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Podcast episode

Elite Networks: The Hidden Driver of Inequality? w/ Dr. Vuk Vukovic – EP263

Dr Vuk Vukovic, economist and founder of Oraclum Capital, joins Gene Tunny to discuss elite networks, their economic impact, and the future of democracy. Delving into his research, Dr Vukovic examines how political connections affect income inequality and corporate success. He shares his innovative Bayesian approach to predicting financial and political trends, offering a glimpse into his hedge fund’s methods. The episode also tackles the dangers of centralized political power and explores solutions for empowering communities and fostering trust in democratic institutions. 

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

About this episode’s guest Dr Vuk Vukovic

In brief: an academic and practitioner

​Academic…

  • Oxford PhD, LSE Masters, Harvard, Berkeley
  • 5-year university teaching experience
  • Published in top journals, published a book (@Oxford University Press) => Elite Networks
  • Expert member of Parliament committee

Practitioner…

  • Running a hedge fund in NYC, Oraclum Capital (ORCA), based on our scientific innovation in network theory 
  • Before that, founded two companies: market research consultancy & boutique rating agency
  • Macro-based trader & investor for over 10 years (learning by doing: lots of mistakes, lots of helpful lessons).

Timestamps for EP263

  • 0:00 – Gene introduces Vuk and his work on elite networks and Bayesian analysis
  • 3:54 – Vuk explains how they use social network analysis to identify “super forecasters”
  • 7:47 – Vuk discusses the performance of his hedge fund Oraclum Capital
  • 9:29 – Vuk goes into more detail on their social network survey approach
  • 12:54 – Gene and Vuk discuss Vuk’s thesis on how political connections contribute to inequality
  • 20:21 – Discussion of Lina Khan and potential risks of Trump-Musk connections
  • 25:02 – Vuk discusses how corruption and concentrated power can lead to poor economic outcomes
  • 33:30 – Vuk outlines recommendations for decentralizing political power and re-empowering citizens
  • 39:13 – Vuk’s final thoughts on the role of elites and the need for system design to channel their influence positively

Takeaways

  1. Elite Networks Drive Inequality: Dr Vukovic’s research shows that corporate executives with political connections earn significantly higher salaries, fueling income inequality.
  2. Bayesian Analysis Enhances Forecasting: Dr Vukovic argues his approach improves financial and political predictions by weighting opinions based on network diversity and historical accuracy.
  3. Centralization vs. Decentralization: Dr. Vukovic argues for reducing centralized political power to lower inequality and enhance democratic processes.
  4. Democracy’s Resilience: Whilst acknowledging current challenges, Dr Vukovic remains optimistic about democracy’s ability to adapt through trial and error.

Links relevant to the conversation

Info on Dr Vuk Vukovic:

https://www.vukvukovic.org

Elite Networks book:

https://www.amazon.com.au/Elite-Networks-Political-Economy-Inequality/dp/0197774237

Oraclum Capital:

https://oraclumcapital.com/

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Transcript: Elite Networks: The Hidden Driver of Inequality? w/ Dr. Vuk Vukovic – EP263

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. The transcript was then looked over by a human, Tim Hughes from Adept Economics, to see what mischief the otters had been up to and to correct some of the things they might have missed whilst splashing around in the river. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Vuk Vukovic  00:03

So you mentioned Musk before, just to briefly return to that. So the danger here would be that he would use because he’s not elected, right, the Trump administration, Trump is so it would be a danger if Musk uses his political connection to get favorable business decision for his companies, subsidies for Tesla, subsidies for his other companies, or, you know, preventing regulatory inquiries into his businesses. So that will be something that has a potential danger in terms of, you know, exploiting the system to your benefit.

Gene Tunny  00:35

Hello and welcome to the show. This episode, I’ve got a great guest to tell us all about elite networks and his Bayesian approach to analyzing financial markets. It’s Dr Vuk Vukovic, PhD, CEO and founding partner of Oraclum Capital. Vuk, welcome to the program.

Vuk Vukovic  00:57

Thankyou, Gene, thank you for having me. Pleasure to be here.

Gene Tunny  01:01

It’s good to have you on you’ve you’ve been doing some really fascinating work it appears, you’ve got your own hedge fund, and that’s come out of your Bayesian analysis of, I think it’s social networks, isn’t it, and that informs your financial market analysis. Can you tell us a bit about that please?

Vuk Vukovic  01:18

Yeah. So the network analysis is kind of the underlying, let’s say, motivational factor. But there are two different things, right? One was so the book came out as a part of my PhD thesis from Oxford, where I did use sort of network analysis to kind of look at relationships between politics and the corporate world and how it affects certain economic outcomes, in this specific case, the impact of income distributions, right? So I found that people, so corporate executives that are more connected to politicians tend to have much higher salaries than same corporate executives that are not connected to political executives, right? And this causes a very significant increase of, it explains a very large part of the rise of income inequality in the West in the past 40 years. So that was one that was kind of the academic thing, whereas the whole fund was basically that started on a also an academic paper, but it was something completely different for us, of me, me and my two my two partners and my two colleagues back then now partners in the fund looking at specifically how bubbles, social media bubbles, help us better explain and derive better signals from people making predictions right? So we use this with elections, specifically in 2016 with the Brexit referendum and the Trump election in 2016 got both of them really, really accurately. And then again, Biden, later on, Macron and a bunch of other things, and the underlying so again, the underlying factor, the underlying mechanism, is network analysis, but we used it to try to figure out which people are better at making predictions. Right? Because in our surveys, when we do a survey, not every person is valued the same way. Some people are better than others, and we’re using network analysis to figure out which people are better. So for example, if you’re in a cluster and like an echo chamber, then you’re very likely to be biased. Right? Either, think of it, elections, right left wing bubble, right wing bubble. You’re only surrounded by like minded people. You only see one version of reality. You’re own, right? But if you’re more heterogeneous groups, meaning if your friends who you hang out with in social media, if your friends are some of them are left wing, some of them are right with wings, some of them are centrist, then you have a higher probability of being right about an election outcome, right? Doesn’t necessarily mean that you’re right, but you have a higher probability. So what we basically do is we weigh people’s opinions based on the probability of them being more or less accurate. That’s the whole the whole approach,

Gene Tunny  03:54

Right! Okay, and are you scraping this data from Twitter, from or X or various different social media sites?

Vuk Vukovic  04:02

Yeah. So we started on Facebook back in 2015 like in 2016 before, before the whole Cambridge scandal, after that, and Facebook was no longer an option, but so we continued on Twitter and LinkedIn, mostly

Gene Tunny  04:15

LinkedIn, Okay, gotcha. Yeah, that’s interesting. So, I mean, what’s what’s interesting is, potentially, I’m part of your sample, and so are listeners of the podcast around the world. So I think that’s fascinating.

Vuk Vukovic  04:31

Yeah that’s the idea. We want to get it as diversified group as possible, so diverse decentralized opinions. That’s that’s the whole point. I don’t want clusters. I want people from all around, doing different things,

Gene Tunny  04:41

Gotcha, and what’s what’s your acronym? Is it based on Bayesian? Can you tell us a bit about that, please. What’s that stand for?

Vuk Vukovic  04:50

Yeah so we named it the Bayesian Adjusted Social Network Survey. Bayesian adjusted is because we asked people two questions. The first question is, what you think is going to happen? For example, who’s going to win an election, or, in case of markets, where the market is going to be by the end of the week. And the second question is, what do you think other people around you think, what’s going to happen? Now, when you get to that second question, that’s where the Bayesian element kicks in, right? Because we noticed and we did this initially, when we we were trying out this methodology, we tested on students, all three of us, myself and my two partners were academics, right? I have a PhD in economics. My partners have PhDs in physics and computer science, and we test some students by asking them to predict their test scores. And then later we did with elections, again, an experimental setting, right? So we give some some of them a question, some of them we don’t give a question, the second question. And we notice when we give the second question, the question of, What do you think your friends around you are going to do? That kind of encourages you to go back to your previous question and reverse it, or, you know, and be more accurate that way. It’s it forces you. It’s kind of, you know, Bayesian and you have a prior posterior probabilities. You, you adapt, you update them. That’s the whole idea.

Gene Tunny  06:03

That’s fascinating. And as you get into this, how did you identify this topic, and who was your thesis advisor? And I mean this, I mean this is very original work. It’s sort of not the standard sort of thing economists would look at, at least as far as I’m aware. So how did you get involved in it, and who was your advisor on it, please Vuk, I’m interested.

Vuk Vukovic  06:23

Again this was done before. So the whole thing, the network thing, analysis for the Bayes on right, what I mentioned was done before I went to Oxford. That was 2014/15. I went to Oxford, 2016 So, and this was done by myself and my two colleagues. As I mentioned, one is a computer scientist, one is a physicist, and we wanted to publish this as a paper, right? We were aiming to publish it like Nature or Science, but once we saw how good it was, we decided not to publish it, and we decided to monetize it instead, like, let’s make some money out of this. It’s very precise, right? It gives us really, really accurate results for whether it was like testing on students or when we did actual elections, it was really precise. But the thing to answer your question, so my PhD supervisor was Ben Hansel. he was a professor at Oxford. Really great guy. I But the research I’ve done there is a bit different, right, that was focused more on, like, the political outcomes of, you know, corporate and political connections and economic outcomes of corporate and political connections and its impact on inequality. So that was a bit different. That’s where the book came came out from. But again, as I said, like the underlying the common factor is network analysis,

Gene Tunny  07:37

Gotcha and you’re Oraclum Capital. So where’s that based? And I mean, how is it performing? Can you tell us a bit about that, please, before we talk about your book?

Vuk Vukovic  07:47

Absolutely So Oraclum Capital, it’s a hedge fund based in New York, and it’s performing really well. So we opened the fund in February 2023. Before that, I did almost two years of testing it, I had my own account. I took $20,000 of my own money and brought it up to 54 in over a year and a half. And we were doing this in a newsletter. So people were following us, and I was literally posting like screenshots. I bought this and I sold it so as to get like credibility from people. And once that was that happened, so we decided to launch the fund in February, we started with about 2 million AUM, and by now, by November, 2024 we’re up to 25 million, where performance has been about 56% since inception, gross return. So net is about 45 something like that, net return per investors. So pretty, pretty good.

Gene Tunny  08:38

Yeah, yeah, yeah. And again, this is for, like, on your website, this is for accredited investors. So it’s not just for, yeah, for ordinary mums and dads out there. It’s for, you know, people with significant assets.

Vuk Vukovic  08:51

Yeah there’s a minimum, we’re raising the minimum from January 1, $250,000 and yes, you have to have a status of accredited investor. Again, it’s a hedge fund. So it’s not really something that is for the retail and average retail investor, but we are planning down the line to have an ETF potentially, and that would be open to retail crowd. But that’s a, again, that’s a long term plan.

Gene Tunny  09:13

Good one. Yeah, it’s a fascinating approach. So you’re looking at, again, we were talking about it before, looking at what people are thinking in you’re scraping all this data from social networks. You’re trying to identify the people who are good at predicting and what they’re thinking…

Vuk Vukovic  09:29

Yeah and it’s and it’s all about two things, about, like, your consistency, your consistent responses. So since we have the market prediction, and that goes every week, so we’re tracking people’s performance over time, right? And it’s also about your positioning in the network. So we don’t take any data, you said, scraping. We only scrape the connections of your friends, right? And we can see your who your friends are if they also come into the survey. So we take your whole network, but we only see if your your friends, who’s friends with you, if they also come into the survey, right? We don’t have any we don’t collect any other socio economic. Like, we don’t even collect the names of these people, right? We know some of them. We reward. We give them money, right? So every quarter we reward, it’s a competition that we run. So we reward the top 20 with $5,000 for the distributed across top 20 people. We’ll probably be increasing that in the years to come. And and the whole point is, since, so since we reward them. So some of them have uncovered that they are, in fact, day traders, and they’re like trading markets, so we know their names, but this is just because we pay them the prize. Otherwise, a lot of them are even anonymous in the survey, which is fine to us.

Gene Tunny  10:35

Oh right. Okay. So you’ve got a survey, and then you you figure out who in that survey, are the best predictors based on, yeah, I guess there’s their network and also their…

Vuk Vukovic  10:47

The position in the network is number one and the number two is performance over time, right? So maybe your position in the network is like, I place you in a bubble, but you’re actually pretty good, so your performance goes up, so that means we value your opinion more, right? Yeah. And vice versa.

Gene Tunny  11:00

Yeah and one way of thinking about this, it just occurred to me, I don’t know if I’m the I’m on the right track here, but you’re identifying super forecasters, in a way. And I’ve had Warren Hatch on the show from Good Judgment. He’s worked with Phil Tetlock on the Superforecasting stuff, which is just fascinating. I think he’s in New York somewhere. He’s doing, he’s doing great work. You’ve got a you’ve got a different approach. And, yeah, sounds, sounds fascinating.

Vuk Vukovic  11:25

I read Tetlock’s book somewhere over there, right? I’ve read it, and it’s, it’s really good, and I like their approach. What we, so, yes, we do call them superforecasters, but we basically call them also our best observers, right? So people who are best at observing the environment around them. So that’s the kind of the most valuable opinion.

Gene Tunny  11:44

Yeah fascinating. That’s good stuff. Okay, I want to ask about your book Elite Networks, because I think this is an interesting thesis. It’s one that, I mean, I’ve got, yeah, I’ve got some real questions about this, because, I mean, inequality has always been with us, right? And so we understand why a significant amount of inequality exists, because there’s a distribution of talents and skills and resilience or grit across the population. And so we have people who, you know, we’ve got doctors or specialists who work, you know, ridiculous hours and have lots of stress, and so they’re going to be more highly paid. Corporate lawyers as well. But your thesis, it seems to be, is that much of the increase in inequality, if I’m interpreting you right, or a large part of the increase in inequality, particularly among that top 1% like if we look at what’s happening with income and wealth data, we do see particularly in the United States, I guess in the UK, to a lesser extent, and in Australia, to a much lesser extent, we see that top 1% or top point 1% really pulling away. And your, am I right? Your thesis is that much of this is to do with political connections. Can you tell us a bit about that? Please.

Vuk Vukovic  12:54

Mmm, absolutely. So what you mentioned is, so I’m not bothered by, as you said, like the inequality between people based on, like, unique talents and difference, again, some people are on a global market, superstars, right? On a global market, most popular singers, sports persons, etc, it’s a completely different game, right? The demand for them determines their payoffs. But what I’m looking at is, if you look at the distribution within the top 1% or even the top 0.1% which is, as you mentioned, was for the past 40 years, the biggest driver of income inequality. Is this has been shown by the inequality literature almost unequivocally when you look at the distribution within them. So there is this political effect that hasn’t been researched that much, right? So I looked at that specific issue. So he had a database of about a million corporate executives and politicians from the US and the UK. So I was totally focusing on these two countries, because that’s where I had the data from. Not a lot of data exists outside, unfortunately, even though it would be great to see that as well. So I was looking at these people, and I was trying to make the connections between who’s connected to politics among the top corporate, corporate executives. I was only looking at board members, right so C suite and board members. And I found that if you look at within companies, right, if you’re a board member that is connected to a politician, I’ll explain how we measure connections. If you if you’re connected to a politician in the United States, that means you have a salary, an annual salary higher about $150,000 from 2000 from the year 2000 in the year 2016 in the UK, it’s about 90,000 pounds, which is a very significant effect. It’s a lot. It’s a big increase in salary, right, on average. And again, so you’re looking at the tail of the distribution, and you’re looking at differences between them, meaning that some people have a much higher salary because of their political connections. The way I measure political connections is simple. I look at people who used to work together. So if you were, you know, if you’re a corporate executive, they used to work in government, or the people that used to study together. Or, and this is the most fun part, if you belong the same societies, right? So country clubs or like charity organizations or think tanks or stuff like that. Again, it doesn’t necessarily mean that these people are friends, but you can get to each other very quickly, right? So maybe, you know, you and I are not friends, but we belong to the same group, and you know, if I need to get to you and your personal power, I you know, it’s very easy for me to get to you, because we won’t belong to the same group. That’s kind of the idea. And if you have this level of connection, it shows statistically significant that it has an effect on on the increase of top incomes.

Gene Tunny  15:36

Yeah, yeah. It’s an interesting hypothesis, and there’s certainly some evidence of it. I mean, they talk about the revolving door between Goldman Sachs and US Treasury, or something like that, that sort of thing. And in Australia, we seem to have a revolving door between ministers offices and then the government relations positions in the big corporates like Qantas. And that’s become a bit of a scandal over here recently. What I’m interested though, is, you know, there’s correlation and then there’s causation. So how are you confident that this is actually a causal thing, that the political connections are what leads to the higher income or the, you know, the corporate sort of success it was, you know, higher incomes, uh, versus the fact that, I mean, if you’re in a, in a corporate, you’re, you’ve got to deal with government, right? You’ve got no choice, because government wants to get in your business, right? So you, you really have to make those connections. Can you, could you talk about that please?

Vuk Vukovic  16:37

Absolutely, that’s why I’m looking at, that’s why I’m looking at the within firm effect, right? So I’m trying to look at within firms. So you’re comparing two people that are the same level, right? One and the only difference, so there’s, you’re comparing always similar individuals, same amount of experience. So you’re controlling for like things like age, experience, the fact that they both work in the same company that has, you know, a level of connections to politics to whatever extent, and then. But the only difference between the two people you’re comparing is one is politically connected, the other is not, right, and based on it, so that’s your source of exogenous, exogenous variation, shock, right? And so because of this effect, you will see if this person’s political connections has any effect on their salary. And I found it that does, right? So the question that you asked would be, if, okay, obviously, if you look at between firm differences and yes, in some firms you’re going to have much higher salaries, and others, you can see the super the so called superstar firm effects. So obviously, some firms are more connected to politics. Look at big tech, for example, right? So they’re an example of companies that used to be that developed their business models based on economies of scale of innovation, obviously, right? Your Googles, your Amazons, your your Apples, etc. So they have this level of innovation, and this is what built their market share, right? Economies of scale as well. But then at this point, right, at this point, the life cycle of the company from innovators, they’re turning into rent seekers, because now it’s a question of preservation. Right now it’s a question of regulators trying to disrupt their monopoly positions, which, obviously they do have monopoly positions, so regulators trying to disrupt them. So what do they do? They hire former members of government to lobby the government not to do those, the legislations right? That’s how the political process works. So in that particular story, obviously, again, the between firm effect is going to be huge, which is why I look at within firms. So I go to within certain Microsoft or an apple or whatever, right across the basket of several thousand companies, and you’re looking at these connected and non connected individuals to try to see if there’s a if there’s an impact of the political connection. And it turns out it is. So again, causality is obviously difficult to prove, unless you have like, firm experiments. But this is as close as you can get to a experiment, not out of experiments. We could call it a quasi experimental approach. It’s not a real experiment, but it’s something close,

Gene Tunny  19:01

yeah, yeah, that’s interesting. I mean, there are clear, clearly, examples through history of I mean, people who are well connected politically, and that helps them out in business. We’ll have to see what happens with Elon Musk and how long his bromance with the President Trump lasts and what what that does for his business. Yeah, yeah. And then you’ve had like, someone like Donald Rumsfeld who moved between, like he was, he worked for the Nixon and Ford administrations. Maybe he was defense secretary. Then he went to Monsanto, I think, and then back to defense. So then the people like Hank Paulson, who went from Goldman Sachs, the US Treasury. And…

Vuk Vukovic  19:42

Yeah I have him in the book, right? So I have his network is drawn in the book, so you can see these connections, you can visualize them, and it looks amazing, right? I also have, like, (inaudible) saying the same impact, or Bob Rubin, who was Treasury Secretary, and then Clinton, and then went to Citigroup, and then he. He was running Citigroup during the crisis, and then got, you know, he went out of the company, got 100 and something million dollars of a bonus during the financial crisis. So that’s the kind of level, right?

Gene Tunny  20:11

Yeah yeah. Actually, he’d be a really good example now that I think about it.

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Gene Tunny  20:50

Now, back to the show.

I’ve got a couple of questions first, just so I don’t forget it. You mentioned big tech and the abuse of market power that is probably occurring in some cases. What do you think about Lena Khan? Do you have any thoughts on her and what she’s been doing at FTC and the and do you have any insight into what’s going to happen with the Trump administration? I mean, I imagine they’re going to get rid of her, but do you have any thoughts on how she’s been going?

Vuk Vukovic  21:20

No, I haven’t, I haven’t looked at that in particular, but, yeah, I mean, there is, there is a specific danger, because Trump is an example of a person, of an individual who is, you know, embodiment of an elite network himself, right? So this is a mixture of politics and business into one person, right? Where he has a strong business background. He’s obviously using this. I mean, again, the reason he was elected was not because of that. He transcended that, right, this whole pop, he created this whole populist image that people are kind of looking to towards as an agent of change. And that’s all fine, and well, um, but you know, if you, if you’re, the danger would happen if he would use his political power to promote his own businesses, right? Or to kind of prevent the people in government to do their own, to do their jobs in regulating and supervising, etc. Obviously, government itself is corruptible. That’s clear. You know, I’m so my background in academic research was corruption research, right? So I know a lot about the topic, and I’ve done a lot of research on that. So you mentioned Musk before, just to briefly return to that. So the danger here would be that he would use is because he’s not elected, right? The Trump administration, Trump is so it would be a danger if Musk uses his political connection to get favorable business decisions for his companies, subsidies for Tesla, subsidies for his other companies, or, you know, preventing regulatory inquiries into his businesses. So that will be something that’s a potential danger in terms of, you know, exploiting the system to your benefit. You know, hopefully it doesn’t happen. We’ll see. But yeah, if you look at kind of countries where inequality is high, you would see events like this happening, right, where you have a group of like oligarchs around the person of power, donating money or whatever, and getting back very, very concrete. It doesn’t even have to be like necessary corruption itself, but it can also be influence, right, misusing political power.

Gene Tunny  23:19

Right yeah, and on that. Do you have examples in your book of particular countries?

