratospheric valuation and the Federal Reserve, in two papers, set the stage for yet more aggressive monetary policy.

Those events are linked, of course, and though it may take a while, both will bear some bitter fruit.

Twitter, a great but overvalued company, is likely to ultimately disappoint investors. That may well happen when an overly confident and aggressive Fed finally gets its comeuppance. Or rather gets the latest in a repeating series of comeuppances.

First, let’s look at Twitter, which opened at US$45.10 per share, 73% above its IPO price. That put its market cap at about US$32bn, or 53 times sales, making it the most expensive single technology stock on a price-to-sales basis.

Even if we forecast stupendous growth, this is a stock which will struggle in the next couple of years to produce sufficient profit to justify even current pricing.

Not only is it considerably more expensive than Facebook and Linkedin, for the US$32bn you could buy cereal maker Kellogg and semiconductor company Advanced Micro Devices and have another US$10bn or so to play with.

I can’t shake the feeling that technology shares are suffering from, for want of a better phrase, irrational exuberance.

You never get a bubble without a good story, and rarely without some earth-shaking change in technology, but it also helps if you have one more thing: loose monetary policy.

That we have, in abundance. Judging from the noises coming out of the Fed, we may well soon be about to make a great leap forward in radical monetary policy.

Forward guidance and total credibility

Two significant papers by Fed economists were released in conjunction with a conference this week.

The one which got the most attention, by William B. English, J. David Lopez-Salido and Robert J. Tetlow, argued that the Fed can cause unemployment to drop more quickly by pledging to hold interest rates pinned to zero for longer than they do now.

Called forward guidance, this is a policy under which the Fed simply tells the market what it will do and waits for the market to duly reprice credit in response.

The paper argues that the Fed could use a lower unemployment threshold for rate rises than its current 6.5%, perhaps 5.5%.

But will investors genuinely believe a forward commitment by the Fed, or any other central bank, for that matter?

“Forward guidance is a stupid academic fantasy grabbed by those who wish to escape making real policy,” former Bank of England policymaker Adam Posen said on Twitter.

“Cheap talk is not credible, especially given uncertainty and committees.”

(Yes, I do see how perfect it is that policy is being panned on the genuinely wonderful but overpriced Twitter on the day of its IPO, which Fed policy helped make so successful.)

And though markets are not behaving as if the Fed will be looser for longer, I have my doubts about how much they will believe it when they pledge to become less loose.

The second paper, by David Reifschneider, William W. Wascher and David Wilcox, posits that following a damaging crisis a central bank might do less damage to the economy by fomenting a second crisis by holding rates low than by raising them to avoid a bubble and bust.

This paper centres on the concept of ‘optimal control,’ essentially specifying what you will tolerate as a central banker in terms of inflation, unemployment and other variables, and then making assumptions about how policy and the economy will interact. This is, significantly, a technique which has been approvingly cited by Fed chief-to-be Janet Yellen in the past.

Again, this only works if, first, people believe the Fed will do what it says it will, and, second, that the Fed is actually good at forecasting and understands how the economy works.

Neither point is believable.

It is impossible to know if this is simply musing, or if this represents an evolution of thought at the centre of the Fed. Nor can we know how successful Yellen might be at pushing forward guidance and lower target unemployment as policy.

What seems clear, and you only need look at Twitter to see, is that the markets believe that monetary policy will be good for risk assets.

Two financial busts in 13 years apparently aren’t enough.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at

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