A few years ago, the comedian Louis CK had a great skit where he describes sitting next to a guy on a plane when the in-flight wi-fi stopped working. He reminds the audience of the marvel that is streaming a YouTube video while hurtling through the air in a tin cylinder at 30,000 feet; and when the wi-fi cuts out, his neighbour shouts “THIS IS B*@LSH1T!” and demands that it be fixed. Louis reflects on how quickly the world owes this guy something he knew existed only 10 seconds ago, and that some of the most amazing human advancements have occurred relatively recently and are wasted on the crappiest generation of spoiled idiots.
I can’t help think of this disgruntled air passenger when seeing a lot of what is being circulated on the internet amidst the global shutdown (the late ‘Wood’ excluded), and I’d like to offer some early observations on its causes and effects. The people dying, those directly affected by the new virus, and all the healthcare professionals need to be at the front of our minds. We need to do everything we can to reduce the human toll. Unfortunately the people infected by Covid-19 and all of those helping them are the people bearing the brunt of what I think can be considered a positive feedback loop to a system that is massively over-leveraged in almost every respect. Having worked in the finance sector for over ten years, I’ve seen the positive and in some cases extreme negative effects of leverage, but I’m not limiting the definition to financial leverage. I broadly define leverage as any individual or entity using something to its maximum advantage, or organizing its resources to the maximum degree or capacity.
The financial crash of 2008 resulted from enormous financial over-leverage and lack of appropriate regulation and began with the explosion of the American sub-prime lending market. This had ripple effects through a hyper-connected system that scourged savers throughout the world. While the effects of the Covid-19 virus are distinctly different from the last financial meltdown, one broad similarity is that it’s a global problem without an individual culprit. We could try to blame the stripper portrayed in the film ‘the Big Short’ for buying multiple rental properties in Florida with cheap leverage, the greasy mortgage brokers who lent her the money knowing she’d be unlikely to repay, or the Wall Street machine that packaged such loans, but where would we stop? We could further trace the ‘guilty’ through to the people that marketed and sold the derivative products, or even to German and Korean savers who ultimately bought them.
Some are more to blame than others, but it was a deeply interconnected and highly Leveraged system that brought down a house of cards.
In this sense you could compare the Florida stripper-come-real estate investor to the Wuhan native who, according to the internet, just wanted a quiet evening to enjoy his bat soup. It’s tempting to search for the source of the problem in order to blame, but the virus’ universal havoc is the result of a hyper-connected system from which we all benefit. The bat soup could have been anything else and could have come from any other place. It’s the speed at which the destruction resulting from the alleged bat eating shot through our system that seems unprecedented.
All aspects of our economy have become enormously leveraged. Any type of leverage inherently magnifies the effects of a system’s upside, while usually doing the same for its downside. In other words, leverage is not a one-way bet. We leverage, for example, our hyper-specialized global supply chains in order to optimize our use of working capital, and this provides us with cheaper products. But this specialization makes our economy more sensitive to any failures or shocks to any link of the chain. When Trump refers to the ‘China virus’ I can’t help but think of some of the recent YouTube videos of obese Americans coming to blows (with Jerry Springer-esque hair pulling) while panic-buying in supermarket aisles over how full their respective carts are with cheap products that were likely made in Asia. Developed economies have derived enormous benefit from integrating supply chains with emerging ones, but in many ways haven’t internalized the costs.
Developed economies have derived enormous benefit from integrating supply chains with emerging ones, but in many ways haven’t internalized the costs.
Cheap airfare led to hyper-travel that was unimaginable even 20 years ago. For me this means that I can live and work in London and return to my native Canada a few times per year to stay connected with family and friends. Millions of people now migrate great distances to live and work, leveraging their skills and knowledge in search of higher pay or even to just work in a different environment or culture. This isn’t exclusive to knowledge workers; I’m probably not the only one who’s marvelled at how hordes of Instagram models, participating in an endless party magically whisk themselves between the Balearics, Mykonos, Tulum and Bali. The ability to travel is no longer exclusive to the privileged classes and now seems to be perceived as an inalienable right. There’s an eye-opening heat map plotting the spread of the Covid-19 virus using Instagram account activity; the rapid spread of a deadly virus now in hindsight seems like an obvious cost of hyper-travel.
There are examples of maximum ‘operational leverage’ across our economy, and while it is easy to see who benefits, the risks and many externalities are not internalized by the beneficiaries. The margins or costs associated with the hyper-mobility of goods and people are too low to absorb any shocks to the relevant system, and too low to pay for even known external costs. Businesses such as shipping companies and airlines expanded by offering cheap rates at high volumes, but many are too weak to withstand a period of even short disruption, and they certainly don’t pay for the environmental costs of their services. So, when they crumble, or when ‘external costs’ become internalized, it will now fall on governments to pay for or fix the problem, many of which themselves are not equipped to cope.