Vuk Vukovic  23:24

Oh yeah, yeah so, so I use, I go for, for example, I typically pick the most, like the autocratic ones, where you have these relationships, like like Ben Ali in Tunisia. That was an example of a person whose whose family directly controlled over 20% of the country right by allowing you know who gets the contract gets to do business in the country. You had a similar situation in Suharto’s Indonesia. You had Putin’s Russia, Fujimori’s Peru, for example, or Tangentopoli affair in Italy, where you had the whole government basically going down on corruption charges. This whole system buying political influence was institutionalized like companies had no other way of doing business unless they would give a bribe, right, a kickback, to the politician. But sometimes, you know this, this thing comes from the directionality. Goes from the politician to the business sector, but often it also goes from the corporates to the political level. The Odebrecht scandal in Brazil and South America is a great example of that. This was covered by the investigation Lava Jato in Brazil, where they found out that this, this huge conglomerate of a company, this construction company throughout South America was responsible for electing presidents, electing mayors, electing parliaments, right, determining political decisions, and by channeling over $800 million in bribes and corruption across the across the continent in order to secure huge, huge deals from the south they were building all the major infrastructure projects throughout Latin America. This company was building that’s a great example.

Gene Tunny  25:02

Yeah, okay, and there is evidence, isn’t there that corruption leads to poorer economic performance over time? Is that correct?

Vuk Vukovic  25:13

Yeah absolutely because it, over time, definitely because it channels the resources from like, more efficient to less efficient means, right? It channels the resources to a certain particular group, and it doesn’t distribute them, right? So this is, this is why you have, especially in developing country, this feeling where you have economic growth but the majority of the population doesn’t benefit from it, right? So only a narrow group benefits from economic growth. And when, whenever this happens, you get popular revolts. This happened in 2014 but you had the uprisings in a lot of countries, from Brazil to Turkey to Bulgaria to Ukraine over exactly that, right? So they had, like, 10 years of 15 years of progress, and the population is still relatively poor, so they’re not seeing the benefits. Otherwise, when you have economic growth, it’s supposed to pull everyone out of poverty, or at least, you know, towards the middle class and towards upper incomes, right? You had this in Western Europe. You had this United States, right? Even though, you know, we can, we can talk about different levels of inequality and different levels of corruption, but when you have high corruption alongside high inequality, then the people feel this most prominently, and that’s where where you have negative social outcomes and potential negative political outcomes. That’s where you vote for populist candidates to deliver change, right? And yeah, that’s why, it can become, it can become dangerous.

Gene Tunny  26:33

Yeah, yeah, absolutely. And I see on your bookshelf behind you, you’ve got a copy of Why Nations Fail. I think it is by Daron Acemoglu, and

Vuk Vukovic  26:41

I have all of their I have Power in Progress, Narrow Corridor, all great books,

Gene Tunny  26:45

Right. And they won the Nobel Prize this year for, yeah, for their work on what they call, I think, extractive institutions. And I think that’s one of the themes of your book, is it? So are you concerned that if this trend continues in advanced economies such as the United States, UK, Australia, that we could end up on a on a path towards, I don’t know, what sort of future are you sort of projecting if this trend continues?

Vuk Vukovic  27:14

Great question. I mean, I’m have to in the long run. I’m always optimistic, right? Because I’m aware of all the all the issues, right? Obviously, I write about them, I research about them, and I definitely agree with the conclusions from the Acemoglu and Robinson books. They were my inspiration throughout my PhD. But if you think about the way I coined, the phrase that I coined in the book is something they call the trial and error democracy, right? So you have in certain times, and this last, it can last for a decade or more, periods of what you can call error, right? Go back to the to the west, in the 60s and the 70s, right? Think of the outcomes that you had just in the United States. Right? You had assassination of the President, Assassination of civil rights leaders. You had the United States losing a war in Vietnam. You had geopolitical shocks with Iran, the revolution with Israel, the wars, right? Huge oil shocks because of that. So geopolitical tensions all around, the Cold War at its peak, right? The Cuban missile crisis, all those issues you had domestically. United States, peak racism, the KKK, all those groups. You had economics, stagflation, right? You had high double digit inflation, low economic growth, unemployment being high. A lot of economists in the West saying it’s matter of time before the Soviet Union overtakes the United States. Never happened. Why did it never happen? Because, you know, a democratic system learns from its mistakes, right? It’s not automatic, okay? So it doesn’t happen. Oh, you know, magically something appears, and we’re all better. No, you need to fight for it, right? So the way that people are fighting for it, because they ask for change, they vote for change, they vote for differences. Right now, you know, the whole Trump election was also something that people were asking for change. They were seeing something is wrong. We need, we need a change in the system. We want something better. Inflation was high, our costs of living went up, our living standards went down. We need, we need a change. So, so again, it’s, we’ll see to which extent this happens. But it’s always a question of, you know, people fighting for a better future. Maybe you need to go for a period of a slump in order to go, I mean, this is, you know, a life cycle, if you think about it, right, nothing ever goes up in a straight line. We can look at the average across the past 200 years of, you know, ever since the industrial revolution, we have amazing progress, but it always goes in cycles, right? You had the 1930s and 1940s you had disasters, right? Disastrous outcomes, the terrible war and the 19th century, you had all these issues and crises and social revolutions, etc. But you know, as we progress, it tends to be less and less, let’s say, dangerous to the system in the sense of destroying it, right? If you look at the mid 19th century or the mid 20th century, you were thinking, Oh, this is the end of capitalism, right? But so far, we’ve lived through 15 ends of capitalism and no end in sight, right? So again, the system is there is a problem, obviously. And you know, it’s a good, good thing that we can talk about this, and we can discuss this in a democratic setting. This is the only way to kind of get a get ahead. In an autocratic setting, you have pseudo stability, right? You think that, ah, you know, look at Russia, look at China. Look at all these countries. They’re great, you know, prosperity, etc. But this, this is pseudo stability, because as soon as you disrupt the leader, the system tends to fall apart. And I think, I mean, China didn’t necessarily have that. I think they are going dangerous in that direction with Xi Jinping. I think that before before him, they had his this level of where you don’t have one person dominating the system, right? You have a collective which is fine, but you know, I’m not that optimistic about I’m more or, less optimistic on China than I am on the west, to be honest, despite all the problems that we see there and that they’re evident, right? The problems were evident. But that’s the thing. You’re always going to see problems in a trial and democracy. You’re never going to see problems in an autocracy until it falls apart, and then all the problems surface. This is like classic Eastern Europe after socialism, right? Everything was fine until all of a sudden nothing was fine.

Gene Tunny  31:22

Yeah, yeah. Gotcha. Okay. Well, sorry you mean in terms of everything was fine until nothing was fine, you mean up until 1989 is that what you mean?

Vuk Vukovic  31:32

Yeah, so, so, I mean, I come from Croatia, so we went through for socialism and right in Yugoslavia, certain level of and you can, you can go most countries, okay, Yugoslavia is a bit different in some aspects. But then, you know, you had a system that was growing really strongly throughout the 60s and 70s, but then in the 80s, complete stagnation. If you look at, and I talk about that in the book, if you look at 10 years, the last 10 years of socialism in 1980s you will see in every socialist country stagnation or even economic decline. So the GDP per capita in 1980 1989 went down in almost every single socialist country of the Eastern Europe, Eastern Bloc. The reason is because the socialist model simply ran out of steam. That was it, right, you could no longer replicate the results that you had in the past. And that created these tensions that eventually brought revolutions different ways in different countries. In Yugoslavia you had the war, in Poland you had the revolution in Romania you had the revolution, in Russia things fall, fall apart, fell apart in a different way. But, yeah, it came to its inevitable end. As I said, everything seemed fine and stable, right? Growing. But then, you know, when you’re inside the system, you see that things are really not a fight, right? They’re brewing.

Gene Tunny  32:44

Yeah, absolutely. I want to ask about just coming back to how we you know, what we do about all of this so in the summary of the book, it it says that this book argues that to lower inequality and prevent incentives of elite network formation we must, first and foremost, lower centralized political power and re-empower the citizens and the community by rebuilding trust and relying on the Democratic trial and error mechanism. So we’re talking about democratic trial and error mechanism. Can I ask, do you have any recommendations, specific recommendations about the types of things that should be done to lower that centralized political power and re-empower the citizens please Vuk?

Vuk Vukovic  33:30

So that’s the last chapter of the book, and that was, that’s the only chapter that’s not empirically backed, in sense that I didn’t do research on it, but it was kind of a natural extension of, you know, the findings of the book, right, the findings of the other parts. So I’m looking at things like, so the logic is, if political power is responsible for inequality, if you lower and decentralize power and give more power back to the communities and to the people, then you essentially lower incentives for the misuse of, you know of elite misuse of power. So my ideas, and I mentioned this in the final part, elites are not something that’s inherently negative, right? Even though I might portray it as such in the book, they always existed. They always will exist. And you have a lot of elites that are actually can be beneficial for societies, like, look at philanthropism, right? It developed a number of things throughout in our cultures. But then again, right? When you when they are incentives to misuse power, when power is highly concentrated within a single individual or a single party, that’s always bad, right? And so you want that. You don’t want the concentration of power. You want the dispersion of power. That’s the element of decentralization. So the way you do this, I mean, it’s, it’s not easy and it’s not simple. There’s no magic bullet here, right? There’s, there’s series of reforms that we can think about like so, you know, increasing transparency of government, right? In making sure that every citizen visits has a insight into every single check that the government ever spends. That’s one thing, right? Free, transparent media Absolutely. Media freedom is essential in that kind of kind of environment, doing things like, you know, I’m talking about introducing KPIs for politics, right? So you have a certain fiscal, budgetary constraints, or debt constraints or monetary policy constraints, and if the government, you know, exceeds those limits to a certain extent, and it has like, let’s say, six or 12 months to fix it, unless it doesn’t. Everyone loses their seat and is no longer viable to run for election. That’s a very strong commitment mechanism. So I’m talking about introducing mechanisms like these that will push incentives, not in the way of exertation of power, but in a way of, you know, making power more distributed, that’s the idea.

Gene Tunny  35:43

Yeah, absolutely. I think it’s a great idea. So there’s an idea from a colleague of mine, Nicholas Gruen, who’s an Australian economist who I work with closely, and he’s been getting a lot of attention internationally for his idea. It’s not his original idea, but he’s one of the leading advocates of it at the moment, for citizens juries, sortition, this idea, which I think is a terrific idea. And Martin Wolf, the FT columnist, he wrote positively about that in his book The Crisis of Democratic Capitalism, which is I think perhaps a companion book to yours. Uh, really, I mean that, you know, you similar, similar themes about, I guess that you know, he’s got observations on inequality and what’s driving that now, I guess this is where, this is the final question.

I want to make sure I understand this. So your hypothesis is that a large part of the inequality we’ve seen is due to these elite networks, connections to politics. How do you, how do you quantify that? Have you done a quantification, so how much of the inc…, the breakdown of the increase in inequality, increase in the share of the point 1% or the change in the genie coefficient, however you want to measure it, what proportion of that is due to the phenomena that you’re studying, versus, say that you know, wider access to markets through the tournament effect, or whatever you call it, through just being able to connect with the wire the whole world via the Internet and skill bias, technological change that David Autor has written about. Have you quantified this at all Vuk?

Vuk Vukovic  37:21

No, yeah. So again, I put a direct number, right? So $150,000 higher salary if you’re connected, compared to if you’re not connected, right? So that’s a very, you know, strong, strong number. And so high ends, a big number, right? But the thing is, so obviously, if you look at so what you mentioned, the tournament effect, the superstar effect. That is fine. That’s going to happen in a globalized world. It’s always going to happen. And there’s no problem with that. And my problem is when it happens as a form of (inaudible) of power. So to quantify in terms of size, I haven’t looked at that specifically, but we can. But I can say that this is if it explains 20% of the variation, it’s a lot, even if that’s much, and I think it’s probably even higher,

Gene Tunny  38:06

Yeah, gotcha, okay, I think that’d, that’d be a good question to ask. Yep, yeah. And there’s quite a bit of like, it’s a it’s an interesting research field, and it’s something I’ve got to be I’ve got to look at more. We’ve got a local there’s an Australian economist, Cameron Murray, who’s done a bit of research for this. He’s got a book called Rigged, which was Game of Mates, which is, you know, interesting idea. So, and, you know, Cameron sort of looked at how decisions regarding property rezoning and all that sort of thing is highly correlated or, you know, is you’re more likely to get a favorable rezoning change of use of your property if you’re politically connected than if you’re not. So there, there’s some interesting evidence there of of the role of politics in all of this so…

Vuk Vukovic  38:55

Absolutely, unfortunately, you know, again, that’s the thing, right? If there’s, if power is too concentrated, you know, you just have to get the one person to change some stuff. You’re going to do that, right? That’s, that’s the idea.

Gene Tunny  39:07

Yeah absolutely. Okay. This has been fascinating conversation. Any final points before we wrap up?

Vuk Vukovic  39:13

I mean, yeah, I think we, we kind of summarized it well. Your questions were great. So, so thanks for that. But yeah. I mean, kind of the main message, the main argument from the book, is like, again, elites are not necessarily bad, right? You they’re like, politicians. You have good politicians, you have bad politicians, right? It’s up to us to try to make the system design mechanisms of the system that can be they can channel their influence into something good rather than something bad. That’s the whole idea. You’re always going to have bad people around, right? My point is, let’s not, you know, let’s not. So even if you need to elect someone who’s bad, or, you know, a psychopath or sociopath whatever, people tend to be calling their, their their elected leaders, and they call them all of them psychopaths or sociopaths, why even give a you know, a sociopath so much power, let’s, let’s not give them, let’s not give them that much power. And it’s not a new thing, right? If you look at countries like, you know, in Scandinavia or Switzerland, power is not concentrated, that’s, that’s the idea.

Gene Tunny  40:14

Right, in Scandinavia, Oh, yep, in Switzerland, with the decentralization, yeah, yeah, gotcha, yeah. Really good point. Okay, Dr Vukovic, that’s been terrific. I’ve really enjoyed the conversation. I will put a link in the show notes to your book. I recommend people get a copy of it. And yeah, this is something I’m going to be having a closer look at in future episodes. So again, thanks so much for your time. I really enjoyed the conversation.

Vuk Vukovic  40:39

So did I it was really good. Thank you very much,

Gene Tunny  40:43

Righto, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economicsexplored.com or a voicemail via speak pipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you, then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

Obsidian  41:30

Thank you for listening. We hope you enjoyed the episode. For more content like this, or to begin your own podcasting journey, head on over to obsidian-productions.com.

Credits

Thanks to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts and other podcasting platforms.

Categories
Podcast episode

Balancing Needs & Wants: Chris Ball, Hoxton Wealth, on Global Wealth Management in an Uncertain World – EP255

Chris Ball, CEO of Hoxton Wealth, discusses the company’s focus on wealth management for internationally mobile individuals, particularly in Dubai. Hoxton Wealth, with offices globally, offers fee-based services to high net worth and mass affluent clients, emphasizing comprehensive financial planning. Ball highlights the use of AI for administrative tasks and the challenges of property investing in the current political climate. He also addresses the debate on retirement income withdrawal rates, advocating for a balanced approach between needs and wants. Ball mentions the impact of geopolitical risks and economic trends on their business and the importance of risk-tailored investment strategies. NB This episode contains general information and should not be considered financial or investment advice. 

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com  or send a voice message via https://www.speakpipe.com/economicsexplored

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

Timestamps for EP255

  • Introduction (0:00)
  • Hoxton Wealth’s Services and Client Base (4:59)
  • Challenges in Property Investing and Political Climate (5:14)
  • Client Profiles and Financial Planning (5:28)
  • Investment Strategies and Risk Management (14:43)
  • Cryptocurrency and Geopolitical Risks (20:35)
  • Economic and Demographic Trends (23:59)
  • AI in Wealth Management (31:58)
  • Technology and Client Communication (34:37)
  • Final Thoughts and Contact Information (35:44)

Takeaways

  1. The complexity of Global Wealth Management: Managing assets across multiple jurisdictions requires expertise in different tax regimes and regulatory environments, especially for high-net-worth individuals and ex-pats.
  2. AI’s Role in Financial Planning: While AI may not replace human financial advisors, it helps streamline administrative tasks, reduce costs, improve efficiency, and allow advisors to serve more clients.
  3. Property Investment Challenges: Rising interest rates and increasing regulation make property investments less attractive, especially for those looking for passive income in retirement.
  4. Retirement Strategies Vary: Wealth management clients need personalized plans that balance their wants and needs for a comfortable retirement.
  5. Crypto’s Place in Wealth Management: Chris Ball believes cryptocurrencies are here to stay. However, investors need to be prepared for volatility and risk with crypto, making it unsuitable for many traditional clients.

Links relevant to the conversation

Chris’s business, Hoxton Wealth: https://hoxtonwealth.com/ 

Chris’s bio: https://hoxtoncapital.com/staff/chris-ball/ 

Chris Ball’s LinkedIn page: https://www.linkedin.com/in/chrisballhx/ 

Fundsmith Equity Fund mentioned by Chris in the episode: https://www.fundsmith.co.uk/ 

Controversy over Dave Ramsey’s retirement withdrawal rate recommendation:

https://youtu.be/Rc1nJj4vE_w?si=_7fVgjShgFKg6VX-

https://youtu.be/kghKiz1Mi_8?si=2jAP9DtWKN-LoR50

https://youtu.be/dM6Jqm7PPpg?si=pPvYh08bieusPBzO

Info on tax in UAE:

https://taxsummaries.pwc.com/united-arab-emirates/individual/taxes-on-personal-income

Lumo Coffee promotion

10% of Lumo Coffee’s Seriously Healthy Organic Coffee.

Website: https://www.lumocoffee.com/10EXPLORED 

Promo code: 10EXPLORED 

Transcript: Balancing Needs & Wants: Chris Ball, Hoxton Wealth, on Global Wealth Management in an Uncertain World – EP255

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Chris Ball  00:04

Crypto is here to stay number one. I don’t, I don’t really think it’s going anywhere. I think you’ve got to be quite that, have quite thick skin to invest in crypto and be comfortable with ups and downs. Probably most of these things is, as we saw, kind of pre 22 was that a lot of people don’t really understand what cryptocurrencies are and what drive them, and unfortunately, a lot of people lose a lot of money.

Gene Tunny  00:35

Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode. Please check out the show notes for relevant information. Now on to the show. Hello and welcome to the show. In today’s episode, we’re joined by Chris ball, CEO of Hoxton wealth, we talk about his company’s focus on wealth management for internationally mobile individuals based in Dubai. Hoxton wealth operates globally, with offices in the UK, Australia, the US and Europe. The company caters to high net worth and to mass affluent clients, offering fee based services. Chris emphasizes the importance of understanding clients’ needs versus their wants and developing comprehensive financial plans for them. In our conversation, he highlights the use of AI to streamline administrative tasks and the challenges of property investing in the current political climate with various left wing parties proposing radical policy interventions. OK, thanks to Lumo coffee for sponsoring this episode. This grade one organic specialty coffee from the highlands of Peru is jam packed full of healthy antioxidants. There’s a 10% discount for economics explored listeners and details are in the show notes. Okay? Without further ado, let’s dive into the episode. I hope you enjoy it. Okay? Chris ball from Oxton wealth, the CEO and founder, thanks for appearing on the show.

Chris Ball  02:22

Thanks very much for having me appreciate it. Gene, yes,

Gene Tunny  02:26

be good to chat about wealth management and what you’re up to. So you’re based in the Middle East. Is that right? Chris,

Chris Ball  02:34

exactly, yes. I’m based in Dubai. I’ve actually been in the Middle East for 13 years now. So I moved out in 2011 in August, 31 of August. 2011 actually was in Abu Dhabi for nine years, which is the capital of the UAE. So Dubai’s more well known part of the business, well part of the country or part of the territory, but Abu Dhabi is actually the capital, and that’s where a lot of the oil wealth is in the United Arab Emirates. So yes, I’ve been based here for 13 years. Really enjoy it. We built out our business here. My kids were born here. So it’s been, it’s been quite a nice place or good it’s been a good place to me, I suppose, is the best way to put

Gene Tunny  03:18

it right. Okay, and what’s your business involved? What does Oxton wealth focus on?

Chris Ball  03:22

So we’re a wealth management business team. We focus on helping people that are internationally mobile manage their funds. And we’ve also got a UK domestic business as well, where we help people domestically in the UK with their financial planning. You know, we help with everything from helping people plan for retirement, plan for their kids’ education, funding for property purchases, tax planning, insurance planning, all of this good stuff that fits under that umbrella of financial planning. We’re a fee only or fee based service as well. So we don’t get paid commissions unless it’s for insurance related products, but all the financial planning and the investment advice that we give, we charge a fee, which makes us quite unique internationally, because a lot of people still work off the commission only model, and all day, every day, we’re helping people globally manage, manage their money in The in the most effective manner. We typically have people come to us with more complex situations, so maybe assets in Australia, but living in the UAE, or assets in the UK and living in the States. And we’ve got businesses globally. So obviously, in Dubai, where I currently am, we’re licensed and regulated. Also got offices in the UK. We’re regulated by the Financial Conduct Authority. We have offices in Australia, where we’re regulated by ASIC. In the US with the Securities and Exchange Commission sec, and in Europe, our base is in Cyprus, which gives us that global coverage and enabling people move around to, you know, to manage their. Their their money and their funds and their planning more effectively. Gotcha.

Gene Tunny  05:03

And what’s your client base look like, broadly? Is it a lot of expats? Yeah,

Chris Ball  05:09

a lot of them are gene A lot a lot of our clients are expats or internationally mobile. Funnily enough, a lot of them have gone back to their home destinations as well now. So we have quite big footprints, dostically, with domestic what you would see is domestic clients, but it’s they’ve lived internationally, and now they cut, now they’ve come back. But, yeah, we, we typically help people with more complex financial planning needs than, you know, I’ve been a plumber and have, you know, put away a bit of their retirement, and they just want someone to manage it. So typically, we’re dealing with assets in multiple countries, and helping people plan for the next generation and how to how to pass it

Gene Tunny  05:46

on, right? And you have a lot of high net worth individuals. We

Chris Ball  05:51

do, indeed, yeah. So we deal with what we call mass affluent and high net worth individuals. We don’t have too many ultra high net worth individuals that we deal with our service or how we you know, the advice that we provide is is more geared to towards mass affluent and high net worth individuals, but typically, like I said, it’s more complex planning needs. So assets spread around different tax taxation rules that you need to take into account different regulatory regimes because they’ve got assets in different places and really working with them to find the best solution for them and their families,

Gene Tunny  06:27

right? Okay, before we I want to ask you a question about that. But before we do that, can you explain what do you mean by mass affluent versus high net worth? I mean, I just use high net worth individual, I sort of had an idea in my mind of what it is, but I wasn’t thinking too specifically. And then you mentioned ultra high net worth. How do you distinguish between those categories? We typically

Chris Ball  06:51

do it in kind of investable assets. So we’d say, let’s say I don’t know, half a million, up to a million, or that’s probably more like 250,000 up to a million, of assets we would class as what we call mass affluent. So there’s, you know, a lot of those people, and they’re affluent high net worth, we typically say from one to 5 million, and then ultra high net worth would be 5 million plus.

