Chinese Banking System, Uber’s Financial Losses, and more from the Federal Reserve

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• published: 07 Jul 2017
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Subscribe to Hidden Forces Here: http://www.hiddenforcespod.com/ In this Market Forces segment of the Hidden Forces podcast, Demetri Kofinas speaks with Deputy Editor of Grant’s Interest Rate Observer, Evan Lorenz. Their discussion ranges from the Federal Reserve to the Chinese banking system, and the ride sharing platform Uber. The two begin their discussion by delving into some of the great, investigative research conducted by Evan and Grant’s into the Federal Reserve’s balance sheet and the way in which it manages liquidity in this “new normal” financial system. Evan goes into the nitty-gritty details of IOER (interest on excess reserves), as well as the Fed’s Reverse Repurchase Agreement Operations (RRPs) conducted by the Open Market Trading Desk at the Federal Reserve Bank of New York (New York Fed). Before the Federal Reserve’s unprecedented interventions into financial markets in 2008, excess bank reserves hovered at just around 2 billion dollars. This narrow margin of liquidity gave the Federal Reserve the ability to intervene in the federal funds market using Open Market Operations (OMO) in order to affect the rate at which banks could lend overnight (the risk-free rate). This is the way in which the Federal Reserve has traditionally set interest rates across the economy. After the financial crisis of 2008, and after the Federal Reserve expanded its portfolio from roughly 80o billion dollars in assets to roughly 4.5 trillion dollars in assets, excess reserves have grown from roughly 2 billion dollars to 2.2 trillion dollars. The second part of Demetri Kofinas and Evan Lorenz’s discussion centers on China. Specifically, the discussion focuses on the state-directed Chinese banking system and the unprecedented credit growth that we have seen in China. In particular, the two zero-in on the credit growth seen since 2011. Financial assets in the Chinese banking system are estimated at 35 trillion dollars compared to global GDP, which is roughly 75 trillion dollars. This makes the Chinese financial system equal to roughly 46% of global GDP. “We have never seen a financial system that large relative to the world,” says Evan Lorenz. In order to put Chinese banking system assets into perspective, let’s look at some other examples. In 1985, shortly before the plaza accords while the dollar was still soaring, the US banking system got to be about 32% of World GDP. In the early 1990s, when the Japanese Yen was making some of its highs of 80 yen per dollar, Japan’s banking system came to represent roughly 23% of World GDP. Furthermore, the US has a roughly 18.5 trillion dollar economy compared to China’s roughly 11-12 trillion dollar economy. This means that those 35 trillion dollars in assets represent more than three times the size of the Chinese economy. Since 2011, China has added the equivalent of the entire United States banking system – 17 trillion dollars in assets – to their financial system. Inevitably, this has had a huge knock-on effect on neighboring economies, in particular, emerging market economies with large commodity sectors, like Australia. All of this has created some concerning abnormalities in Chinese credit markets. In June of 2013, for example, there was a large seize-up in the Chinese interbank lending market. The third story discussed by Demetri Kofinas and Evan Lorenz deals with Uber and with some of the more recent writings of Hubert Horan regarding the company’s ominous finances. Uber is currently valued at roughly 69 billion dollars, a valuation based off of the money it has raised in private funding markets. Yet, Uber has lost 2.8 billion dollars in the last year. “Uber’s losses have been scaling along with its revenue,” says Evan Lorenz, as it has been using subsidies in order to outcompete other companies in the space. Besides its front-end, user interface, Uber has not offered much else in the way of innovation, according to Evan. Unlike other businesses that benefit from economies of scale, Uber has not been able to take advantage of those same benefits, since it does not deploy its own fleet. Neither has it been able to create meaningful barriers to entry, since its drivers can drive using competing platforms, and since the cost of competing with Uber is simply the cost of acquiring a single car by a single driver. Reflecting these challenges is the additional $708 million dollars that the company lost in the first quarter of 2017. Since it was founded in 2009, Uber has burned through at least $8 billion. The company says it has $7 billion of cash on hand, along with an untapped $2.3 billion credit facility. “This could be the biggest financial blow-up in the history of private placements,” says Demetri Kofinas. Follow us on Facebook: https://www.facebook.com/hiddenforcespod/ Follow us on Twitter: https://twitter.com/hiddenforcespod Follow us on Instagram: https://www.instagram.com/hiddenforcespod/