The use of maximum operational leverage is seen nowhere better than companies such as the FANGs, or Facebook, Amazon, Netflix and Google. These companies can leverage the ubiquitous nature of their services to pay tax in the lowest cost jurisdiction, to leverage technological advantages to extract enormous profits with relatively tiny labour inputs and have used their early advantages to create near-monopolies. While they have created enormous value for their shareholders and customers, governments have not found a way to make them pay their fair share of tax. Just think of the external costs of all the Amazon deliveries (pollution and plastic), the social costs of social media addiction or even just the cost of regulating these companies to ensure they’re playing fairly.
Politicians are currently being forced to make calculations they are ridiculously ill-equipped to make. They need to quickly enact measures to prevent the spread of the deadly virus, while balancing those measures with ensuring their healthcare systems remain functional, all in a way that doesn’t completely kill their economies (which could cause much deeper problems than the virus itself). But politicians don’t have the tools or resources to best make these calculations. Imagine if Google, Amazon and Facebook were required to make ‘solving’ the current Covid-19 crisis a priority; maybe we would have to sacrifice privacy, but I wonder how the response would differ? There must be a way to better use the technology available to these companies for public good, whether it be tracking the spread of the virus to seeing which prevention measures actually work or coordinating research and data amongst scientific communities. Of course, there are examples of this already happening, but the point is that they’re small relative to the amounts these companies have privately benefited.
Operational leverage has been coupled with over 10 years of increasing financial leverage since the global financial crisis. We just didn’t learn our lesson, or we did, but gradually and blissfully forgot it. Western voters, particularly the asset owning classes, have voted for successive governments that have maintained policies of artificially cheap money, propping up asset values and inhibiting the appropriate pricing of risk. This has served to further exacerbate inequality, both socio-economical and inter-generational. Just ask a successful 20 or even 30-something in Hong Kong, London or Vancouver about their prospects of buying a house. And by successful, I mean financially successful; then ask a teacher or a healthcare worker the same question. The system is completely broken.
Massive swathes of the economy have also used cheap money and financial leverage to profit from betting on these risks, and while they generate outsize profits when it goes right, they magnify the problems through our entire system when they don’t. Many of these activities serve little social purpose and may in fact just cause harm. While any global pandemic would inevitably send a shock to financial markets, the shock has already been massively exacerbated by speculators, and many continue to make bets amidst the ‘lockdown.’ But like the Florida stripper landlord and the Wuhan bat eater, these actors are enabled by and can even be a product of a creaky system that’s taken its eye off accountability and the greater good.
The people who will suffer most from this crisis are not the ones who have benefited from maximum leverage. However, those who have benefited tremendously will continue to look for ways to use the broken system to their advantage.
Like the guy losing his sh1* over a disruption to his in-flight wi-fi, most of us are probably just hoping this quickly subsides and that cheap travel, cheap goods and cheap leverage resume. But I think we should ask ourselves some honest questions about how a virus could so quickly bring the entire system to its knees only a few weeks in, with much more pain likely to come.
Our immediate focus should be on reducing the suffering of the elderly, vulnerable and those directly affected by the virus. But then we should ask ourselves the much bigger question of why our creaky over-leveraged system can so quickly buckle under a virus that’s relatively similar to those that have occurred for centuries, especially the SARS pandemic of 2002. We need to ask why governments are being asked to fix and pay for the impact of this crisis by the same people that have lobbied them to step aside to allow for highly leveraged and weakly regulated growth, and how our system can re-allocate its resources to better prepare for and withstand such a shock.
All types of entities that are operating with maximum leverage need to internalize some of the costs that are already being passed on to governments so early into the Covid-19 crisis. Maybe €60 flights to the Instagram hotspots need to end, and if bat soup isn’t banned it should at least be totally unaffordable. Greater regulation is likely needed to ensure businesses can withstand shocks (and continue to pay workers and other liabilities) and in many cases higher prices for consumers are required, and (dare I say) greater and more efficient taxation.
Healthcare systems need to be constantly examined and we need to continuously invest in them, also ‘leveraging’ the technology available in the private sector. This can improve the efficacy of the enormous amounts of money already being invested in them, and also to better co-ordinate the medical and scientific community to prevent shocks and to better respond to them when they occur.
The fundamental pillar of leverage is that someone always has to repay. Leverage can be a very powerful tool and can create enormous benefit. If this crisis teaches us anything it’s that we’ve created a deeply interconnected system that needs some reshuffling to ensure that leveraged players are appropriately contributing to it, and can cover their proverbial bets when they go the wrong way.
Stealing from the future for tonight’s fun.
Excellent Anders! Astute, caring and well-written.
Well done Anders! Love Uncle Ran
Certainly a time to reflect on our lives, the choices we make and the consequences facing us all at this time Anders. Our interconnectedness means that our wrong choices impinge on everyone else like Batman of Wuhan! Mankind does not face this dilemma alone: “God so LOVED the world He sent His only son that whoever believes in Him shall not perish but have eternal life”. Our choice x