Gene Tunny  07:15

Gotcha, okay. And you talked about how you help them manage their their affairs. What are the typically, what are the things you look at, or what are the issues you deal with? I mean, you mentioned assets in different jurisdictions and tax I suppose I’m wondering, how do you, how do you go about finding a solution for your clients? A

Chris Ball  07:36

lot of people come to us with a very you know, they typically come in with one thing that they want to get, you know, one thing they want to get sorted. So let’s say a lot of our clients, what we call us connected people. So they have assets in the US, but they no longer reside in in the United States. So we would work with them to help them manage those US assets when they no longer reside in the US. But what most people really want to know is how much and when. So how much do I need and when can I stop working if I want to? Yeah, and you know, they’re the type of questions that we ask people because it’s difficult. You have to look holistically at all of their assets. You need to understand what their objectives and what motivates them and what they want to do, how much and when is very broad. How much you need will depend whether you want to fly business class, or you know you’re happy with economy, or whether you want five holidays a year, or you just want to go on one, whether you just want to travel domestically, or whether you want to live internationally, whether you want to support your kids, all of these things. It’s about questioning and listening and trying to find out, ultimately, what’s important to the client, to help them understand how much that they will need when they want to stop working. Now, where, you know, we kind of split that into kind of two buckets, which is, you know, what do I what do I need? You know, what’s a want, what’s a need, I suppose the best way to describe it. So what do I need to survive? And what do I want on top of that? And you know that also helps us understand realistically when they can retire. So you know, if you want $200,000 a year of income, and you’ve only got half a million dollars saved up at the moment, between your assignment assets in your bank account, you’re going to need to work for a bit longer, unfortunately, and helping them understand when that, you know, is likely to be given how much they can put away. And, you know, looking at realistic returns, and also stress testing that and flexing it as well. Yeah, is important. And you know, they’re the kind of things that we do, and they’re the kind of things that we really help people with. It’s about helping them develop that plan.

Gene Tunny  09:45

Yeah, gotcha. And you do financial modeling. How do you actually come up with that advice?

Chris Ball  09:51

So we’ve got an app that we have. So the first kind, I suppose, the first kind of step is, is that we would look to help people understand where they are. Are in the journey right at the start. So, you know, it’s great knowing where you want to get to, but if you have no idea where you started from, you’re not going to know how to get there. Very simply. There can be multiple ways to get to destination. So first off, it’s really getting a, you know, building a balance sheet, building a view of your net worth, of what you currently have. So we can get a good picture of where you currently are. We then go to the next phase, once we’ve got that. And we do this all on our app, our Hoxton wealth app, it’s free to download, even for people that aren’t clients, and they can go through this same exercise. The next is understanding their objectives, what’s important to them, understanding what they want out of life. Like we just said, The next phase is the modeling gene, which is we do through Cash Flow Planning, so ultimately helping them understand how much, and then looking at when. Then it is developing out the financial plan with them, step four, and then step five, which in my view, is the most important part, is constantly reviewing that with them every, every year, every six months, to make sure it’s still in line with what they want, making sure, you know, if there’s been any life changes we’ve, we’ve been working with them to ensure that their plan still works, or in making any tweaks to it if we need to.

Gene Tunny  11:17

Yeah, okay. Oh, that’s that’s good. And Have you followed this debate in I’ve seen it on YouTube between Dave Ramsey and and other financial advisors about what percentage you can take out of your your retirement funds each year and live on without running the risk of running out of money. And so one of Dave Ramsey’s colleagues, George Carmel, I think it is He. He was saying, Oh, be really conservative. There’s a he was saying 3% I think the fire people financially independent retire early people say 4% and then Dave Ramsey goes, no, that’s just too conservative. You can take 8% out or so, yeah, it was, yeah, but no one else agreed with Dave. That’s a huge controversy on about that bit of advice. I don’t know if you had a if you came across that at all, or had any views on that, but I’ll put some links in the show notes anyway, if people are interested in in checking that out. I just thought it was interesting that there was that even with someone like Dave Ramsey, who’s a well known financial advisor, he Yeah, that advice just seemed a bit yeah. It was very contentious. So there’s still some, it’s not a, I guess there is an element of that is up for debate and some of this advice. And suppose it depends on what rates of return you’re assuming and what level of risk you’re willing to tolerate. I don’t know if you’ve got any thoughts on that at all. Chris,

Chris Ball  12:55

yeah, I think the issue with kind of operating this, kind of, what the rule of four some people call it, it’s, you know, 4% which is the fire people like you said it’s, you know, it’s kind of widely adopted, I think, by a lot of planners. I mean, really, again, what we look at is, is okay, so needs and wants, you want your needs, ideally, to be built up with some kind of fixed level of income, because you don’t want to be worrying about your needs in retirement. So far, at the moment, what an area that we’re looking at for a lot of people, is using those needs or getting those needs funded by annuities, if you can do that when interest rates are high, and lock it in now, actually, that gives you a really good base in the US. You’ve got things like social security in the UK, state pension, etc, that can go towards that. But building that solid base up can be, can be a very sensible and prudent thing to do, because then you haven’t got to worry about the needs. With the wants, you can be more flexible. And typically with the wants, you want to be more, you know, in it, and you know you’re talking about 4% but you might actually want to take out 8% in the earlier years, and then 3% later on, as life tends to slow down, and that’s what we see a lot of as well. As people get, you know, older and maybe less mobile and want to go on less holidays, then you know that what’s the point in taking out more you really want to spend more in the earlier years? Well, probably when you can enjoy it, and then less than the later years, when you know, potentially, you know, health or or, or other issues, and getting around might, might prove a problem. Um, ultimately, what you don’t do is die the richest person in the graveyard, either way. Yeah. But also, you don’t want to be having to go back to work at 75 because that’s no fun for anyone, because you’ve run out

Gene Tunny  14:39

of money. Yeah. Yeah, exactly. So that point you made about, okay, make sure they get a steady, dependable income. And you were saying, annuities. What about investment property? To what extent are you getting? Are you advising them on the types of investments to generate that steady income? Do you have thoughts on. That, Chris,

Chris Ball  15:00

I think, I think property investor. I mean, look, it depends what parts, what parts of the world you’re talking about. So property investing, for a number of years, has been in vogue. So a lot of people have really found it attractive, or wanted to be a landlord. Now, what we’re finding is, with it rising interest rates, is it’s not very attractive to be a landlord. And actually, there’s a lot of headaches that come with being a landlord. So mortgage payments have gone up, but rental increases haven’t gone up as much. There’s very there’s more, you know, there’s a lot more socialist movements in the western world as well now that are making it more difficult to become a landlord. And, you know, put pushing, uh, pushing tougher regulation and on on landlords and how they operate, and then obviously, you’ve got all the maintenance that goes along with it as well. Do you really want to be trying to arrange a plumber in your 70s when you’re enjoying your retirement because your rental property is gone? Probably not. However, some people are portfolio landlords, and they’ve got, you know, a big you know that they use it for their fixed level of income. It is a great level. It is a great way to earn an income, I believe. And it should probably, you know, you should have some property in your portfolio, the cornerstone of it. But if you want a hands off investment, and you don’t like the day to day running of it, then you know, you should almost forget it, because I think it will become more of a job in retirement. It’s like most things, you’ve got to really want to do it and enjoy it, whereas your more traditional style investments, much less hands off, much more liquid. You know, there’s no management involved really, you know, by dividend paying stock or something like that. So I feel that more people are going to creep back into that side, and property will become less in vogue as we go forward. But, yeah,

Gene Tunny  16:48

gotcha. So can I understand? I just want to understand, are you, are you advising on the specific investments they should make, where they should put their money, or you just advising on the broadly what they should be saving what the broad asset allocation should

Chris Ball  17:04

be. So we’re holistic financial planners. We do take into account people’s risk tolerances and then ultimately help them devise investment portfolios that are suited to their risk. You know, we everything we do is risk created for our clients. Ultimately, we don’t want to be putting someone in 100% equities or a single stock equity, if they are if they won’t sleep at night when the market goes down by 10% you know, it’s all about what tolerance that you have to risk and how comfortable you can get with taking on risk yourself. But you know, typically, Gene we don’t advise on individual stocks and shares, so we’re not saying, buy Apple, sell Amazon, buy Tesla, sell Nvidia. They probably don’t want to sell nervidia at the moment. But ultimately, what we’re set what we’re saying to them is, is that we are broad based, indexed investors. We have a few actively managed funds in there with active managers that we feel have a good chance of beating the market over time due to their investment philosophy, which is typically long term investing. But we are in this for the longer term. We’re not day traders, we’re not jumping in and out. We’re not jumbling around asset allocation. We’re not trying to be territory specific. It’s it’s broad based, indexed investing is what we typically do,

Gene Tunny  18:24

yeah. And so those active investors, or the fund managers, where are they based? Are you able to say anything about them? I mean, I recognize it might be confidential, but what sort of businesses are we talking about there?

Chris Ball  18:38

So one of the funds that we invest in is a fund called fund Smith. I don’t know if you’ve ever heard of them before, by a guy called Terry Smith. So he’s the UK’s answer to Warren Buffett. They run about a 50 billion US dollar equity fund. They do, you know they do really well. He’s actually in our office yesterday, talking to our team. So we invested in it, in their active fund, other funds that we’ve looked at before, Blackrock world technology, we found that’s been good fun to get technology exposure, and there’s a couple of others as well. But really what we’re looking for is long term over performance of the equity market, which, as we know, it’s very difficult for a active manager to do over a long period of time. But there are the kind of, there are the there are the individuals that can potentially do it. And ultimately, I know it’s very difficult to pick them, and statistically speaking, it’s unlikely that they will over long periods of time, but we find it just offers, you know, that kind of passive, active hybrid can be quite nice and can offer some good returns to,

Gene Tunny  19:41

okay, so, well, a combination of passive and active. Okay, gotcha, gotcha. And how did you come to pick those funds you were looking at their historical performance, or you just, I mean, I imagine they do a roadshow, they pitch to you. I mean, how do you make the decision which, uh. Which fund manager to go with. So we

Chris Ball  20:01

have a fund research team that are constantly looking at different managers and speaking to them. We have a buy list, and then from that buy list we, you know, we essentially drill down. We have investment notes on each and then we’ll drill down and pick the underlying model portfolios. So we don’t tend we tend to run model portfolios again. Our our planners are financial planners. They’re not investment advisors. They’re two separate things. So we have a set of investment advisors that construct the portfolios for the financial planners. Gotcha?

Gene Tunny  20:35

Okay, yep, yeah, that makes sense. And I should ask, because I’ve had a few guests on the show talk about crypto, and what are your thoughts about cryptocurrency?

Chris Ball  20:46

I think crypto is here to stay number one. I don’t, I don’t really think it’s going anywhere. I think you’ve got to be quite, quite thick skin to invest in crypto and be comfortable with ups and downs. Probably most of these things is that, as we saw, kind of pre 22 Hey, it was during 2021 when the market, the crypto markets, got up to their highest points, was that a lot of people don’t really understand what cryptocurrencies are and what drive them. And unfortunately, a lot of people lose a lot of money when your next door neighbor becomes a expert in something. It normally means that the market is getting pretty hot and it’s time to get out. Unfortunately, when you’ve got people shouting to the moon every five minutes, then you know it’s it can make things slightly more difficult. But I do think, if you are happy for a large risk rated return, are you happy for a very big upside, but also happy to stomach that the big downside that can go with it and the volatility, then I think crypto does present an interesting opportunity. And like I said, I think it’s here to stay, but that’s not something that we would typically advise on. That’s just kind of my personal opinion on it. But as a business, we, we aren’t regulated, to advise on crypto, right?

Gene Tunny  22:01

Okay, yep, gotcha. And how concerned are you with geopolitical risk at the moment, particularly since you’re in the Middle East, is that affecting your your advice at all? Yeah.

Chris Ball  22:15

I mean, look, we don’t advise locally in terms of our you know, we’re not investing in local assets here in the Middle East. Obviously, political tensions are rising with, you know that Hamas and Israel, and now Hezbollah and Israel, that seems to be getting stronger. Obviously, if there is an out and out war, that wouldn’t be good for the Middle East, but you would expect things like oil prices to rise pretty rapidly as a result of that, especially if it’s affecting especially for other parts of the Middle East, getting involved as well, Saudi UAE, other bigger players, that would not be good necessarily, for for the overall region, in terms of locally. Are we seeing anything on the ground? No. I mean, this business is normal. You actually hear very little about it, unless you’re reading a lot of the publications. It’s not impacting your daily life in any way. Obviously, we’re looking, from a investment, short term investment perspective, at what’s happening in the US. And you know, seeing, we’re seeing how then elections in November will play out Ultimately, though, we don’t think a lot of it will impact too much. I think you know, if Miller Harris gets in, then ultimately it will continue. How, how will what we’ve seen with Biden more the same, and then obviously, if Donald Trump gets in, you know, we know that he tries and pushes up the markets. We might seem see a bit more of a short term push in it. But really, you know, the Constitution in America is, is, is insanely well guarded, and doesn’t really allow governments to make too many horrendous decisions. You know, it has to go through. Congress has to go obviously, before it can, you know, be put into action. So it’ll be interesting to see how it goes and what happens. But I wouldn’t expect anything too drastic, right?

Gene Tunny  24:07

Okay, okay, fair enough. And I’d like to ask about the economic and demographic trends and how they’ve affected your business and what you see happening over, say, the next decade or two. I mean, are you seeing changes in the demographics of your client base? Are you seeing more of the high net worth individuals due to I don’t know to what extent you’d you’d see it, but there are concerns expressed by some about growing inequality globally, the rich getting richer, the poor getting poorer, so to speak. Do you see that those impacts in what’s happened with your business, the growth of your business, the composition of your client base?

Chris Ball  24:53

Yeah, I think yes, and no, I suppose that there is obviously that worry that the rich are getting richer and the. Were getting poorer, that that equality gap, I think what we’ve seen more of is the flights of wealthy people to places like the Middle East, or places with lower taxes, as we’ve seen Taxes increase. And obviously, you know, that was bound to happen with the amount of money that they were spending during covid and, you know, trying to push the push through more money into the economies that’s got to be paid back for from somewhere. And I think it’s kind of like payback time now, especially in the UK, we’ve got a Labor government in now, and Keir Starmer came out and said, those with the broadest shoulders would bear the cost of it. You know, for everyone, basically, you know, if you’re rich, you’re rich, you’re going to get taxed more than anyone else, so that obviously, what concerns a lot of more wealthy people, I think that you’ve got the one end of the spectrum, which is the ultra high net worths that it doesn’t really matter, and they will go wherever they need to, and obviously they can pay for the advice. It’s more that kind of mass affluent ultra high net worth that it will really pinch the can’t move as easily. And, you know, we’ll, we’ll get caught up other things that we’ve seen, obviously inflation and rising interest rates. You know, that’s that’s been interesting, because we’ve obviously seen money come out of equity markets and go into things like money market instruments. So, you know, there was an insane amount last year in money market instruments, because interest rates were so high and the risk rated return meant that you could keep it there, and you were getting over 5% return. I mean, you know, why would you be investing in equity markets that had the potential to go down quite a lot? You know, technological advancements, we’ve obviously seen things like aI really driving the markets this year as well, and that’s had a big impact whether that kind of shine wears off, and what happens over the longer run is this, is there a lot of hype with looking at some of the PE ratios of some of the S, p5, 100. I mean the top seven, all of them are over 30. I think bar meta, which was at 29 that’s a lot. I mean, I think it was something like Tesla, yeah, he was paying, I think it was nearly double check, but I’m pretty sure it was like 74 I suppose. I mean, how can a car manufacturer be beat that? I know they’re trying to build themselves as more as a technological business, but crazy. So a lot of things like that are driving our business as well, because ultimately, it’s driving more wealth to people that hold that and have back technology. Shift to ESG, another one you know that we’ve had, we before, covid, if you remember, everyone was on this call, whole kind of environmental, social and governance piece. It seems a little bit less in your face now, but I think we’ll get back to that as as things, as things die down a bit more. Maybe not with a Republican, with a with a Republican Congress or republican president, but we shall, we shall see how that plays out. There’s so much that goes on that that impacts how we operate, but it’s really just trying to put your finger on it, isn’t it, and see which things really move the move the dial.

Gene Tunny  28:09

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  28:43

Now back to the show. You remind me about the tax settings in the Middle East. Said is, am I right in remembering they don’t have an income tax is that right? Some

Chris Ball  28:57

countries do, but ultimately, where I’m currently based now, the United Arab Emirates, doesn’t they recently introduced corporation tax, but there’s no income tax on individuals. Saudi Arabia, no income tax. QA no income tax. Qatar, no income tax. Bahrain, no income tax as well. So the GCC zero income tax for individuals,

Gene Tunny  29:22

right? And, I mean, Saudi’s got, I guess, does UAE get oil income too, like the Saudis do from their their state owned oil company, yeah, and have a soft and wealth fund. Okay, I’ll have to, I’ll look a bit more into it, but yeah, it might put some links in the show notes. So it’s interesting, isn’t it? That’s one of the reasons people are attracted to to Dubai, for example. And you get a lot of really good people go to Dubai. But then there’s also concerns about money laundering. I’ve seen that there’s concerns about Australian outlaw motorcycle gangs, their members. Buying up luxury apartments in Dubai high rises. There was a 60 minute story about that couple of months ago. So yeah, Dubai is very attractive to people with money from all sorts of different places in the world, all sorts of

Chris Ball  30:16

backgrounds, exactly. I mean, Dubai was on the gray list for money laundering, until recently, where it’s come off. So I think that was the kind of jolt that was needed locally. And they take it very, very seriously. So the banks over here, you know, probably more so than you get in Australia and in the UK, constantly asking you, where’s the money come from? You’ve sent money. Can you prove where it’s come from? Like, there is a there is a high area of transparency that’s needed with the banks. You can’t operate in this opaque nature anymore. You know, cash transactions for properties, they’re trying to wean out and things like that. So they are making it more and more difficult and trying to take it seriously, as you would expect from an economy that is developing and wants to be developed, and is doing, you know, all the good things that they’re doing it, it would be a shame to get tarnished with that, with that brush, but, yeah, I mean, look locally the wealth is earned from, you know, the locally Abu Dhabi, the wealth is earned from will that is then, you know, that has been their main source of income. They’ve developed the Abu Dhabi Investment Authority, and then various subsidiaries around that as well, which is their sovereign wealth fund, which ultimately they go out and invest in other businesses as well to try and buy returns. So when the oil does run out, they can continue to support the country as well. And obviously, very similar to what they do in likes and Norway Saudi Arabia’s got there, I think it’s the the PIF, the public investment fund as well. So, yeah. So, you know, it seems like a lot of these Gulf states, that’s how they want to go and do things, which is obviously great, because if that keeps income taxes down, then then that’s obviously good for them to attract wealth as well, which will ultimately be spent indirectly in their economy as well,

Gene Tunny  32:00

yeah, yeah, okay, and that’s, that’s good, Chris, it was a good overview of different, different factors, different trends. What ask about AI. You mentioned AI and you were talking about, you know, what that meant for the market, for investment opportunities, what does it mean for you? What does it mean for wealth management? Are you taking advantage of it?

Chris Ball  32:22

Yeah, definitely. I think that AI will not replace advice, because advice is about questioning and trying to work with you to get answers. But where, I think you know, ultimately, people want to see the whites of people’s eyes when they when they invest. It’s it’s nice to deal with a person. And I don’t think you’ll replace that in the in the near future. Anyway, I think ultimately, AI, what we’re using it for, is to try and limit the amount of repetitive tasks that we have to do, trying to take, you know, trying to improve our administration, processes, data entry, processes, all of these things by using AI, which ultimately, hopefully drives down costs, increases profit margins within the business, and means that ultimately we can try and help a wider range of people that need our services. Because, again, you were talking before about that equality in terms of net worth that exists in wealth management as well. I mean, you know, there’s a subset of people that could probably really do with advice, but don’t get it because it’s not profitable for firms to be able to service them. They can’t do it. They can’t run it at a loss. So yeah, so it’s we all. I think we’ll see more AI tools come in to offer simplified advice to that subset of people, and then as their wealth accumulates, then they’ll be able to deal with maybe more face to face advisors, where, when it becomes a, you know, feasible for them and for the company?

Gene Tunny  33:51

Yeah, yeah. So there’s talk about robo advisors. So is that that’s what you’re thinking about. For the people with the smaller amounts of of funds they there’d be automated advice.

Chris Ball  34:03

Or, yeah, I think, I think Robo advice is an interesting one. I don’t think a good financial planner has ever lost a client to a robo advisor. Okay, robo advisors more. I’ve got $100,000 or $50,000 I don’t want to use an advisor. I just want someone to place the funds for me. So it’s more. I think it Okay. Probably replace investment advice, but the financial planning aspect is much more personal.

Gene Tunny  34:25

Yeah, gotcha, because you have to take into account the personal circumstances figure out what Yeah. The thing I liked how you were, you were talking about needs versus wants and the standard of living that they want in retirement. I thought that was, they were good points, right? Oh, okay. And how, finally, how are you using technology to interact and communicate with your clients? So, how does so, do you have an app or a portal that they Yep, okay,

Chris Ball  34:56

so we’ve got the Hoxton wealth app gene, which is our client portal. So they can, like I said, they can see their overall net worth, their plans, their policies, they can upload their documents. We communicate through push message out to them and things like that. And we’re really developing that out to become our one stop shop to communicate with clients. We have our back end, which is our operating system, effectively, which is called matrix. And that is how we, how we, you know, do fact finds, how we manage our client relationships, how we help the advisors manage more clients efficiently, rather than through paper based things, losing data, you know, data security, data integrity, is super important to us, and also, you know, it’s, it’s, you know, worth a lot to a business in terms of management information and the like. To, yeah,

Gene Tunny  35:46

absolutely okay. And Chris, what, what? Where can we find more about you? Do you have a podcast? Do you have a newsletter that people can can subscribe to? Yep,

Chris Ball  35:57

so I feature regularly on a podcast called financial planner life. But the best place to find out more about me is through my LinkedIn profile, which is Chris Paul. If you just type Chris Paul Hoxton into the search bar, it will come up and then also, obviously our company website, http://www.hoxtonwealth.com, you’ll be able to see more on you know what we’re about and what we’re doing and how everything’s going.

Gene Tunny  36:23

Okay? Well, I’ll put links in the show notes to those, to your LinkedIn, for sure, and to your to your website. Found this really informative. And, yeah, good discussion, Chris, I like the point you made about, yeah, the risk to investment properties. We’re seeing that here within Australia, because we’re having a, you know, major housing crisis, and I guess, yeah, big increase in homelessness. That was a sharp increase in rents about a year or maybe a year or so ago, and now you’ve got a political party, which was the Greens political party, and it’s morphing into a party of renters, and they’re getting a lot of traction because there are a lot of disaffected, you know, people out there who, who are, you know, not happy with the housing situation. And so, yeah, the great, but the so I understand where they’re coming from. The issue is that the policies that The Greens are advocating for are not actually correct the problem, and could actually make it worse with their the idea of red freezes and caps and things so that all sorts of silly, you know, really bad economic policy. But yeah, I thought your point was well made, and it did it. So, yeah, yeah, absolutely, that’s a really good point. Any, any final thoughts before we wrap up?

Chris Ball  37:47

No, that’s it for me, really, unless you’ve got anything. But thanks very much for having me on. Really appreciate if your if your listeners want to download our app, the Hoxton wealth app, type it into the app store, they can download it for free. Yeah. And if you ever need anything, let me know. Will

Gene Tunny  38:04

do okay? Chris ball from oxen wealth, thanks so much for joining me.

Chris Ball  38:08

We appreciate gene thanks very much.

Gene Tunny  38:11

Righto, thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics, explore.com or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you, then please write a review and leave a writing. Thanks for listening. I hope you can join me again next week.

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Credits

Thanks to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts and other podcasting platforms.

Categories
Podcast episode

Navigating Volatile Crypto Markets & Avoiding Scams w/ Ben Simpson, Collective Shift – EP249

Ben Simpson, founder of Collective Shift, a crypto education and research company, shares valuable insights into the volatile world of cryptocurrency. Because the crypto field is filled with misinformation and scams, Ben emphasises the need for comprehensive education and reliable research before making investment decisions. He emphasises the importance of understanding the risks and potential of Bitcoin and other digital assets. He also discusses the regulatory landscape in Australia and the disruptive potential of decentralised finance (DeFi). NB This podcast episode contains general information only and should not be considered financial or investment advice.

If you have any questions, comments, or suggestions, please email us at contact@economicsexplored.com  or send a voice message via https://www.speakpipe.com/economicsexplored

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

What’s covered in EP249

  • Introduction. (0:00)
  • Crypto market volatility and how to navigate it. (1:40)
  • Bitcoin as a digital gold with potential for long-term growth. (6:54)
  • Crypto regulation, tax treatment, and education. (12:21)
  • Investing in cryptocurrency, avoiding scams, and seeking professional help. (16:44)
  • Bitcoin ETFs and investment options in Australia. (21:06)
  • Crypto market volatility, correlation with the stock market, and investment strategies. (25:20)
  • Crypto investing and decentralised finance with Ben Simpson. (31:03)

Takeaways

  1. Understanding Crypto Volatility: Cryptocurrency markets, especially Bitcoin, are highly volatile. Investors must be prepared for significant price swings and understand the underlying factors driving these fluctuations.
  2. Importance of Education: The crypto space is filled with misinformation and scams. Ben emphasises the need for comprehensive education and reliable research before making investment decisions.
  3. Regulatory Landscape: The regulatory environment for cryptocurrencies, particularly in Australia, is still evolving. While Bitcoin and Ethereum are generally considered safe from a regulatory standpoint, many other cryptocurrencies could face challenges.
  4. Decentralised Finance (DeFi): DeFi has the potential to disrupt traditional banking by offering financial services without intermediaries. This space is growing and may offer exciting opportunities for investors.
  5. Safe Investing Strategies: Ben advises new investors to start with Bitcoin and be cautious of lesser-known cryptocurrencies, many of which may lack real value and be risky investments.

Links relevant to the conversation

Collective Shift: https://collectiveshift.io/ 

Ben’s YouTube channel: https://www.youtube.com/@BenCollectiveShift 

Ben and Bergs podcast: https://open.spotify.com/show/5xir3V8fvtmHTAQy2D9dQd 

Transcript: Navigating Volatile Crypto Markets & Avoiding Scams w/ Ben Simpson, Collective Shift – EP249

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:00

Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene, Tunny, I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode. Please check out the show notes for relevant information. Now on to the show. Hello. Thanks for tuning in to the show. In this episode, we sit down with Ben Simpson, the founder of collective shift, a leading crypto education and research company in Australia, Ben shares his wealth of experience in navigating the volatile and often chaotic world of cryptocurrency investing. One of the key takeaways from our conversation is the importance of understanding the inherent volatility of the crypto market. Ben discusses the volatility of crypto markets, explaining why assets like Bitcoin can see dramatic price swings. He also touches on the regulatory landscape in Australia and the importance of having clear guidelines to protect investors. Ben emphasizes the need for comprehensive education and guidance as the crypto space is rife with misinformation and scams that can easily trap unwary investors. Finally, Ben shares his insights on the disruptive potential of decentralized finance. Defi, righto, let’s get into the episode. I hope you enjoy it. Ben Simpson from collective shift, welcome to the program.

Ben Simpson  01:39

Thanks so much, so much for having me. It’s good to be here.

Gene Tunny  01:41

Yes, it’s excellent. Ben, so you’ve been doing some fascinating things with collective shift. Could you tell us a bit about which you’re the founder of? Could you tell us a bit about collective shift, please? What is it that you’re that you’re offering?

Ben Simpson  01:55

Yes, I’ve been full time investing into the crypto space for seven or eight years, and it’s a very messy, chaotic industry, lot of misinformation, lot of bad people in the space. It’s just very difficult to get clarity on what’s going on actually when you invest in crypto. So when I first started out, I personally didn’t really know what what was going on. Took me a lot of time to figure out blockchain and Bitcoin and Ethereum and just all these terminologies and what it all meant. And I started working with someone in the education space to help people with crypto and eventually, I started my own thing about four years ago. And you know what we built now is we’re the largest independent education and research company in Australia. We have over 1000 paying clients around the world that pay us for crypto investment research and sort of advice. And then also we provide research and content to the crypto exchanges here in Australia. So those coin spot, Swift X, those are buy and sell cryptocurrency for like for retail customers, we provide them with some of their content research as well. So yeah, we’ve got a team about 10 full time now here in Australia. And yeah, we’ve been around for about four years. And my my mission is just to help people try and navigate their way through crypto the right way. Because I know I’ve been burned in the past in a space it’s very easy to lose money and be led down the wrong path. So we’re trying to just help people the right way, right?

Gene Tunny  03:19

Okay, and you mentioned that you were concerned about some of the misinformation in the in crypto, what, what type of things we we are you thinking of? It’s just

Ben Simpson  03:29

a lot. So in cryptocurrency, there’s 1000s and 1000s of different cryptocurrencies right now. So like, if you think about the stock market, there’s basically that equivalent in crypto, but a an endless amount of cryptocurrency projects you could buy, and my opinion is 95 to 98% of them are worthless, like they’re just built on, you know, community and, you know, FOMO, and you know, they don’t have a lot of underlying real value. And a lot of people get sucked into these projects, buying them with the hope of making a lot of money because they provide these crazy marketing guarantees and returns and all these sorts of things that people get sucked into and ultimately lose money. So that’s really where we’re trying to help guide people, from an education standpoint, where to invest. And then ultimately, cryptocurrency is extremely volatile, and it can be hard for someone to stomach the risk that comes along with crypto, Bitcoin on its journey from, you know, a few $100 to today, 55, 60,000 US dollars has gone up and down hundreds of times, you know, more than 10% and sometimes it goes down 4050, 60% in a period of days or weeks, which can be very concerning for a lot of people, because you don’t get that in the stock market right. If two or 3% in a day is kind of big in crypto, you could see 1020, 30% moves in a day. So we try and just help people understand why that happens, how to have the mindset and understanding of where the market’s going and not panic and and ultimately, try and, you know, not lose money. Yeah,

Gene Tunny  05:00

gotcha. Okay, there’s a few things I wouldn’t mind following up there. Ben, so, I mean, there’s the issue of, I mean, why does this happen? Why is crypto subject to such wild swings? Why is it so volatile? For one, could we start there, please? Yeah, let’s

Ben Simpson  05:18

start there. So one common thing that some people don’t know is that cryptocurrency trades 24/7 right when the stock market opened, has opened, open and closed times at Monday to Friday, cryptocurrency trades 24/7 and what we saw, you know, in the last few days in Japan, you know, Japan saw one of his worst days since the 1980s in the stock market. Recently, I think it dropped seven or 10% in a day, they hold to trading. You they literally just withdrew the sell button. You can’t sell anymore, right? In cryptocurrency, that that’s not, that’s not a thing. You can’t just hold trading in crypto, right? This is a free market. There’s no one, there’s no intermediary to stop what you’re doing. So it’s a free market. And ultimately, people you know, have emotions they fear, and if they’re going to sell, they’re going to sell. And in cryptocurrency, because the market caps of these projects are relatively small, you get these liquidation events, and what happens is basically these cascading effects of traders get liquidated, whales get liquidated, retail investors then panic, and then you get these huge fluctuations. So there’s a lot of different variables, but ultimately, it’s a free market. No one’s manipulating it from a, you know, intermediary perspective, and if people are scared, they’re going to sell. And it happens pretty quickly, right?

Gene Tunny  06:27

Okay, now, if you’re getting into this market, I mean, if you’re interested in crypto, do you, do you provide some guiding principles, or do you identify red flags. Can you tell us a bit about what new investors should be looking out for?

Ben Simpson  06:45

Yeah, so if I have a new investor that comes to me and wants to figure out how to create an investment portfolio, I really, I really try and recommend that they start off with just Bitcoin. It’s really important to understand that Bitcoin is the biggest, most leading cryptocurrency. It’s the most well known. Then there’s 1000s of other cryptocurrencies after that, right? So it’s important to differentiate Bitcoin from cryptocurrency, because Bitcoin is a cryptocurrency, but bitcoin is its own separate thing, and that’s the way I look at it. So I usually start off by just looking at Bitcoin, and Bitcoin, ultimately, for me, should, or for others, should be looked at as a hedge against, you know, your overall investment portfolio, right? It’s not correlated to stocks or the property market or bonds. It’s ultimately a completely separate asset that is in its own area. And I would probably think even only 1% of your entire net wealth into Bitcoin, I think is a pretty good good idea, just in terms of its risk to reward ratio. So the reward being potentially, if it pulls off what it’s trying to achieve. In terms of the global monetary asset, the price returns are quite or the projections are quite large, where the risk is quite minimal, in a sense of it’s been around for 10 or 12 years. It’s now got its own ETF, which was the one of the largest ETF launches in history. It’s owned by a lot of NASDAQ listed companies. You know, it’s owned by governments on their balance sheet. So, like, the risk of Bitcoin now is far, far, far less than what it has been in the past and where we think it could go. I think everyone should consider it in terms of just, even only a little

Gene Tunny  08:21

bit. Right? Okay, so in terms of where you think it can go. I mean, you, are you thinking Bitcoin to a million? I think was that? Was that Kathy Wood, did she have that prediction? I mean, is that? Is that serious or credible?

Ben Simpson  08:35

I mean, look, you know, who knows is really the answer gene like, you know, who knows where this could go? The biggest thing that I think is the most important thing to understand with Bitcoin is it’s a limited supply asset. There’s only 21 million Bitcoin that ever be created. And the supply and demand economics, as we’ve seen recently, there’s more demand for Bitcoin that there is supply, right? And just basic supply and demand economics is showing us that if you get a lot of people wanting an asset, and there’s very few, there’s very few of it, you know, the price, you know, goes up over time. Do I think you get to a million dollars? I do think you can get there at some stage. Maybe, you know, it’s probably gonna take 1020, 30 years to get there. But for me, Bitcoin compound has been compounding at 60% year over year for the last 10 years. It’s up 75% of the last 12 months. It’s one of the best performing assets on the planet. For me, I think it’s one of the best investments you can own.

Gene Tunny  09:29

Right? Okay, and what’s your what’s your theory or like, Why do you think that there is this underlying value? Because there is a lot of skepticism about cryptocurrency, particularly from economists, and there’s all sorts of concerns about regulatory risk. I mean, you pointed to the fact that, okay, it’s been held. You know, certainly people are investing in it at the moment. But, yeah, I just wonder what’s the story regarding the actual. Use case for it? Is there a use case outside of some illegal transactions? Yeah.

Ben Simpson  10:05

And I think, I think the hardest thing for most people to wrap their head around is that, you know, you can’t touch it, you can’t feel it, you can’t smell it like it’s a completely digital asset, and it doesn’t have free cash flow, right? Warren Buffett hates it. He calls a rat poison square, right? There’s a lot of people that don’t like it, because it’s not, not similar to what’s been around in previous times. If we look at a country like, you know, Venezuela, right? Or, you know Mexico, some of these places, not, maybe not Mexico, but Venezuela, right? We look at some of these places where they’re fiat currency, Argentina, sorry, who was I was looking for their local local currency has inflated so much that it’s basically worthless, right? It just continues to inflate. Because of the government has printed more and more money. So holding something that isn’t controlled by government, something that is inherently deflationary, in a sense that it doesn’t increase its supply. In fact, the circulating supply slows down. People are looking at Bitcoin now as a new digital gold, you know, not to say it’s going to replace gold. Gold is, you know, one of the safest assets on the planet, but this is a new version of gold. I use Bitcoin to pay my employees. If I go and try and pay my overseas staff with my bank account, it gets shut down. Many phone calls from their frauds team. They want to know where it’s going, why it’s going. They take huge conversion rate fees. It takes two weeks to arrive. It’s horrendous. Where I can send bitcoin instantly to anyone in the world with no middleman, and they can receive it, you know, within seconds. And that’s being utilized more and more, from from from businesses in different countries, as well, from a payments level. But ultimately, the the use case for me is it’s a digital gold. It’s an asset that, you know, continues to perform, you know, over time. And I think the best way to look at it is, is that digital gold, you know, analogy, and we’re seeing, you know, companies like micro strategy and NASDAQ, listed company, you know, holding hundreds of 1000s of Bitcoin now in the balance sheet, because if you continue to hold cash, just the the purchasing power of your dollar is doing to devalue. Like, where do you park your cash? What? What asset can you hold that’s going to be a hedge against inflation? You know, a gold has an outbeat. Hasn’t out beaten inflation in the last five years. Like, where do you put your money? And Bitcoin starting to be seen as something that you can park your capital in,

Gene Tunny  12:19

right? Okay. And what do you see is that, are there regulatory risks with Bitcoin and other cryptocurrencies? Central banks are looking at CBDCs, the central bank digital currencies. Is there a risk that there could be a regulatory crackdown on Bitcoin and other cryptocurrencies? Yeah, I

Ben Simpson  12:41

definitely think there’s a risk for some cryptocurrencies. You know, again, important to differentiate Bitcoin different to other cryptocurrencies. The SEC in the US has clearly defined Bitcoin as a commodity, and now they have their own Bitcoin spot ETF, now the Ethereum spot ETF. So the government has approved, and the SEC has approved these financial instruments to buy bitcoin and Ethereum in the US and Australia tends to follow. There’s a Bitcoin ETF in Australia, so it’s from a regulatory framework. Bitcoin and Ethereum really is in a safe category now, but there is a lot of other crypto assets that could, could potentially look like securities, and that sort of plays a bit into some of these exchanges not being able to sell it. But no, the direction we’re going in and what, what we’re seeing now from the US and Australia is that, you know, even Donald Trump, right? Donald Trump, the other day, spoke at the Bitcoin 2024 conference, and wants us to be the hub of crypto. He wants the US to be the center of, you know, cryptocurrency sort of development in the world. So, yeah, I think it’s actually moving towards politically pandering or not politically a good thing for these, these candidates, to be pro crypto, because the reality is, a lot of people own it,

Gene Tunny  13:58

right? Okay, and what’s, what’s the regulatory environment like here in Australia, been seeing some of Senator Andrew Bragg’s commentary, and like he he’s been grilling Treasury public servants at estimates hearings, and it looks like that they’ve been rather slow in in setting up a regulatory environment, would you know what the issues are there? I mean, is what needs to happen with regulation in Australia for crypto? Yeah, I

Ben Simpson  14:29

think that then we’re actually asking for more regulation. Really like, because there’s really not much clarity. Like, and as an educator and someone that wants to help consumers, there is very little regulation. It’s very much in a gray area. You go and talk to lawyers and they give they give you a roundabout answer, but you know, I think the reality is gene that this asset class is so new and so few people truly understand it, that the existing regulation of securities and stocks and assets just doesn’t fit well with crypto, because it’s so unique and it’s so different. But. Many loopholes and so many unknowns and variables. I know there was a paper drawn up about recommendations recently, but, you know, these things move relatively slowly, and it goes through a lot of hands, so I’d love more regulatory clarity. You know, we saw some pretty poor things that happened in the US over the last few years, like FTX, you know, Celsius, these crypto exchanges that were doing nefarious things, you know, ultimately, that had nothing to do with the underlying asset. That wasn’t bitcoins fault, that was people running these exchanges that wanted to defraud customers. That was their fault. And if we had better regulation and overview, perhaps that wouldn’t have happened. So we’re welcoming that. It’s just yeah, these things take time with the politics and government. Unfortunately, yeah. And

Gene Tunny  15:41

what does it mean for the the tax treatment of crypto? So if you make a gain or a profit on your or a capital gain on your crypto, you’re liable for for tax for that. Are you?

Ben Simpson  15:51

Yeah, yeah, just like normal capital gains, like, if you sell Telstra shares for BHB shares, it’s a taxable event. Um, you pay your capital gains. You know, some investors may think that they can get away with it, but reality is, cryptocurrencies are built on a blockchain, and a blockchain is an immutable ledger that anyone can see, yeah, and we’ve seen the ATO now develop software to actually go and track these, these accounts that aren’t paying their tax. All the Australian exchanges have to report on all their users, so, you know, they’re having a real crackdown on that. And as they should, people thinking they get away with it is not, it’s not the right way to think about it. You know, people are paying their capital gains. And, yeah, there’s, there’s a lot of oversight now in that tax space as well. So, yeah, very much similar to the stock stocks. How would you how you pay your tax?

Gene Tunny  16:36

Yeah, gotcha. Okay, interesting with the just going back to the crypto education. I mean, I think that’s so important. Because the concern I have is that the, you know, everyone thinks crypto is a the next big thing. And, I mean, you know, possibly it is and yet, but you have a lot of dumb money go in, and you’ve got or a lot of people who probably shouldn’t be putting all their hard earned savings into into a speculative asset. I mean, maybe, I mean, you’re steering people toward the more established ones, but they’re also, you know, there are 1000s of other crypto currencies out there. So, yeah, if you did, if you did come across a proposal or a new what is it? Is it an ICR initial coin offering? Or, if you’re looking at investing in crypto, what are the sort of things that you should be that that would be a red flag that would set off alarm bells that, because I know I’ve heard this term rug pull. How would you how would you know if you could be a victim of that look?

Ben Simpson  17:40

Unfortunately, it’s very common in the cryptocurrency space. You know, I tend to direct people in only investing into older coins that have been around for a little while, like these. ICOs, initial coin offerings were a big thing back in the day, and unfortunately, a lot of people get sucked into these because they promise return, like anything that promises returns, guarantees percentage returns over a period of time. Has crazy lock up periods where you have to basically give your cryptocurrency and lock it up for a period of time to earn rewards, anything that pays you to bring on other people, like a Ponzi scheme, anything that has crazy marketing on social media. None of these good projects do any of that. And ultimately, a lot of those are probably scams, if any of the projects you’ve invested in does that. So ultimately, focus in the top assets. You know, the top 10, top 20, Bitcoin, Ethereum. Solana, start there before working your way down. The further down the market capitalist you go, the more risky the investments are. And unless you really tapped in to know what you’re doing, it can be very difficult to navigate. You know those investments and rug pulls are common the further you go down. Rug pulls are basically, you know, if you think of standing on a rug and someone pulls a rug underneath you, that’s just really when the founder or the owner, or there’s a there’s a hack of the project, and you lose all your money. So you really do need to be careful.

Gene Tunny  18:56

Gotcha. So if someone comes to you, so would they go to the collective shift side? And then there’s a online course you can do,

Ben Simpson  19:04

yeah. So we there’s basically two tiers. So one is, we just have our platform where you sign up, you log in, you can see all of our token ratings. So we do, you know, token things like morning staff for crypto, that’s what we’re trying to build, token ratings research community. We do live group sessions. They can jump on a live session with me, and I go through the market and how I’m investing. And then we have a higher tier. For those that are a bit more have a bit more capital at play. Usually they’re wanting to invest a quarter of a million plus, or they already have that invest in crypto. That’s where you can work one on one with me. We have private events. We do online sessions, you know, private sort of WhatsApp group, where we can kind of help you out and deliver you more support. And that’s really where we have our team of analysts by your side to give you independent information. And that’s really what people pay us for, because you can go online, you can listen to YouTubers, you can try and figure it all out yourself, but it’s going to take you a heap of time. You won’t know who to trust. Most likely, the person is giving you an information doesn’t really know what they’re talking about, and you can lose a lot of money if you’re not sure what you’re doing. So that’s really where we can come and help.

Gene Tunny  20:10

Yeah. So what takes a heap of time doing the research or getting set up or getting the wallet? I mean, what? What actually takes the time probably

Ben Simpson  20:20

initially, just even researching the space, what coins to buy, when to buy, when to sell, how to store it? Where do you store it? How do you you know? How do you not stuff it up? What are the scams look like this like? As you go further down the rabbit hole, there just becomes this infinite amount of information, and you Google crypto, and you just get a million different opinions and a million different people saying different things. And I think really where the time gets sucked in is the information overload. Did you start reading it like this? Says something? This is something else. Everyone has their own opinions, which right or wrong is, Can? Can just send you down a path of confusion? Yeah, and that’s why we work with a lot of people that come to me and go, Ben, I’ve done this, or I made this mistake. Or, you know, I just need help. I don’t know what to do. Can you help me? That’s kind of where we sort of step in. And can guide you. Okay?

Gene Tunny  21:06

And so this, what would this be? Why a Bitcoin ETF is a is an attractive proposition relative to actually owning Bitcoin yourself. Or,

Ben Simpson  21:17

yeah,

Gene Tunny  21:18

am I thinking, how is that right or yeah,

Ben Simpson  21:21

there’s your two options, right? If you want to go, Yeah, Ben, I want to go buy bitcoin tomorrow. What are my options? Well, number one is, you go, you sign up to a cryptocurrency exchange, you buy bitcoin, so you deposit Australian dollars, you buy bitcoin, and then you need to store it somewhere. You either store it with the cryptocurrency Exchange, or you get a wallet and you store it yourself, right? Yeah, that’s what I do. That’s what I recommend most people do. But that is, ultimately, you have to have some sort of knowledge, right? The other option is, you go to your brokerage account and you go and buy a Bitcoin ETF, and that’s what’s been so big in the US recently. You know, there’s a about 9% of the entire Bitcoin supply is now owned by ETFs. And basically the ETF is where you buy a share and that sits in your portfolio, and then the ETF provider is buying that Bitcoin and storing it on your behalf. So you have to worry about all the storage and custody. Yeah, gotcha.

Gene Tunny  22:13

And did you say there was a there’s a Bitcoin ETF here in Australia,

Ben Simpson  22:17

there is, there is, there’s a couple. I’m not actually sure what the ticker is. I’ll have to maybe send that to you later. Gene, that’s okay, just interested, yeah, but there is one launch recently in Australia. I think it might be ebtc. I don’t know. I have to double check, but, yeah, mono, actually, monochrome. Ibtc, monochrome is one of the first Bitcoin ETF, so you should be able to get that in your brokerage account. Yeah,

Gene Tunny  22:44

but the people you’re who come to you, it sounds like you’re helping them get set up on their own. And it sounds like you’ve got, I mean, you’ve got people who are really, you know, keen to learn, keen to keen to get into crypto. What’s the demographic? I mean, can you Yeah, for

Ben Simpson  23:03

sure, it’s really two types of customers we work with. One is, you know, 50 to 65 that maybe are investing in their SMSF, or they have a large amount of funds that they’ve invested into crypto, and they really want to, wanting to set themselves up for retirement. They need some help just figuring out how to do it. And the other demographic is, you know, 3540 years old, have have a have a family, have a business, have large amounts of investments elsewhere, and they might have 500,000 a million dollars. You know, we’ve got guys right up to 25 million in crypto that have their own businesses and stuff going on, and they need our help and our research and our frameworks to help guide them through the market. Think about exit strategy, risk profile, storage, you know, asset selection, you know, it’s like in it’s your own investment. You know, family office for some people, so they need some independent guidance to help Sure. You know, they don’t stuff it up,

Gene Tunny  24:01

right? And are you, as part of that? Are you providing advice on other investments, on their whole investment portfolio?

Ben Simpson  24:10

No, no, just, just, just cryptocurrency. So we give, we give sort of general frameworks and insights and research and data to help them make they still need to make the decision themselves. You know, we’re again, back to the regulatory piece. You know, we’re going to be first in line to get a cryptocurrency financial license when we can that. That doesn’t exist right now, because crypto isn’t, it isn’t seen as a financial product in Australia. You know, well, commodities aren’t. So, you know, once that becomes available, you know, we’re going to be first in line to get that, but for now, we just give general sort of information, and then people make up their mind from

Gene Tunny  24:46

there. Okay, and so do you have the what is it? The Australian Financial Services licensed, AFSL,

Ben Simpson  24:54

yeah, yeah, that’s what. I mean, we actually can’t get one for crypto, right? Okay, yeah, because it doesn’t fall. Like, cryptocurrencies don’t fall under that framework. So we had a, we had a meeting with, you know, ASIC, a private ruling, you know, while back, and it was just, unfortunately, they can’t provide one, because cryptocurrencies don’t fall under that and that’s where that regulatory discussion is going on. At some stage it should fall under something, yeah, and they will be able to be able to go and get that, yeah,

Gene Tunny  25:20

yeah. Well, it just looks like a real dereliction of duty on the part of our regulators, because you’ve got a lot of people interested in it and investing a lot of money, it sounds like it in it. I mean, if you’ve got people with what was it? 25 million in crypto? Yeah,

Ben Simpson  25:38

wow. And, and, and we, you know, from our business model, Gene, like we, we’re purely independent, right? We charge subscription fees for our information, and that’s it, right? You’ve got others that are charging fees, taking commission on investments, selling investments, getting paid to promote tokens. Like it is the Wild West, what some of these people are doing, right? And that’s completely just unregulated. People just go and do what they want. We don’t do any of that because we’re genuinely trying to help people. But yeah, we’re wanting this to come to the space so people can, you know, be, be more trusting in the information that’s out there? Yeah,

Gene Tunny  26:14

yeah, absolutely. I think that’s, that’s a good, a good strategy. And, yeah, I mean, it sounds like you need some type of license like that. That’d be good if they can develop that, and then, particularly if advice can be provided to people about how this sits within the whole portfolio and what other investment opportunities there are out there for people. Yeah, very good. I’d like to go on before we wrap up, just to you know what’s happened. What’s the state of the market recently? So you mentioned, well, there’s no, I mean, you said there’s no correlation between crypto and other assets. I’d like to talk about that and just understand what you mean there. I mean, because big there was a bit of a sell off, wasn’t there when we had the recent sell off in, you know, the S, P and all that, yep. So, like, how do you think about that? That correlation,

Ben Simpson  27:11

declare, to clarify the price is, is definitely still correlated right now, like, in terms of, like, when the stock market sell offs. You know, there’s definitely correlation with Bitcoin. To clarify in terms of, like, where I think it’ll be in five or 10 years time, I definitely see Bitcoin as a as not being correlated with the stock market. But yeah, what we saw over the last few days with, you know, the recession fears, and then Japan selling off and you know that that that carry trade idea that’s been going on, where people are borrowing money in Japan for zero interest, and, you know, buying assets in the in in in the States, and then Japan increase the interest rates, and all of a sudden everyone gets sort of margin called that found its way into crypto. And then, you know, one of the, one of the fascinating things gene is what happened on the weekend was that if you’ve got a margin call on a weekend where you can’t go and just withdraw hundreds of 1000s of dollars from your account. It takes 123, days from your banking. Yeah, you know, just position, right? Crypto is liquid. 24/7, so people need money, and they’ve got liquidity in crypto. You can go, just pull that out tomorrow, right? You need ten million tomorrow. You can get that within a second, right? If you have those that those assets, if you want to withdraw 10 million out of your brokerage account, oh my goodness, right, you gotta call someone out. They’re going to want to know where it’s going. Why is, why are you doing that? It’s going to take multiple days to to get approval. So what we saw was, people need liquidity. They go to crypto. Crypto sold off. There’s a lot of margin calls. Then what happens is the long, the long, traders in crypto got liquidated. The price just dumped. And then that was on our Monday, and by Tuesday, Japan had sort of in the futures market had corrected. Looks like they’re starting to get the money printers going again. And then crypto sort of bounced. I think bitcoins up 10 or 12% Ethereum is up six or 7% you know, overnight. So it was one of those real technical sell off events. Fundamentally, you know, nothing, nothing wrong with the asset class. But that’s, that’s what I mean with the volatility of crypto, things can happen. You know, you’re down 20% one day and up 10% the next day. Like, it’s pretty, pretty wild.

Gene Tunny  29:15

Yeah, yeah. So you’ve got to be prepared for that, and that’s part of what your your education is. So it’s the Yeah. I should note, we’re recording this on the seventh of August in Australia. And yeah, I’m always loath to talk. I’m always reluctant to talk too much about, you know, what’s happening in the market at the moment, because things can, things can change, and by the time you put about the podcast episode out, things can be completely different. But I thought I’d ask you about that. Yeah, that sounds like, it sounds like you’ve got a good, little, good little business there, and you’re, you’re helping people, because there’s certainly a an interest in in crypto, and I think you’re, it sounds like you’re coming from the you. Right place. Is there anything else? I mean, what sort of what are you focused on at the moment in the crypto market? What, what exciting things are you seeing? Ben,

Ben Simpson  30:10

yeah, that’s good question. Gene, I mean, I primarily focus on just building my portfolio of those, those more blue, blue chip, quote, unquote, Bluetooth assets, Bitcoin, Ethereum. I’m a very big believer in decentralized finance, or Defy. You know the idea where you can take out loans, earn interest on your money without the need of a bank, and then you can buy those underlying tokens that that that support that project, and you can earn the fees and interest from the lenders and the people putting up their capital. So defi is a big place for me. I’m pretty heavily invested into that. A lot of that defi activity is built on Ethereum. I’m a very big believer in Ethereum. And then you’ve got other, you know, different things going on, whether it be web three, gaming, whether it be, you know, different blockchains. There’s a lot going on in the crypto space. Yeah, sometimes I think that, you know, and I talk about this a lot, there’s, there’s a million solutions fighting for about five problems that you know, that actually need to be sold. And I think for a lot of people, you know that follow my content online, it’s a bit of a breath of fresh air, because you listen to a lot of crypto people, and it’s just, you it’s just, it’s up only right? It’s never going down. Everything’s amazing. Well, reality is it’s not. And there’s a lot of crap in the crypto space, and I’m really pretty honest about that and calling it out. So yeah, lots going on. But for me, Bitcoin is just Bitcoin and property. For me, the two assets that really I think are going to be the best performers over the next few

Gene Tunny  31:44

years. You’re talking in Australia or Yeah, but I mean Bitcoin internationally. Oh, sorry,

Ben Simpson  31:49

yeah, Australia for property and then Bitcoin internationally. Yeah, gotcha.

Gene Tunny  31:53

Okay. So where can people follow you? Is the best place to follow you? On YouTube?

Ben Simpson  32:00

Yeah, YouTube, if you like video content, just go to Ben Simpson on YouTube. If you’re on Instagram, I put up in like, shorter form content. I put content up on Instagram. I always have my own crypto podcast called called Ben and Berg’s. If you like podcast, yeah. And then we also do a newsletter as well. So if you like email, you can head over to collective shift. There’s a newsletter button at the top, and we send, like, a weekly, weekly digest of what’s going on. So depending on the medium I’m pretty much on all them, I better

Gene Tunny  32:25

make sure I’ve subscribed to that. I don’t think I have. Sorry about that. That’s it. That sounds like the sort of sort of thing I should subscribe to. And was it Ben and Berg? Did you say Ben and

Ben Simpson  32:35

Berg’s? Yeah, B, E, R, G, s, okay. So we do two episodes a week on crypto and again, it’s really no, no nonsense, no no, no bullshit. Is we’d like to call it just sort of giving you what you need

Gene Tunny  32:49

to know. Oh, that’s good. I like that. Your final question that just occurred to me with this defy with the decentralized finance, how disruptive could that be to the traditional banks. So the big four banks in Australia here, for example. I mean, is this something that they should be they should be concerned about?

Ben Simpson  33:08

Yeah, I don’t think it will ever take over the bank stream like I think the reality is that, you know, you look at the big four banks that are probably the biggest companies in Australia, right? You know, I don’t think a lot of people are going to turn away from this, because you need some level of of skill set with defi, but I believe it’s a it’s a better model where you’re not paying the middle person. You know, look how much money Comm, bank and ANZ are making. Like it’s obscene, right? They make all these fees, and it goes to shareholders. And, you know, I understand business as business, but, you know, with a decentralized model, there is no middleman. You don’t have to pay some person in the middle just because they were there. All that money and value can stay within, you know, a peer to peer environment. And, you know, those things already existing. I can take out a loan tomorrow. I can basically take my bitcoin, and I can go and take a collateralized loan out. So I can go and put up, let’s say, $10,000 a Bitcoin, and I can, I can lend out against that Bitcoin as a collateralized loan, so I don’t have to sell my bitcoin, and I can cash flow it without selling it. And that idea, I think, is only going to continue to grow, where people can stay within the crypto ecosystem and not have to go to banks, to go and to finance different activities, you know, loans, mortgages, whatever it might be. So, yeah, I think it’s very disruptive. How long is it going to take to disrupt? Who knows? But yeah, I like that space

Gene Tunny  34:27

right? And now there’s some good companies here in Australia, or are they mainly in the US doing this? There’s

Ben Simpson  34:33

one or two in Australia. We work with a company called Block earner. They’re not purely defi. They’re more of just a lending company, a pure defi company that I’m invested in, that’s in from Australia, is called maple, Maple finance. Oh, yeah, M, A, P, L, E, and yeah. They’re probably one of the largest defi providers in the space, founded out of Sydney. So yeah, a pretty cool project. And go check out as well.

Gene Tunny  34:59

Good one. Okay. Hey, Ben, it’s been terrific. Anything else before we wrap up? No, that’s it, mate. Thanks

Ben Simpson  35:03

so much for having me. Gene and yeah, if anyone wants some some help, we also do some free, like, just a free 30 minute call. If you’re thinking about getting into crypto or you need some help, you can jump on a call with one of our team, and we can help you out. Just head over to our website, which is just Google collective shift. And yeah, we’ll see what,

Gene Tunny  35:19

how we can help. Yeah, that’s terrific. I mean it, it sounds like, yeah, you’re coming from the right place. And my, my next door neighbor at what? So in in Brisbane, Thomas, he’s well aware of you. So he’s, he gives you the big tick of approval. So, well, I’ll put links in the show notes to you all the to your to your website and to your podcast and YouTube. Ben has been terrific. I’ve really enjoyed the conversation. Thanks,

Ben Simpson  35:46

Gene, thanks for having me. Man, bye.

Credits

Thanks to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts and other podcasting platforms.

Categories
Podcast episode

The Tax Guru the WSJ says has Wall Street’s “Strangest Hustle”: w/ Andy Lee, Parallaxes Capital – EP237

According to the Wall Street Journal, this episode’s guest Andy Lee is “The Tax Whiz With the Strangest Hustle on Wall Street”. He’s the founder and CIO of Parallaxes Capital, and he joins us to talk about tax receivable agreements (TRAs). Andy explained what TRAs are, how they come about for companies going public such as Shake Shack in 2015, and why he’s investing in them. Disclaimer: Nothing in this episode should be construed as financial or investment advice. 

Please contact us with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple Podcast and Spotify.

About this episode’s guest: Andy Lee, Founder and CIO of Parallaxes Capital

Andy founded Parallaxes Capital in 2017. Previously, he was with Lone Star Funds, focused on investing in the Americas. He began his career at Citigroup.

Andy graduated from the University of Illinois at Urbana-Champaign with a Masters in Accountancy and a Bachelors in Finance and Accountancy.

Andy has been featured in publications including Wall Street Journal, Capital Allocators, Institutional Investor, NBC, Forbes, ReOrg Radio and Fitch’s LevFin Insights. He has spoken at events and conferences for organizations such as the Association of Asian American Investment Managers (“AAAIM”) and leading academic institutions including the University of Illinois, University of Pennsylvania and Texas Christian University (“TCU”)

When Andy is not working, he enjoys taking his corgi (Taco) on long walks.

Fun Fact: Andy, rarely one to back down from highly ambitious goals, ran a marathon less than 180 days from ACL, MCL and PCL surgery.

Source: https://parallaxescapital.com/our-team/ 

What’s covered in EP237

  • Introduction. (0:00)
  • TRAs for companies going public in the US. (6:18)
  • TRAs agreements and their value for private equity investors (i.e. pre-IPO owners). (12:52)
  • Tax refunds, risk management, and investment opportunities. (19:57)
  • TRAs and investment strategies. (24:47)
  • TRAs and their potential as a diversified investment. (30:55)

Takeaways

  1. TRAs convert future corporate tax savings (e.g. from depreciation expenses) into current income streams.
  2. TRAs provide long-dated, typically 15-year income streams that can be sold by pre-IPO owners (e.g., private equity investors).  
  3.  Private equity firms use TRAs to increase their earnings from the sale of businesses they’ve invested in. 
  4. Ideal Candidates for TRAs are large, stable companies with predictable long-term profitability (e.g. Shake Shack), rather than high-growth tech startups which often lack immediate profitability.
  5. US tax expertise is required to properly analyze and invest in TRAs.

Links relevant to the conversation

WSJ article about Andy, “The Tax Whiz With the Strangest Hustle on Wall Street”: https://www.wsj.com/finance/investing/tax-whiz-strange-hustle-wall-street-d51ddbc6 

Parallaxes Capital: https://parallaxescapital.com/ 

Lumo Coffee promotion

Lumo Coffee Discount: Visit Lumo Coffee (lumocoffee.com) and use code EXPLORED20 for a 20% discount until April 30, 2024.

Transcript: The Tax Guru the WSJ says has Wall Street’s “Strangest Hustle”: w/ Andy Lee, Parallaxes Capital – EP237

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Andy Lee  00:04

Tax is the largest asset class in the world that no one’s ever heard of. It’s a very much part of the fabric of our society. Like there are so many avenues through which tax assets are expressed and are monetized.

Gene Tunny  00:26

Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you could join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, and welcome to the show. In this episode, I talked to the man that the Wall Street Journal has described as the tax whiz with the strangest hustle on Wall Street. It’s Andy Lee from parallaxes capital and we’re talking about tax receivable agreements T RAS. What on earth rtra is and why has Andy invested in them? How did companies like Shake Shack end up bound by T IRAs? Stay tuned to find out. Please be aware that Andy’s firm parallaxes capital is a big investor in TRS and nothing in this episode should be treated as financial or investment advice. I would love to hear your thoughts on the discussion that I have with Andy today. So please get in touch and let me know what you think. And if you have any questions, my contact details are in the show notes. As sponsor this episode is Lumo coffee a seriously healthy organic coffee with three times a healthy antioxidants of regular coffee. Lumo coffee offers a 20% discount for economics explore listeners until 30 April 2024. Be sure to check out the show notes for more details. Without further ado, let’s dive into the episode. Enjoy. Andy Lee from parallaxes. Capital, welcome to the programme.

Andy Lee  02:09

Thank you for having me.

Gene Tunny  02:11

It’s a pleasure, Andy, I’m keen to learn about this very exotic, very interesting, and, you know, asset class I hadn’t heard of before before I learned about what you’re doing these tax receivable agreements, so keen to chat about that to start with? Could you tell us about parallaxes? Capital? What’s the idea with the name? How did you come up with the name? Absolutely.

Andy Lee  02:38

So a parallax is an astronomy term. Whereby you look at a planet from a different vantage point to arrive at a different perspective of an object. So there are several meanings in the name, the first being an ode to my old firm, it was called Lonestar funds. And so looking at a person having a different perspective, the more secular meaning around was that many people look at problems from a singular point of view. And in order to solve an equation, like you need to look at it from multiple perspectives, to arrive at multiple solution sets. And so the plural of parallax parallax cysts. And so that was as parallax was unavailable. parallaxes was, and so that was helpful. But also it talks a little bit to my faith. I’m a Christian. And as a Christian, and we’re not so much focused on the here and now, but more focused on eternity. So a very long term perspective.

Gene Tunny  03:41

Very good. Yes, it’s a it’s a good name. I always remember those that classic 1970s film with I think it was Warren Beatty, the parallax view, which is one of those great 1970s conspiracy films that I’d recommend. So yeah, very, you know, top marks on the name. So well done. I’ve got to ask me, what is parallaxes? Capital? What? So if you’re a, you’re a fund manager of some kind, or what are you actually doing?

Andy Lee  04:10

So we’re an investment manager based in the in the US and we have raised six funds dedicated to the strategy of monetizing tax receivable agreements. So a tax receivable agreement, think about it, like a long dated annuity that is not too dissimilar from a streaming royalty on metals or mining, musical royalties of pharmaceutical royalties. So long data annuity like cash flows, that we provide upfront liquidity for to holders of these assets in order for them to have to recycle that capital to do other more productive items.

Gene Tunny  04:55

Gotcha. Okay, so, a couple of things there just immediately long dated how long and by the upfront liquidity? I mean, what is this? Is this a repurchase agreement? Or are you? Are you buying them outright? What’s, how do you how are you? What’s that involve?

Andy Lee  05:16

So are the two questions the first duration lies? It’s typically a 15 year piece of paper. Just to provide a perspective on it, we actually have fun one was a 21 year of fun to hold the paper. I know I look very young as an Asian American, it’s a gift, as I’ll call it. But people weren’t sure if I was even 2001 When I went out to raise our first fund. On the second question, it is the latter. Do what you suggest that we buy these outright from counterparties, including the likes of private equity, their CO investors, management team as well as founders, providing them upfront liquidity for what is otherwise a unloved and misunderstood asset.

Gene Tunny  06:02

Okay, gotcha. Right. And what is the asset itself? So there’s obviously a stream of income coming from somewhere for this to be valuable, what is the actual underlying asset? Absolutely.

Andy Lee  06:18

Think about it almost like a tax refund, that one might receive after they file their taxes. So some here in the US, every April 15, individuals have to file their taxes, fulfilling their tax obligation to the United States. Oftentimes, many of these individuals have overpaid their taxes. And so on April 15, they would file your taxes, the US government would say, hey, Jean, you’ve overpaid your taxes by 100 bucks, we’ll pay it to you in two months. For many individuals, they might want the money immediately. And so there are businesses such as the likes of an h&r block, that would say, June instead of waiting for $100, in two months, we’ll give you $95. Today, a Buy It Now price, we do the exact same thing. But not for consumers. We do it for corporations, where they have 15 years of refunds available to them, that would come due. And so instead of waiting every year to get that annuity, they want that money today. And so we prospectively provide them that factoring solution upfront proceeds.

Gene Tunny  07:37

Ah, okay, I think okay, this is starting to make sense. Right. So what type of companies are we talking about? I mean, what from my reading? And looking into this, it looks like is this is this highly relevant to the tech sector to startups?

Andy Lee  07:55

I wish I’m the only one, it may not be the most relevant that attack sector is primarily driven by the fact that many tech firms here in United States are very focused on growth at all costs, relative to profitability, many of them, or the vast majority of the tech sector runs unprofitably Primarily because the market prior to 2020, to value them on growth, more than they did on cash flows, primarily because they believed that these were long data annuity streams. And the SAS businesses were long data annuity themes, and that whenever they stopped growing, they will become incredibly profitable. That obviously then come to fruition whenever growth stopped. So that’s not the where we primarily transact names that we’re are associated with, include the likes of a REMAX, a Shake Shack, yeah. Duffin Phelps, so large corporates that are investment grade near investment grade businesses, there’s also the Edit element that as quickly as a tech business disrupts a industry itself is vulnerable to being disrupted. And so for an investment manager like myself, focus on the space that we’re in, like, we don’t focus on the next year or next five years, we have to believe that a business is going to be a going concern for 15 years. So that’s a very different perspective or lens that you have to look at a opportunity, primarily because you might be a great business today. Do I believe that you’re gonna be a great business in 15 years, if you’re not a great business? Senior, you might be a great business for five years that will result in me getting a return of my capital. Ultimately, I’m in business to get a return on my capital. And if you’re no longer in business in your six, I got my money back. And then I just wasted a huge opportunity cost for my investors.

Gene Tunny  10:08

Yeah, yeah, gotcha. And how does this tax receivable agreement? come about? Then? And also, I mean, okay, so I guess maybe I need to go back a bit. What’s generating this, this tax refund primarily? What is it that that is generating these potential tax refunds that will be coming in the future and that you’re able to then you buy you effectively buy those tax refunds off the companies? So I guess I’m interested in what’s generating them, if there are any sort of commonalities. And also then how do you go about making that agreement? What’s the contract look like? Is it regulated? Or is there a standard form? Can you tell us a bit about that place? Andy?

Andy Lee  10:55

Yeah, absolutely. So the most common version of that is, whenever a company is going public, they enter into a specific tax transaction in the US transforming their business, from what we call a flow through, which is a partnership or an LLC becoming a C corporation, that transaction is known as the up seat transaction, that transaction enables the company to be a beneficiary of large tax assets that will become available to them over 50, typically 15 years. So that’s an incredibly valuable asset. As a result of entering to these transactions, they enter into the agreement, the agreement is relatively rote. It’s while it’s a cottage industry, much of it has been rinse and repeat it over 30 years has been around since the 1980s. And so something that as well Warren precedents, as well as presidential documents for them to follow. And so for us, these are ultimately ended up in the hands of what we call a natural holders. So in the private equity context, private equity firms have tenure fun lives. So they take a company public, and oftentimes, they sell down the equity within the 10 years that their funds allow for them. These, if you took a company public in your A these assets, then start a 15 year clock. So in your two to three, it will be your 11 for private equity fund, you’re looking to move on and sell these positions. And that’s where we stop at we’re a second during market liquidity provider for these

Gene Tunny  12:51

assets. Rod okay. And I mean, you talk about large tax assets. What if, if I understood your terminology correctly? What are you talking about? Are you talking about what is it is a depreciation or is it the things that Yeah, Okay, gotcha

Andy Lee  13:10

items that can be depreciated or amortised. So raw. What what what’s an item that depreciate a car? A building on land is not depreciable because like obviously land is the land. But things are amortised include things that aren’t intangible in nature. So customer relationships, among others, that might be available intellectual property, among others.

Gene Tunny  13:37

Gotcha. So this is a way for these companies to to get well to get to get cash to reinvest in their operations or to you know, for working capital, whatever. Can you explain what is it? What’s in it for them? Because I mean, they they sacrifice this, you know, the this tax, you know, this expense that they can use to reduce their, their tax liability in the future? They get the upfront cash, what is it? Is it is it out of desperation that they’re going into these agreements. So how

Andy Lee  14:11

I would make a slightly different connotation. Remember, I mentioned that the sellers are private equity firms, or investors among others. So at the time of the IPO, these assets are owned by the company. Remember, pre IPO, the Board of Directors got our fiduciary duty is to maximise value for pre IPO shareholders, the public markets, we as in the US have seen a massive move away from active to passive investors. active investors are very focused on understanding what intrinsic value are, and so they’re very focused on understanding the free cash flow capabilities and generation of a business. However, on the other side of the equation passive Investors are more algorithmic, algorithmic or systematic in nature and are focused on among other things, revenue, multiple growth rates, EBIT, da multiples, price earning, none of which really captured the value of tax assets, primarily because they’re less standardisation across things such as capital expenditure, and intensity of a business, working capital, cash taxes. And so as a result of not necessarily the attributes that they seek being captured by the evaluation metrics, these tax assets are ignored. And so private equity firms are saying, Look, this fundamentally improves the free cash flow generation of a business. If you’re not going to give us an incremental value, incremental value for it, we’re going to extract it for ourselves by entering into a tax receivable agreement. So the holders of these cash flows are more sort of private equity firms. As a result of the finite fund lives, we step into the breach to provide liquidity to.

Gene Tunny  16:12

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  16:17

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Gene Tunny  16:47

Now back to the show. What’s an example of a private equity firm as a Carlyle Group? Is that the sort of group you’re talking about, or KKR?

Andy Lee  16:57

Yeah, all of these massive mega funds all have trs, primarily because they had it for the investment manager themselves when they went public. And subsequent to that the principals realise the disconnect in how the the various markets private and public markets think about it differently. And if they’re extracting value from their portfolio companies, as private equity got more and more competitive?

Gene Tunny  17:25

Yeah. Yeah. I mean, it’s, it’s interesting to me, it’s one of these, these niche types of investments. I mean, honestly, I hadn’t heard of them before. You know, actually, there’s not Nishioka. Well, tell me more. 

Andy Lee  17:42

Tax is the largest asset class in a world that no one’s ever heard of. It’s a very much part of the fabric of our society. Like there are so many avenues through which tax assets are expressed, and are monetized. In the US, we have the concept of tax credits, that are now that were historically transferable or monetizable. And now they have direct pay. I don’t know you’ve been to Europe, with your significant other, and may have gone shopping in that regard. In the in Europe, there is what they call it the value added tax for which is a foreign or you can get a refund at the airport. Yep, there’s a huge business, global blue, that’s currently owned by Silverlake, that generates hundreds of million dollars of EBIT da by running the VAT tax refund programme at the airport. Similar to the example I gave you on individual taxes, that in commercial business that basically says to travellers whenever to depart in the EU, hey Jean, instead of waiting to get a check to Australia for that 1000 euros will just give you $700 Today, and they earn a sweat relative to that. There are so many businesses like that, across that run the gamut. And the lack of understanding creates the opportunity because it is the single largest opportunity set that doesn’t have commercial elements to it. And intellectual capital that has been brought to bear. Why is that? primarily driven by the fact that tax professionals here at least here in the US, when people hear attacks, they literally run away all the plug your ears, that like that’s the last thing they ever want to talk about. Every year we have to file on April 15. People consider it like being worse than going to the dentist. So like it’s something that is a very misunderstood and underappreciated even though there’s clear value add that can be created an economics that can be derived from it. Yeah,

Gene Tunny  19:56

yeah, for sure that that example you gave is a very good one. And that’s really helped crystallise in my mind. And so you’re, you’re doing what they’re doing. But with, well, you can compare what you’re doing with what they’re doing, you’re doing it for big corporations or for the private equity companies that have invested in them, they want to get out, you come in, you provide some liquidity, and you take this stream of these, these benefits that they can get from reducing their taxable income so that they will pay you that benefit associated with that in the future. You’ll get it from you get it from the company itself, too. Can you tell us what the agreement like who’s the contract or the Yeah,

Andy Lee  20:42

the agreement is between the TRA holder, then the private equity firm, now parallaxes. And the company every year, yeah, post tax filing season, the company has obligated to deliver a notice to the holders, if they utilise the asset, and the calculation of the refund, at which point of time, they have to repatriate the refund to the holder of the TRA. And so for which every q4 is a little bit like Christmas, we a little bit of an early Christmas, where we started collecting payments for the underlying payment stream. Gotcha.

Gene Tunny  21:24

Okay, so with the example you gave of the business was a silver like the global blue that does the refunds, or they will pay you up front? The VAT or the VAT refund? And they there’s a there’s a discount applied? So they get a benefit they’re taking on? Suppose they’re probably taking on less risk if they’ve got receipts? How do you think about that risk? I mean, what risk is there from, from your point of view? And how do you manage that risk? Yeah,

Andy Lee  22:00

yeah, three primary forms of risk that we manifest. The first and foremost is credit risk. So in global blues example, the EU governments failing and choosing not to, or stepping them on the pavement. For us, it’s more, it’s entirely around is the business going to exist? To the point about do I believe that this is a durable franchise, and will be around in 15 years. And so I have to believe that the company is a going concern will be a going concern, profitable and will exist in earnest. And so that’s a big part of our underwrite. And our focus on these businesses, we’re not looking for a flash in the pan, were looking for long, durable franchises. One on credit risk. The second risk is you never lose your tax asset. Like in the same way, if you don’t go, you don’t use a global blue solution, you still are eligible for the refund for multiple years. So you can go, you can fly back to Australia, on your next trip to Europe, you can file your tax refund. And that has we can do it’s the exact same thing, tax assets never get lost. They’re merely deferred. And so that has the potential to impact our IRR, which is a time weighted measure. But obviously, it’s an extent we collect it, then it doesn’t hurt our total profit dollar or mo YC on the opportunity. The last aspect is around corporate tax rates. So think about a tax acid as being the derivative of two variables, one at the tax asset itself, the notional value of a tax asset, so think about a net operating loss of 100. Think about the tax rate being your price to let’s just say 25% 100 by 25 results in a $25 cash flow. To the extent that tax rates went down and to 20%, then the tax acids 100 by 20, or $20 to the extent and went up 100 by 40, then you get $40. And so relative to most other asset classes, we have an inverse relationship to the primarily because if tax rates went up, equities likely would see some form of a correction downwards. Conversely, on the way up, ever when tax rates went down, equities would likely rally. We have an inverse relationship to that. And so for many of our investors, they view it as a nice tail hedge relative to potential policy changes here in the US.

Gene Tunny  24:47

Gotcha. Okay. So you mentioned a term before MOC. So that is multiple on invested capital. So just clarify that. That makes sense. Right? So, yeah, just thought I’d ask you about that, that risk. Because, you know, whenever you’re swapping these, or you’re taking on these, or that the stream of benefits and you’re providing upfront money, that can be risky. And we saw what happened with Lex Greensville, from the green cell family, which is a dime in Brisbane and Queensland, which is south of Bundaberg, which is where the green cell family farm is. And, you know, he was he was doing great things, but then, you know, he got into got into trouble because he thought he found this, you know, this this thing, this part of the market that no one really was properly servicing before and was providing, you know, he was buying the invoices, I think, wasn’t he and then we’re providing that supply chain finance. And then, you know, it was all working until the pandemic and and companies started delaying payments, and then the whole thing fell over for him. So he was in. And that was a real shame. What happened there real, real, real shock. So yeah, I just just wanted to ask you about the risk, because I like I just wonder, is there a risk here that? Yeah, I just want to make sure you’re I mean, I’m sure you are, you’re crunching the numbers, you’re highly experienced in this in this industry?

Andy Lee  26:22

Yeah, I think for Greensville, I mean, Dale had on the asset side of the equation, to your point, there started to being deferrals or delays to the cash flows that they were receiving, there was a little bit of an asset liability mismatch, whereby they was the liabilities they borrowed heavily, and would deliver at an incredibly aggressive rate. And so that resulted in them being unable to fulfil their obligations on the liability side of the equation today. We have also achieved securitisation. Today, our book is unlevered as we have paid it off, but that is something that we are incredibly conscious about. And look, there’s always that under inherent tail risk. The point is like you should never have too much of a mismatch. And so inherently, it’s we’re always very concerned about not having too high of a leverage level that we will be unable. Should there be shortfalls in our expectations or under writings. Yeah, yeah.

Gene Tunny  27:30

Right might have a look at some of the, what you’ve got on your website. There are some interesting things here on your website here. So I’ll put a link to that in the show notes. So parallaxes capital is an alternative asset manager and as a market leader in monetizing tax receivable agreements. Okay, so I think I’ve got a much better understanding of what that’s all about. And the stats you’ve got on your website, I don’t know if these are still current, but it says 20 Plus tax receivable agreements, purchase so they’re, so they could be large companies like Shake Shack or whatever. REMAX you mentioned that you’ve got these tax receivable agreements from and then it’s $750 million of an discounted principal balance purchase? Could you explain a bit about what what that seven 50 million figure means? Please, Andy,

Andy Lee  28:25

absolutely. Remember the example that I gave you as to the value of a tax asset such as a net operating loss multiplied by a tax rate of a 25%. We own across our portfolio $750 million of cash effective tax assets. So if you want to understand what our notional number is, you do that 750 divided by a 25% tax rate. And you would end up with like $3 billion of notional. So 30 million is what our portfolio over the next 15 years will deliver back to us should deliver back to us. Rod,

Gene Tunny  29:06

okay. And do you provide any indication of what the potential rate of return to investors is?

Andy Lee  29:14

on a net basis? We deliver call it a 15% return. Ron, okay.

Gene Tunny  29:21

Gotcha. And, Ron, so that’s obviously going to compare favourably to to more traditional asset classes, but of course, you know, risk associated with that, and nothing we’re saying here is we’re not I’m not offering any financial or investment advice, of course. Right. And who’s investing in your funds? Andy? So you’re in New York City, I believe. Who who’s investing in your funds? Is it family offices? Is it is it investment, Marilee

Andy Lee  29:54

endowments and foundations as well as small pensions? Right and Oh, CIOs,

Gene Tunny  30:00

endowments, foundations and small, small pensions Did you say confirm

Andy Lee  30:05

as well as address or CIO firms?

Gene Tunny  30:09

Sorry, I’m not familiar with that acronym IC, sorry, what type of firms and

Andy Lee  30:14

outsource Chief Investment Officer firm. Think about smaller endowments may not have the sufficient scale to hire their own research teams to allocate capital. And so they aggregate capital into a larger firm, who then deploys money on their behalf in an outsource format. As a result of that bundling, they’re able to capture economies of scale as well as gain access to best in class managers,

Gene Tunny  30:46

broad Okay, without necessarily recommending, in particular, outsourced CIO, cio firms, you know, any examples of them? I’d be interested in following up on those I can’t say I’ve really come across many of them. There

Andy Lee  31:00

are some huge ones such as a partner’s capital. A Hamilton lane, a stepping stone. Yeah, a Cambridge associates. A RCEP.

Gene Tunny  31:15

Yeah, right. Now, it’s fascinating. I mean, one of the things that our previous guest on my show, David Bahnson, who’s with oh, gee, the name of his firm escapes me, but it’s quite a, he’s got quite a reasonable amount of funds under management. He’s over at over on the West Coast. I mean, one of the points that he makes on on his capital brief show is that the the capital markets in the US are just so deep. There’s just so much. So so much money, obviously, with so much talent and so much creativity and innovation. And, you know, this is what I’m learning today is what I’m seeing today. Is is part of that it’s part of that story. It’s it’s all it’s it’s really fascinating. Yeah, so yeah, thanks for thanks for all this. I’m sorry. So my questions might be, might be a bit bit basic, but I’ve, yeah, there’s

32:14

a lot. We’re all learning together.

Gene Tunny  32:16

Very good. Very good. There’s a lot I’m unfamiliar with in this in this space. So it’s really good. My final question and it relates to a book I’ve been listening to recently. It’s Tony Robbins, his new book, The Holy Grail of investing. I’ve been listening to it on Audible. I don’t know if you’ve come across it at all. But it’s, yeah. It’s very good. Because I mean, one thing about Tony Robbins is that he just knows all of these ultra successful ultra wealthy people and he’s able to pick their brains. So he’s talking to people like Ray Dalio and, and I think Paul Tudor Jones, I think was a client of Tony Robbins. But what he picked up from Ray Dalio is this idea of this holy grail of investing and he asked Ray Dalio for some advice and, and Ray Dalio is best advice to him was, what you’ve got to find is eight to 12, uncorrelated investments for your portfolio. So he’s talking about things that, yeah, they’re uncorrelated, so they’re not going to vary. You know, what’s the right way of thinking about this there? Because the returns are so I suppose unexpected or random relative to everything else, that if you get enough of them, then you should you can outperform the market. So even if the markets in a downturn, you can still be, you can still be doing okay. So I think that’s the that’s the basic idea. I probably haven’t explained that well enough to come back to that. But I think it’s an interesting concept. And, I mean, how do you see this your tax receivable agreements? How do you see them as part of a diversified portfolio or as part of trying to achieve this, this collection of uncorrelated investment assets that Ray Dalio would call the holy grail of investing? Do you have any thoughts on that?

Andy Lee  34:10

Yeah, absolutely. So like, look, there are so many different opportunities that are as a result of an inefficient and inefficiency, opaqueness of a market as well as size of markets that create incredible moats for one to be able to harvest what I might describe as alpha from it. And that alpha isn’t necessarily something that is academic in nature, is just driven by inefficiency. That can be an opportunities like what global blue does. They have a regulatory moat. Like, no one day Oh, there’s only one kiosk at any given airport. There’s only one way for you to get a refund unless you want to go Go home and send multiple stamps and mailing your refund, that inherently has have some exposure to obviously discretionary spending, among others, but you’re looking for opportunities where they’re just such inefficiencies and markets that you’re able to harness that operational alpha, um, that can be created as a result of sourcing. And so like, I think Elliott says, is incredibly well, that they seek to sweat their assets. What they do isn’t difficult. It’s just incredibly laborious. And so that’s what we try to do at parallaxes playing in non traded markets, ie there are no brokers. Unlike a, you can’t buy this on a Bloomberg or on your friendly broker, like those are things that that require you to go out and transact on a individual by individual basis. Is it hard to do? No. Is it something that many want to do? Also very much, that’s not something that many desire to do? The best and the brightest here in the US aren’t looking to make their living and become a master of universe and tax? That’s just not something that occurs? No,

Gene Tunny  36:14

no, certainly isn’t. I think it’s so fascinating. You mentioned I mean, alpha, so you’re going for that excess return, you’re talking about excess return relative to typical market returns. And then you mentioned Elliot, and I’m trying to remember the I don’t know, I can’t remember the name of the whole firm, but as Elliott, the is that the firm that buys distressed debt, and then Sue’s the countries that it’s that it’s bought the debt from

Andy Lee  36:41

most famous for Argentina. Yeah, gotcha. Or Argentina or seizing having seized a warship from Argentina. Rot.

Gene Tunny  36:48

Yeah. Wow. Okay, I’m gonna have to cover them in a future show. That’s fascinating stuff. Okay, Andy, that that’s been do

Andy Lee  36:57

something that many are unwilling to do. Yeah. How many investment firms are willing to confront a country and confiscate a warship?

Gene Tunny  37:08

Yeah, it’s, it’s bold. It’s certainly Absolutely. Right. Okay. And it has been terrific. I’ve learned, I’ve learned a lot. And yeah, so again, it’s an illustration of just those deep capital markets and just the level of, of ingenuity, the level of rigour that is being applied to finance Well, in the US and worldwide. So this is, this is terrific. Oh, finally, I should ask is this just is this mainly a, what you’re doing this? Is this mainly applies to the US, does it? Or do you see it happening in other countries

Andy Lee  37:50

that technology can occur all over the world? Um, that’s likely not something that I thought parallaxes can pursue. Primarily because tax is a very local domain of expertise. You’re not going to have a US tax preparer. help prepare your Australian taxes. They’re just not familiar. They’re barely familiar with Canadian bumper rules, or Mexican tequila taxes. They’re very much not familiar with Australian. It’s just a local domain of expertise. Gotcha.

Gene Tunny  38:20

Okay. Right, Andy, anything else before we wrap up?

Andy Lee  38:24

Nope. Thank you so much for taking the time. No worries, I

Gene Tunny  38:28

will put a link to parallaxes capital on your on the in the show notes. And yeah, refer them to to your material. So if you’re interested in you’re in the audience, and you want to learn more about tax receivable agreements, you can you can check out Andy’s website. Andy, you’re obviously one of the great authorities on this issue. So I would definitely refer people to us. So Andy Lee from parallaxes capital. Thanks so much for your time. I really enjoyed the conversation. Take care and be well rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

39:47

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Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

Categories
Podcast episode

Unlocking the Financial Black Box: Transforming Business Efficiency w/ Andrew Walker – EP232

This episode explores the crucial role of efficient financial management in driving business performance and productivity. Guest Andrew Walker, a seasoned financial consultant, shares his extensive experience advising businesses on utilizing data for improved cash flow and strategic decisions. Walker emphasizes the transformation from traditional bookkeeping to strategic financial planning as businesses scale.

Please get in touch with us with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple Podcast and Spotify.

About this episode’s guest: Andrew Walker, CEO, Improcus 

Andrew, with over 30 years of executive management and accounting experience, across global and local markets, brings a depth of experience and credibility built across the manufacturing, retail, franchise, construction and transport sectors. Whether as CEO or on the shop floor, Andrew understands the challenges and demands of business. Andrew has an intuitive understanding of business in both financial and functional areas. His work experience includes:

  • CEO of Improcus, a South East Queensland business improvement consultants company/business and has worked with 100 companies in 10 years with an aggregate annual turnover of $1.0b CEO of AAF Industries Plc, a London stock exchange listed company specialising in design, manufacture and installation of modular buildings in Europe. The Group also included a laboratory furniture manufacturing business and a scaffolding division.
  • CFO BTR Dunlop Ltd, listed on the Johannesburg Stock Exchange, responsible for all South African operations and the Financial Controller for Africa reporting to BTR PLc. Turnover R1.0billion
  • Divisional Finance Director of Dorbyl Automotive Components consisting of 16 divisions supplying various automotive components to OEM’s.
  • Financial Controller for the Aberdare Power Group, the largest manufacturer of power cables in South Africa

What’s covered in EP232

  • Introduction (0:00)
  • Streamlining business processes to improve cash flow. (4:15)
  • Automating business processes for efficiency and growth. (9:19)
  • Improving business performance through financial analysis. (13:54)
  • Financial management and growth in a business. (18:30)
  • Financial management and business growth. (23:55)
  • When businesses need a CFO or financial controller. (28:52)
  • Private equity, AI, and business trends. (32:09)
  • Business software and data analysis. (36:22)
  • Business productivity, taxes, and insolvency. (42:37)
  • Financial reporting and cash flow management in businesses. (46:54)

Takeaways

  1. The Peter Principle in Finance: Promotion beyond competence in finance roles can critically hinder a business’s growth. It’s crucial to elevate financial management capabilities as the business scales.
  2. Automation and Efficiency: Leveraging modern software and automating processes can significantly reduce time and errors in financial reporting, enabling quicker strategic decisions.
  3. Strategic Role of Chief Financial Officers: A CFO’s role transcends traditional bookkeeping, focusing on external growth opportunities, mergers, acquisitions, and stakeholder management. Understanding when to transition from a bookkeeper to a CFO is key for business evolution.
  4. Data Utilization for Decision Making: Effective use of data, including forecasting and performance analysis, is essential for driving strategic business decisions and identifying areas for improvement.
  5. Cash Flow Management: Proactive cash flow forecasting and management are critical for navigating financial challenges and seizing opportunities, underscoring the importance of a competent finance department.

Abbreviations used in the show

  • ATO – Australian Taxation Office
  • BOM – Bill of materials
  • CFO – Chief financial officer
  • CV – constant velocity, as in CV joint
  • DIFOT – Delivery in full on time
  • ERP – Enterprise resource planning
  • GST – Goods and Services Tax
  • IPO – Initial public offering
  • PAYG – Pay as you go

Transcript: Unlocking the Financial Black Box: Transforming Business Efficiency w/ Andrew Walker – EP232

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Andrew Walker  00:04

I come across businesses, where the bookkeeper who started out with the original owner is now the CFO. And that’s the real old Peter principle that applies to finance departments as well. So, and when you have a person that has been promoted past the level of competency, what happens is they then start employing incompetent people below them.

Gene Tunny  00:33

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, thanks for tuning into the show. This episode of Economics Explored explores business performance and productivity with our special guest Andrew Walker, a financial consultant who works with businesses to improve efficiency and profitability. Andrew has over 30 years of executive management and accounting experience across global and local markets. He’s advised major companies in the manufacturing retail franchise construction and transport sectors. In this episode, among other insights, Andrew talks about how businesses could better utilise data to improve cash flow and drive strategic decision making. This episode of Economics Explored is brought to you by Lumo coffee Lumo is seriously healthy organic coffee. Lab tests have confirmed that Luma coffee has tripled the amount of healthy antioxidants and poly phenols than regular coffee. Health benefits from these poly phenols include a lower risk of heart disease, anti inflammatory effects, and improved mental and physical performance. Lumo coffee would like to offer economics expert listeners at 20% discount off all coffees for a limited time only until the 30th of April 2024. Go to Lumo coffee.com. And at the checkout, use the code explored 20 That’s all uppercase, X floored and the number to zero for a discount on all Lumo coffee valid until April 3020 20. For that code again explored 20 Check out the show notes for further details. Right. Oh, we’d better get into it. I hope you enjoy my conversation with Andrew Walker. Andrew Walker, thanks for joining me on the programme. Yeah. Good to see you again. Gene. Yes. Excellent to see you, Andrew. So I’ve been along to some of your breakfast. You’re very good at organising people. And you’ve got a really good group here in Brisbane, of business people, people with experience in the practicalities of running businesses and growing businesses. And I’m keen to pick your brain today regarding business performance and business productivity, because as economists we drone on all the time about efficiency and productivity, making a penny Dewar pounds work as my grandfather used to say something very critical, not critical, but a joke about economists. So I’m interested in your reflections as someone who who does work with businesses and advises businesses. What is it that other barriers to high performance? What is it that’s limiting the efficiency? The productivity of businesses, please? Yeah,

Andrew Walker  03:49

well, Gene, I think one of the there’s there’s a number but let’s start off and talk about some of the key ones that I deal with from a financial perspective. For example, inefficient processes. You know, outdated, convoluted processes can slow down the operations, waste, valuable time and resources, inefficient workflows also, and redundant tasks and excessive bureaucracy can contribute to decreased efficiency, and some of these sorts of things. For example, if you remember back in the day of mainframe sales, IBM had a salesperson of business development and design team, a credit approval team, and they were taken up to six months to turn a potential quote into an order. And they actually changed the whole process and made the salesperson, the responsible person to make sure it went through all the departments efficiently, and they reduced the time substantially. So I did some work with a franchisor on his sales process for bringing in franchisees and they were taking exactly the same thing six months around actually trying to vet the people, get them in, talk to them. And if you’ve got good franchisees if They’ve got the money, they want to take the opportunity, they can’t wait six months for somebody to decide whether they’re going to come in. And so we went through a workflow process, identified the issues, and actually cut that right down to one month to get the activity of signing up more franchisees a lot quicker than waiting six months to go through the whole process.

Gene Tunny  05:18

Right? What what sort of business was it that were broadly what industry was

Andrew Walker  05:22

it? I it was in the, in the industry in motor vehicles?

Gene Tunny  05:26

Right. Gotcha. Okay. Right.

Andrew Walker  05:29

You know, and other processes. For example, when we talk about processes, people immediately think about a manufacturing process in an organisation. They are lots of other processes that are actually embedded in the business. For example, I did some work with a large scaffolding business a couple of years ago. And the important thing there was their debtors were, you know, way above what they should be, and we brought them down from I think it was 65 days to I think, 45 days, there was an inflow of $1.6 million in the small business now. That’s, people think, Oh, well, what do you do, but you’ve got to examine the whole process from taking a new a new customer on what’s their credit limit, what’s the process of resolving credit notes quickly and efficiently. And so that you remove all the reasons for them not to not pay the business. And so having identified the process made people accountable within the organisation we were able to bring, the data stays down. And that helped in the sale of the business, because what was happening is we were setting the business up for sale. And the working capital average, when you sell a small business always catches people, because they think that debtors are are going to continue at that high level. And when you bring them down in a sale process, you actually have created an average working capital higher than what you should have. And therefore you’ll end up having to chip money in at the end after the when the deal is done.

Gene Tunny  06:56

Could you just go over that? Again. I’m just trying to make sure I understand that book. So I think you’ve identified a critical issue for any business, which is the cash flow. I mean, cash is king, and a lot of businesses get into trouble because they can’t manage their cash. And you had an example where did you say debtors days? So the people who owe your business money? Was it 60 days or something

Andrew Walker  07:21

like that 60 days, and we had to bring it down to 45 days to bring it in terms. And so if you when you start negotiating the sale of your business, especially with the purchase, I will lock in a date. Yeah. And in order. And through that process, I look at the last 12 months. What is the average working capital? Yeah, and when the actual transaction happened six months later, they use the average working capital. And when you hand over the keys to the business, they then calculate what the working capital is on the day and apply amid the metric to the average working capital of the previous 12 months. And if the working capital is lower than the average 12 months, the seller has to put the money into. So before you sell a business, you’ve got to make sure your balance sheet is actually well organised. The debtors are clear the creditors are always paid in terms that you can have a really good quality working capital base.

Gene Tunny  08:18

Yeah, so you’re gonna get all that lined up. So with the 60 days, on average, they were taking 60 days to pay. Right? So this business wasn’t chasing the invoices up is that right? That they weren’t managing their invoices properly? Well,

Andrew Walker  08:33

there was a lot of issues in there. Because first of all, getting the right customers, okay, don’t take on customers who are probably dodgy. So part of the whole process is, make sure you’ve got good customers. Yeah, make sure they understand your processes, and your terms of trade. And if they have credit notes, it’s important to get those credit notes processed quickly, because that becomes a reason for non payment. Right? What

Gene Tunny  08:57

What do you mean by that? Can

Andrew Walker  08:58

you explain what you mean by if I have the business $100,000 And I’ve got $3,000 I’m queering and questioning because the service didn’t happen or the product wasn’t supplied, or it’s a bad quality product. I use that as a reason not to pay the full 100,000 Yeah, so you know, it’s about processing those credit notes really quickly.

Gene Tunny  09:19

Gotcha. Okay, yeah, sorting, sorting out those issues. And so

Andrew Walker  09:23

another another sort of area is lack of automate automation, in a in a business. And once again, we straightaway think of the factory with robotics and welding and that, but also in the whole financial process, automating all the different systems to produce the financial management report to the end of the month is important. And I had a client this goes back a good few years, and their finance team took 30 days to produce the management reports of the previous month. And it was just out of control. And it was spreadsheets upon spreadsheets upon spreadsheets reconciling, reconciling reconciling and and when you When you when I laid it out on the boardroom table, because the owner didn’t believe this was this was a 30 30 million is probably a 30 40 million business now. I laid everything out on the boardroom table and said, right, you reconsider your team reconciles the spreadsheet to that spreadsheet. And I said, this is a waste of time, I said, let’s just let’s invest in some software changes. And the software changes, push the data from the ERP system straight into the financial system, they were able to produce the reports within three days, which is where you get to real world class standards. Okay,

Gene Tunny  10:33

so just for those of us who aren’t familiar with the lingo, ERP stands for enterprise

Andrew Walker  10:38

resource planning. So it’s the whole, it’s the engine room of the business. So you’d have a financial system. And then you have the engine room. So if it’s a manufacturing business, it’s the bill of materials, it’s the labour, it’s the planning, all of those things around that create the activities, which then create a financial transaction that gets pushed into the financial systems in the business

Gene Tunny  11:01

by their software packages, or applications you’d recommend for this sort of thing? Well, no, it’s

Andrew Walker  11:05

about understand well, what I found in a lot of businesses that are getting involved in is the inefficiency is they’ve bought really good packages, right? The implementation has only a 20% delay, okay. And so it’s about understanding, yeah, people have done and then actually increasing the implementation of those packages up to the right level. And so in this instance, it was using the existing ERP system, changing the report writing, creating the link straight into the financial things. So there was no reconciliations and wasting time, they had a saving because we then were able to let the Financial Controller Go, which was $100,000, salary, wasting time doing all these requests, because that was they were they weren’t adding any value in the business. Yeah, in a perpetual income 100,000 a year, that’s a million dollars in 10 years that you’ve saved by simple small automation within a business. Yeah.

Gene Tunny  12:00

And this is, I mean, this is across the economy, right? This is what I think’s interesting about this, because as economists, we we tend to assume competition, competitive markets, weeds out the inefficient operators. And to an extent that’s true, right? I mean, that’s, that’s obviously true. You do have the situation where there are many businesses that just aren’t living up to their potential. They’re, like 10 or 20% off what their potential is. I don’t know if it’s that high. But for many it could be I mean, there are there a lot of there’s still a lot of inefficiency in business out there.

Andrew Walker  12:30

You know, I was dealing with a fast moving consumer goods business, and they were, they were processing different kinds of sources, which the order would come on a Wednesday, it would be cooked Wednesday night, it would be processed Thursday, it would be on a track Thursday night, into suddenly for the shelves for the weekend shopping. They they Dafydd delivery in full on time was was around 76%. And and you know, that whole process, they had implemented SAP, yeah, but they’ve never taken it into the production area. The production painting was sticky notes or post it notes stuck on production planners wore a telephone note, you know, telephone call and email, open the door, the wind blows, we’ve lost a few levels of

Gene Tunny  13:17

production cafe, right? Yeah,

Andrew Walker  13:19

exactly. And so what happened was, you know, I’ve, I’ve pushed this all out, and we then moved as SAP implementation into the production process. And that then opened it up. And after two months of working with the team there, I’ve got it up to 99%. Three months in a row, we achieved 99% The effort, and we also moved the business away from product centric, to customer centric at the same time, which customer centric had more margins than product centric, because product centric was high volume, this just get hot volume into this.

Gene Tunny  13:53

It’s gonna ask you about this die fight. I haven’t actually heard that expression, or haven’t heard it spelled as or set as die fight. It’s a good one. I understand what what you’re talking about. I mean, that’s 76% that’s, that’s terrible.

Andrew Walker  14:07

There’s more. So what happens is you lose then shelf space in the supermarket, because you’re not there on time. So you, you you get removed from the eye level shopper wants to pick off the comfortable level and you say your shelf space then moves down to the bottom shelf, because other people have got in front of you in terms of your your your space allocation within in the supermarkets and boutique.

Gene Tunny  14:29

Sorry, the supermarkets in the TV boutique shops selling the sources in APA Gotcha. Are they met other benchmarks for what all of these metrics? So you’re, you’re a former or you’ve got experiences as a chief financial officer, is that right? That’s correct. Yeah. And are there benchmarks or commonly accepted benchmark standards for what those data days should be for what die fight should be that sort of thing. Like when you go into a business that you Are you saying, like, based on my experience or based on industry benchmarks, you’ve got to be hitting these key metrics. I think

Andrew Walker  15:08

every business, you’ve got to actually look at it and understand it. You can’t just have a, there’s not a standard, there’s a standard bent benchmark, let’s say 45 days for dead end. But if half of your sales are cash, yeah, then it’s not 45 days, it’s probably 20 days. So when I walk into a business, and I start reviewing it through my model for real improvement, I have a look at that and say, Well, if 50% of your sales are cash, we exclude that out of the calculation. Otherwise, you look pretty good, because you might be reporting 30 days. And if the benchmarks 45, but you’ve got cash at 50% It’s actually misleading. So yeah, and our fight with that fight is about delivery in full on time. Yeah. 100%. Yeah. There’s no question that’s, that’s a standard you need to achieve. And so there are lots of different ratios. And the one has to just examine the business and identify, what are the key ratios and drivers that drive profit in the business?

Gene Tunny  16:06

What was his model for real improvement that you’re talking you’re talking about?

Andrew Walker  16:10

Okay, so I’ve I’ve developed some software offers a German platform, and the software is called jeddaks. And so that actually brings the financial information in. And I’ve developed a one pager that shows how to improve the business by making high level strategic decisions in the business, if I reduced it as days by X days, if I reduce stock by y days, and I put creditors out by another two days, what is the cash impact, but that is using all the historical information. And then I do the same on the profit and loss in terms of sales price increase, volume increase, expense increase, and then that’s all hinged around the DuPont, you’ll probably know the DuPont analysis, going back to the 60s, right created the return on capital employed. And then on top of that, I’ve then introduced cash flow to that to the point analysis, because now when he developed it was about return on investment return on capital employed. Today, it’s all about cash, cash is king, as you said earlier, so I’ve got this model for real improvement, which also helps then link corporate strategy to the financials. And then you develop that if you say you’re going to increase your your turnover by 10%, you then have to drive that in the rest of my modelling down to which product, which customer, what price, what product, what channel, and that then makes people within the organisation at the coalface accountable to the corporate strategy. So that’s the one of the big things that are found. We are very good at vision mission and fluffy stuff. But when it comes in to managing the actual coalface, it gets a bit difficult because it gets blurred. So my model for real improvement then looks at and says, that customer that price in that month on those products goes up by 5%. And that’s how you achieve it. And if you’re not achieving it, then people become answerable on that monthly management sort of review process. Right, which is what happens sometimes in businesses is the turnover goes up 10% For something totally different reasons. The core strategy is never dealt with. But we all pat ourselves on the back saying, Oh, we we achieving our corporate strategy, when in fact, we haven’t addressed the items that was identified at the strategic sort of review. Right,

Gene Tunny  18:30

gotcha. And how do you make sure that the people at the coalface are doing the things that need to be done to hit the targets? I mean, I do go and talk to them. You have dev workshop with them how to,

Andrew Walker  18:43

okay, so I’ve been, I’ve been working with a group of highly intellectual individuals in a business, I like to keep them the name out of the podcasts. And they were very focused around delivering their professional skills to their clients. Yeah, with no concept of profit. And there was just one high level p&l, then actually, and the profit had come down over a number of years. And you know, it was on a reduction, and I got involved to help them. And one of the things I did is turn it on its head and said, Well, hold on. You’ve got regions here, let’s let’s put in regional profit and loss statements, and then make the regional managers accountable. And then in this modelling of mine, I then took it down to how many hours are each of the people going to be working? What is the efficiency? What is the sale rate, what is their cost rate? And so now we’ve got this model that they can actually change every month in terms of this person is going to be off for three weeks or take him outside adjust the turnover. And this modelling then creates the three way financials, cash flow, balance sheet and p&l. And so that date in every, every month we review it and have a look at what’s happening within the business and make adjustments to look at the full We have forecast, as a result of I think, as a result to bring in that to play in the organisation, together with focusing around improving the efficiency of the computer system they’ve got they’ve got a cracking system, but they weren’t even touching the surface in terms of the capabilities of that software. I think the this year if it all goes to plan, we would have trebled the previous year’s operating profit.

Gene Tunny  20:25

Wow. Right. And that’s by giving people a better understanding of, of what actually contributes to the bottom line, what the

Andrew Walker  20:36

there’s an understanding hours rates, cost, expenses, margins, selling price to customers, all those things come into play when you’re having those discussions. Gotcha. Okay.

Gene Tunny  20:47

Are there any other barriers? We’ve been talking about barriers to to higher performance?

Andrew Walker  20:53

Yeah, I think, you know, I’ve got an interesting one. And this is, this is where the company starts out very small, the owner brings in the bookkeeper. And as the business grows, he doesn’t look at the finance department, and let it grow with the business and bringing the right financial level skill. So I come across businesses, where the bookkeeper who started out with the original owner is now the CFO. And that’s the real old Peter Principle and applies to finance departments as well. So and when you have a person that has been promoted past the level of competency, what happens is they then start employing incompetent people below them. And because they can’t afford to do the work because of the level of competency, and this always becomes manual and then and so I have this thing, we all know E because mc squared is speed of light, I say the Peter Principle of competency plussing competencies in competency cube, which is the speed to insolvency. And so and I’ve seen this before, we’re the bookkeeper, you know, rises to that position. So as a business is growing, it’s not a barrier, but it’s been able to recognise that as your business grows, you need to introduce different levels of people within the organisation. So you’d start out with a bookkeeper, maybe you then have the tax accountant to a point sometimes people hold on too long to the tax accountants, as the business is growing. And then you go to a financial controller, or Phantom, CFO, Lakhmi, or who then when it gets big enough, you need a real CFO and people don’t understand what a CFO is, versus a financial controller either, you know, CFOs, external mergers, acquisitions, stakeholder management, etc. And you’ve got to be ready to grow at that level before you start bringing CFOs into your business

Gene Tunny  22:46

for CFOs. You’re you’re about creating possibilities. We’re not just being a bookkeeper. But what are the risks? I mean, you can expand on that, but what are the risks of just having the person who started out as your bookkeeper become? Your effective, you know, become the CFO of as your business expands from being a small business to having, you know, millions or 10s of millions or hundreds of millions in revenue? What are the risks? What can go wrong?

Andrew Walker  23:10

Well, I think that the risks are, that person doesn’t actually grow with the business and start looking at the risk profile. You know, if we talk about a bookkeeper does the accounting the day to day bookkeeping of the business, but as you start growing, you start getting increasing your debtors? What about credit limits? What about the risk profile? What about your insurance? What about the systems as your business is growing? You know, a good CFO strike financial controller will be in the business, he’ll have the accounting work working really well. And a good solid bookkeeper is a person who consistently does the same thing all the time, at a high level of quality. And a good CFO will be across the business looking at systems and processes and thinking outside the box. Yeah, I think that’s the difference, I think. And I say this, and I’ve come up the finance route, so I can be critical of my own professional. Good Financial Controller doesn’t necessarily make a good, a good CFO, in the in the different financial controllers, inwardly focused, producing management reports, running the business. From that point of view, a CFO is looking externally outside the business risk profile opportunity to grow. Yeah.

Gene Tunny  24:22

So on these risks, I’m just so where the businesses get into trouble. I mean, they can I mean, some are just there are some that are going to be unviable. But there are many businesses that that actually end up. You know, they end up basically having to wind up because they mismanaged their cash or that if

Andrew Walker  24:41

you talk to any or most liquidators administrators and you say to them, what is the first impression you have when you walk into one of these distressed businesses? And they’ll tell you 80 to 90% of the time, the finance accounting departments in a mess, right, yeah. And that’s where you then have a bookkeeper who He’s become the CFO doesn’t understand the risks involved in running a much bigger business because their, their, their, their processes around transactional, yeah, processing, invoices credit, all those sorts of things and not looking at the bigger risk. And that’s that’s the real issue with regard to you know, these distressed companies, the accounts are in a mess. So you don’t know your product profitability, your customer profitability, where your market growth are, what’s your gross margin? What’s your breakeven, all those critical things that good? Finance controller Cummins CFO?

Gene Tunny  25:37

Net? Right. Yeah. So you could be losing money? Yeah, you’ve got you haven’t got your you’re not? You’re not selling in the right areas? You haven’t got your pricing, right. You’re not making enough money? Yeah, so yeah. Okay.

Andrew Walker  25:52

And so that comes to to what I call the financial blackbox. Yeah. So before you take off in there are playing on your journey of building this business, know what’s in the in the black box. And that’s around understanding what the financial department does, and how they can add value in your business. A lot of finance departments are seen as an overhead, an extension of the ATO to do the best and the GST and the PAYG, etc. But the finance department in a good business provides really quality information to help people make good decisions around what they do in in their business.

Gene Tunny  26:32

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  26:37

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Gene Tunny  27:06

Now back to the show. What are they doing? You’re doing modelling of, of, you know, what different scenarios? Are you thinking about shocks that could hit the business, what sort of works been done in

Andrew Walker  27:21

terms of just a normal. So the way I approach when I look at businesses and I’ve I’ve asked to come in and help, they could be distressed, or they could be growing exceptionally and need some support. The first port of call is the financial system, the financial systems have to be sound and producing accurate quality, timely numbers. And once you’ve got that in place, then you will identify then I start mixing in products, customers, margins, and the non financial elements and merge them together to get some kind of value reporting around. How do you improve the business? Once you’ve got that you can then start doing your ratio analysis and saying, where’s the gaps? Yeah. And then once you’ve got the gaps, and with my modelling, for real improvement, you can then say, what if? What if I put the prices up? And the volume goes down by percent? Or what happens if I put the the volumes up and prices up? What’s the impact, and that then gives you cash flow. But also having identified the gaps. I talked about the p to the power of four, which looks at the process, the process mapping the productivity of the people in that process, the proficiency of those people doing the processes, and then the profit and how the profit is generated. And that that then wraps into a good action plan to help the business go through its problems of getting back to normal profitability again. Yeah,

Gene Tunny  28:52

this is great. So you’re crunching the numbers. I like that. Yeah, because a lot of businesses I mean, they’re, you know, they’ve got founders and the founders, obviously doing something, right. Because they managed to, to grow from just being a micro business and they’re starting to, you know, they’re getting sales and they’re taking on employees, and they’re doing what works for them. But in your experience, you think all on their growth on on their journey through those like I often look at that I watch Dave Ramsey stuff. I don’t agree with everything he says, but I think he’s got some good points. I like his framework for the different stages of the business and how they, they start off with being a mum and dad business. So we get his actual terminology. But you know, the idea is you want to go through these different stages of being a trailblazer and then end up at at legacy and all of that. And I’m just thinking there, I mean, we we’re in the journey of being a business should should, should a business owner be thinking of getting a CFO or going you know, moving in If you’re having a bookkeeper or just having an accountant who helps them out with tax,

Andrew Walker  30:03

yeah, so I think I think it’s an that’s not a simple answer that if I hit this turnover, people have this perception I’m doing 20 million, I need to see it depends on a number of things in the business, you know, if you have a very simple business, which is purely trading, urbanna sell, and it’s a simple transaction, do you really need a CFO in your business, because you’re going to bring the CFO in, he’s not going to actually add the value you want. And invariably, he’s going to get bored. And you’ve wasted the the investment of recruiting somebody who then moves on very shortly afterwards, because it’s a simple business. But when you start getting into, for example, manufacturing, and you’ve got bombs, and you’ve got, you know, having to back flush your bombs in terms of understanding what’s happened in the business, then you should be looking for a financial controller in terms of getting into the nuts and bolts of reporting activities in the factory, the number of tonnes, the tonnes use the scrap, what does that bomb, say? Are we producing more scrap than what the bombs? Do? We need to adjust that that affects our price? What about the process of steel Steel’s gone from it? You know, it went up 25% Down again in the last couple of years. And if you didn’t have somebody on the numbers there, you could have lost a lot of money in an organisation.

Gene Tunny  31:19

What was what were you saying bombs? Will you believe material are sorry?

Andrew Walker  31:25

We’re not going to blog, anything but

Gene Tunny  31:29

materials, materials that

Andrew Walker  31:30

you know, and that’s important. And and then when you in again, back to understanding that the lifecycle of a business Yeah, is there is a point when you’ve established yourself, you’ve got a good business, you’ve got a good product, you know, everything’s good, the culture is good. And you want to now do the big the big expansion, that’s when you start thinking, I need a CFO, if I’m going to IPO it, you know, listed or stake other stakeholders in or I want to exit Yeah, you know, that’s when you need them the CFO. So and it’s not around turnover or number of people, it’s around the type of business and how you operate within that business. Yeah.

Gene Tunny  32:09

As someone who works with a lot of businesses. Do you have any thoughts on this whole, you know, the private equity, sort of, you know, that industry, because I’ve had, well, I’ve had a guest on previously who’s over in Rhode Island. And what he does is he’s looking around for smaller businesses that he can come in, and he can take over and then and then sell at a later date improve things. So I’m just wondering, do you have any, do you have any thoughts on that? I mean, like, there’s a lot of, you know, there’s a lot of negativity out there about private equity, there are people sceptical over there are people who accuse private equity investors have been vultures. Any thoughts on private equity at all? Andrew, I

Andrew Walker  32:57

think I think back everything, this is a spectrum of private equity companies. And if I could define it in the, at one end of the scale, they probably private equity, who want to buy a good business, and they can offer their investors a better return. So they don’t actually do anything, they try and buy low, and then they provide a bigger return. So if you, if you’re in high net worth individual, and you’ve got a couple of million, you want to check in with some of your mates, you can buy business, and you’ll probably get a better return than you would with the banks. But there’s obviously risk with that. So you get private equity that fill that space, and then manage the company. And sometimes you do find, you know, private equities, they have it for three or four years, and then they flick it on to another private equity, and it just keeps rolling around in terms of, but what they’re doing is giving their their investors a better return than what they would have got elsewhere. So that’s the one scale. Yeah, he got to the other scale, you get the private equity, who are looking for the roller. So for example, there have been a few good ones like that the vets the greed, CrossFit story, where they went around and rounded up all the small private vets and brought them into a single group got purchasing power, and helped them with their business, streamline their processes, and then IPO that and made a lot of money out of it. So you get to two scales and like everything, there’s good accountants, but I in my presentations, I have the good, the ugly, what’s the good, the bad and the ugly? And in that spectrum, you know, it’s the it’s a wide spectrum of people out there all looking to make some money and it’s how they do it.

Gene Tunny  34:40

Yeah, gotcha. Okay. Okay. Now, what are the big business trends you’re seeing at the moment? Andrew, do you have any thoughts on AI, for example, how that’s impacting Oh,

Andrew Walker  34:52

that’s, uh, I think in my area, I think we’ve got a long way to go. You know, everybody’s got this buzzword and we can all look up chat, GP or PIO, and get a big download of a whole lot of stuff. And I think we smart. But I think in the finance world, we’ve got this great opportunity to actually develop AI. But it’s going to take, you have to teach AI to produce what you want, for example, so analysing businesses, financial businesses, and then using AI, to, to benchmark that business against the local industry, in terms of what’s out there. And the National, and maybe the international share prices, exchange rates, all those things could have a big impact as your business is growing to use AI to, to give you some kind of understanding on what to do within your business. But I think we saw a long way before we get to that. I mean, AI is getting implemented in a lot of the software to be able to do that now and the software that I’m using jet ox, they’ve got a module on AI. And so you know, we, the, the corporate performance models are really starting to introduce that. But I think we slow way off. But it’s going to be like steel, steel, steel belt tires versus Canvas, you know, what’s ever going to happen. And when they crossed, it was almost exponentially he went to steel belt. So I think there’s going to be a point where AI will just really take off. Yeah, so what’s jet ox again, that jet ox is the software I use to do that I’ve used to develop my modelling. So it’s a big corporate performance management software, right, that big corporations are using in terms of producing this new way financials, their dashboards, because it can drill into different systems, financial, non financial, the ERP systems, and pull that data in and then create dashboards for for managers and team leaders and supervisors to see where they’re going. But then it also links it to the financial, so then you can start pulling your financial in and have really good quality ratios around using non financial data and financial data and creating activities around how do I improve the

Gene Tunny  37:07

business? Gotcha. Now this, hopefully, you can answer this, I think you can answer this question because it’s something I’ve always wondered. And I’ve sort of vaguely a sort of a vague understanding of what SAP or SAP is that system, what is it and how does it relate to the jet ox? Okay,

Andrew Walker  37:24

so, yeah, that’s, that’s an interesting question, because it blows open a hole. Right? In terms of, if we start on the other end of the scale, you’ve got my OB, and you’ve got zero and all these packages. And they produce financial results. And then what they’ve done is they’ve linked other applications or apps to create other kinds of things around the financials, the payroll, or CRM packages, Customer Relationship Management packages. And that’s it. It’s a very small thing. S AP is right at the top where they try and do all of that for you in one package. Right? Which makes it really expensive. Yeah, because then you also almost are actually customising the software to suit your business. Yes. And the business has changed. I think in Australia, there’s a lot of small to medium sized businesses and SAP are now coming up with as it was, I don’t know how long it’s been out. But it’s a PB one, which is for smaller businesses. Because I’ve seen there’s an opportunity in the market. But you know, all the software you finding, they can’t cater for everything, you’d have a really good software package that looks after an engineering shop is a cut up so they’d have the nesting of how you cut your, your laser cutter to not only one big sheet of steel, you’d want to nest all the products on once you get maximum use of the steel. And all so that’s been designed by a really intelligent engineer understanding that business Yeah, but he has no idea of financials or raw customer relationship. So then you have these add ons. Yeah, where’s SAP tries to do everything in one raw. Okay, so jet oxen sits on top of those, that software not not SAP, where you’ve got an ERP system, you’ve got Salesforce manager, you’ve got a financial package with sage or BB or QuickBooks or NetSuite, whatever it is, and you can draw it and he’s competing in, in the space of Power BI, which I don’t really write in terms of raw of widget oxes because jeddaks is right up there with some of the top players.

Gene Tunny  39:43

Okay, I’m gonna have to look at jedoch so I haven’t come across it before.

Andrew Walker  39:47

It’s new in Australia. Yeah, um, practice. One of the gold partners of Jeddaks

Gene Tunny  39:53

Oh, great. Yeah. Okay. Yeah, definitely have to check it out. I think what what you’re This discussion is highlighting to me just how challenging it is really, if you’re in a corporation, you’re in a business or any, you know, even an SME, just how challenging it is getting across all of the data or the financial and performance information within your business. And that’s why you need to have those systems and you need someone like yourself or, or a team that can actually drive it and make sure all the data are sort of, you’re getting the data you need, and is producing those reports that are necessary to make the decision so you can move in time to take advantage of the opportunities

Andrew Walker  40:35

that are in that it’s very interesting, because there’s so much data coming at us new skill, in my view, is is how to interpret that data quickly. Yeah, and get it in a succinct format to make decisions. Yeah, and now you get in every way you look, whatever you’re doing, there’s a data recording. When you’re shopping at Coles or woollies, or you know, all that’s happening all the time. And so those suppliers, and those manufacturers and producers are getting all that data and there’s a there’s an opportunity or not an opportunity. But it’s it’s a problem, because you can end up with data overload. Ron and organisation. So you’ve got to have the skill to be saying, what data do I need out of all this data? And how do I best presented to understand what’s happening in a trend? Or and then make decisions on it? Yeah, and just coming back to your previous question, genius, you have all these systems. And what I believe is, you’ve got to create the electronic thread through your business. And that that thread takes every single system and it weaves its way through. And once you get this electronic thread, you’re actually creating a competitive advantage that nobody can steal. If you make a product, people will take the product, they’ll reengineer it, they’ll ship it to an offshore country, and have it manufactured and come in and smash your costs to your selling price and, and take your market. But if you’re a business, and you’ve got an electronic pipeline, that links your front end of the business, the customer end right down to cash in the bank, the inquiry all the way through to cash in the bank. And if you if you work on getting that really efficient, what it does is nobody can steal it, they can steal people out of your organisation, but that could actually creates a really good culture. And it also then what it does, it makes your systems efficient. So you can put more volume through that swelling the belly. Andrew, do you have any? And

Gene Tunny  42:37

I know this is almost an impossible question to answer. But do you have any feeling for what you know what percentage improvement across industries we could get from? You know, just sorting this sort of stuff out? Right? For, you know, among, among businesses out there? Because it sounds like, look, there are a lot of the sounds, it sounds like there’s potentially a lot of inefficiency or a lot of bad processes that that need to be fixed up across businesses in even in advanced economies, such as Australia. I mean, obviously, we’re, we’re probably far ahead of businesses and some other countries, but what’s the what’s Do you have a general feel for that?

Andrew Walker  43:16

Ah, I think in the businesses operating with small to medium, you know, Bologna, 100 million turnover. Every business, I walk into this opportunity, every single and but the problem is, is people don’t recognise that the owners believe the business they’ve created, they’ve developed it, and you’ve got to have a catastrophic event to happen for them to say, I need help. And that’s, you know, where were you then get the introduction into going into these businesses, and then creating the opportunity? I think, in every single business I’ve worked in over the last 1617 years in Australia, I’ve created increased wealth for for the owners, what percentage and how does that relate from, from your point of view of the macro environment? I couldn’t I wouldn’t even ever guess at a time. That’s

Gene Tunny  44:06

okay. It’s one of those very difficult questions to answer. I’ll have to look to the economic literature and see if anyone’s tried to quantify that that recently, because there are all sorts of studies of, of, you know, how far firms are from the world’s best practice, or you know, what they call the efficiency frontier? Yep. So I might go back and look at that literature and see what that says, but just just chatting with you. It occurs to me too. I mean, yeah, there could be some real productivity gains that we could make in our economy. And that gets me thinking. And, you know, if you’re thinking productivity, you probably shouldn’t then government, but is there is there anything government should be doing? Are there any policy levers that should be that could be pulled or changes in In tax or regulatory settings, do you have any thoughts on that? You’ve gotten

Andrew Walker  45:04

into the big macro worlds? Yeah, in terms of taxes and reducing taxes. And, and that’s those are all very complex discussions to bring down into something simple. I think, you know, I said to most of my clients say always bitching about paying too much tax. Yeah, I say to them, You know what, the more tax you paint means you’re more successful. So let’s get away from, you know, worrying about that to focus on your business, and drive your business rather than worrying about tax and regulations and things like that. Yeah,

Gene Tunny  45:35

I think that’s a really good point. Now, just going back to our discussion of the risks, and one of the risks is, you’re not you’re not managing your cash, well, you’re not actually accounting properly for the fact you will owe tax in the future. And so so many businesses get into into trouble like that. And now the ATO our tax, our Australian Taxation Office, they’re chasing our businesses, and they’ve been pretty hard headed. Yeah, really aggressive about it. And then that’s what’s driving up the insolvencies to an extent here,

Andrew Walker  46:06

I think that’s a bit of a lag from the COVID era that people businesses that should have gone, gone to the wall then survived through job keeper, those sorts of things. And but I think we now seen that and we also seen the person insolvency starting to come through they also up a lot higher compared to the previous year. Yeah, I think that’s a hangover from the COVID days. Yeah. But you know, I mean, if you look at what why did why businesses, why did they go insolvent or be put into administration? And I would say, 80 to 90% of the time, it’s management, it’s bad management in the organisation, you’re going to have catastrophic events, major data fails on you. But as management, you would have seen it, it’s a large data. How did you do the risks? What risks did you take? Did you take insurance on it? So? Yeah, I think that yeah, in terms of, of businesses, and risks, and cash, if you’re running your business well, and you can see the margins and you’re getting monthly reporting happening, that is where you actually drive the business. But if you have a bookkeeper who’s been doing the work and is now in that elevated position, they don’t understand the importance of of producing results three or four days after month in and out of interest from Alan Jackson and and if you know Alan Jackson, he used to sit on the reserve, the Australian Reserve Bank, O ra going back, I don’t know 2025 years ago, when I was going through the BTR thing I had to ask the comptroller for Africa for Dunlop, and three days off the mantained i to produce to London, a set of turnover and operating profits for the Dunlop business in Africa. Yeah, in seven days, I had to produce a set of financials three way with the reconciliation waterfall analysis. And by day 10 We were in the boardroom was Alan Jackson and he wasn’t a con man. He was a real driver. He took the business from, I think about 700 million to $3.4 billion and increased operating profit from I think 14% of sales up to 16%. So he drove that business but one of the real principles on that was monthly financial reporting as quickly as possible and if you didn’t get it I tell you the phone was red hot. Yeah,

Gene Tunny  48:25

so just what was the abbreviation BTR a

Andrew Walker  48:29

Bter? BT and Alex I think Australia as BT in the UK, the listing was BT RPL and yeah, so um, Dunlop. They had a lot of businesses. The African element was, was all around the Dunlop products Slazenger, golf balls, cricket pads, rubber conveyors and all that sort of thing. We used to call it blood tears and repression. And Alan Jackson was, yeah, Alan

Gene Tunny  48:56

Jackson was the CEO to look at look it up. And that it was that an operating profit? Increase? You’re talking about like it sounded. There was hugely impressive. Do you know how that roughly what he did? I mean, it was at all he went on acquisitions.

Andrew Walker  49:11

Right. And he grew the business through acquisitions. But then there was a very strong once I’ve taken over a business, I had a very clear plan. Yeah, this is what’s going to happen. That done the due diligence properly, okay, people that needed to go left on the day, they had the team that were taking over stepping in. And then I had the financial performance, the last three years driven to their standard, and you were expected by the next month to be reporting in their level and they reviewed him and he’s his CFO, Kathleen O’Donovan. Yeah, they used to just keep going around the world. All the locations, so we, we, we’d seem Tinder is regularly or every month in and they would be going through our financials because they had standard throughout the world. So yeah, say the financials in a When I was running the Zimbabwean business we had, we had, we had a coffin business in Zimbabwe, it was prospering because of the, the Isaac. But we had a set of financials, which would have been the same as a company in Coventry, producing CV joints. And that’s how they drive the business. And that’s why finance departments and good financial people in your organisation are important to take it to the next level.

Gene Tunny  50:26

Yeah, it sounds like they were very hands on. You said they were travelling and visiting the businesses. Yeah. Yeah. That’s fascinating. Yeah, not to have to look, look more into that. Anything else we’ve we’ve missed Andrew. I mean, I’ve enjoyed learning about all of this. And it’s, it’s made me think more about the the, you know, the importance of understanding your what is driving profitability, and really getting across that. And then all of the data, the the number crunching that needs to be done, and

Andrew Walker  50:57

let’s come in, as I’ve just said, every month, you’ve got to be reviewing that every month, because people they get one month, and then it just wanes, going to have that, that, that good discipline, and routine happening in your business to then take action to make sure you you’re taking the action in a timely manner. The other thing I think, is, what I found is a lot of businesses don’t actually look at cash flow. And then try and project it forward and come across a lot of financial people, it’s too hard to forecast your cash. Well, no, you do the best you’ve got with the current information. And then you keep tweaking it. And every time you’re doing that you’re getting better at it. And I always say to my clients, when I come on board with them, let’s get the cash flow, three months, six months ahead. So we can know in three or four months time we’re going to hit a problem. Yeah, you can deal with it now. Other discount your products, get cash in or, or have a chat to the ATO and try and extend your terms of payment or whatever, or talk to the landlord. There’s lots of ways to manage your cash and that seems to be lacking. Yeah.

Gene Tunny  52:01

I mean, I do that myself in my business. Just because I’ve learned what one I’ve learned from experience, it’s important to do it and, and to we also did it in in government in Treasury because we needed to make sure that the the Australian Government had enough money, like day to day in the, in the official public account, the Reserve Bank, so the the team at the Australian Office of Financial Management used to do a detailed daily cash forecast for the Australian Government. And yeah, they, you know, they managed to do it. And, you know, the Australian Government is being hit by all sorts of shocks all the time. So, yeah, I think the Australian government can do it, your own small business can do it. That’s a lot less complicated than the Australian Government. I’m

Andrew Walker  52:45

sure it is. But yeah, but that’s a key element of of understanding your business. And that’s from the finance department.

Gene Tunny  52:51

Yeah, absolutely. Okay, Andrew, this has been terrific. Any anything? We’ve missed anything else you’d like to add?

Andrew Walker  52:57

Um, no, not really. I think I mean, there’s a lot of topics we could feel like talking down going down different elements of this. But yeah, and I think for business now is, you know, if we look at it, look at your finance department. And I’ve been doing some, some presentations to different groups around the blank box, opening the financial blank. And I get, I get the CEOs that come to the thing, the presentation to score the finance departments in two different ways that gut feel, yeah. And then score on performance around management accounts. How long do they take? Budgeting, forecasting? zero based budget? All those things? Yeah. And I think I’ve probably, I’ve just I’ve had present, I’ve done presentations to probably about, it must be in excess of a billion dollars of companies all added up an annual turnover. And, you know, What surprises me is it’s 50%, the satisfaction ratio of the CEO, and his finance department is a 50% level. That is, that is frightening.

Gene Tunny  54:06

Yeah, at the moment that the current labour for you

Andrew Walker  54:09

Yeah. And then I go through the whole process with them. And then, and then are related back. How much are you paying these people? Yeah, and you only have 50%. And it’s funny, I said to the one guy said, If you bought if you bought your fancy Maserati, yeah. And then any came was one wheel, how would you feel about it? So, you know, you’ve rented your finance department at 50% value producing the car with two wheels, you know, and so, and I think that’s where I have a problem. It’s my own profession, you know, but I think there’s a really there’s no real standard in in in how financial departments should perform. You look at it manufacturing, they have to produce the product with quality, service with quality or the report with quality. When it comes to the finance department. The scale of a printout out of the system, which is used is used There’s a chocolate via God to a proper set of financials. It is just so broad and a lot of CEOs don’t actually understand it. And so I spent a lot of time on doing presentations to make people aware. What should a good financial department deliver? Okay,

Gene Tunny  55:15

I want to put some links into if there are any presentations you’ve got in the public domain, Andrew, I can put links to them. And I’ll also put a glossary and we’ve covered some yeah, there’s some interesting new terms the the delivery in full on time the die fight. I love that. I’m going to start using that. And the bomb the vom the bill of materials. That’s a good one, too. Very good. Okay. Henry Walker. Thanks so much for your time. I really enjoyed the conversation.

Andrew Walker  55:44

Yeah, that was good to be a gene and always happy to come back and maybe explore a sliver of dollars because there’s a lot of detail in this. Absolutely.

Gene Tunny  55:52

I think I think we might have to do that. So Andrew again, thanks so much. Yeah, thank you, Rod. Oh, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if you’re podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

56:46

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Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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From Jekyll to Hyde: Exploring the Dual Nature of Finance | The Bankers’ Club w/ Prof. Gerald Epstein  – EP226

Show host Gene Tunny interviews UMass Amherst Professor Gerald Epstein about his new book “Busting the Bankers’ Club”, which is about the powerful influence of banks in politics and regulation. Epstein argues the bankers’ club maintains control through political allies and regulators. The conversation also covers financial deregulation, insufficient Dodd-Frank reforms, Quantitative Easing impacts, and alternatives like public banking and non-profit financial institutions.

Please get in touch with us with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple Podcast and Spotify.

About this episode’s guest Prof. Gerald Epstein

Gerald Epstein received his Ph.D. in economics from Princeton University, is a professor of economics, and is a founding co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts Amherst. He has published widely on various economic policy issues, especially in central banking and international finance. His most recent book, Busting the Bankers’ Club: Finance for the Rest of Us, was forthcoming in January 2024 from the University of California Press. 

What’s covered in EP226

  • Banking industry’s influence in politics and regulation. (0:04)
  • Financial deregulation and its impact on the economy. (8:58)
  • Financial system’s impact on democracy and fairness. (13:24)
  • Financial system issues and regulation. (16:24)
  • Economic policy after the financial crisis, including impacts of Quantitative Easing. (22:50)
  • Financial regulation and publicly owned institutions. (28:08)
  • Public banking, crypto, and risk-taking in finance. (33:30)

Takeaways

Professor Epstein argues in this episode:

  1. The “bankers’ club” of allies including politicians, central banks, and economists helps sustain the power and influence of large banks.
  2. Financial deregulation in the US and weak Dodd Frank reforms failed to address issues like too-big-to-fail banks and accountability.
  3. Quantitative easing policies after the financial crisis disproportionately benefited wealthy asset holders over others.  
  4. There is a need for more diverse public and non-profit financial institutions focused on social missions over profits.
  5. Crypto poses risks if it infects the core banking system or continues high-carbon polluting practices.

Links relevant to the conversation

Gerald Epstein’s book Busting the Bankers’ Club: Finance for the Rest of Us

https://www.amazon.com/Busting-Bankers-Club-Finance-Rest/dp/0520385640

Working paper co-authored by Prof. Epstein “Did Quantitative Easing Increase Income Inequality?”

https://www.ineteconomics.org/research/research-papers/did-quantitative-easing-increase-income-inequality

Transcript: From Jekyll to Hyde: Exploring the Dual Nature of Finance | The Bankers’ Club w/ Prof. Gerald Epstein  – EP226

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gerald Epstein  00:04

There’s a phenomenon in the US. The political scientists talk about this called capture that is that the regulatory agencies that are supposed to be regulating the industry, artefact captured by the industry and tend to operate, often in the in the interests of the industry.

Gene Tunny  00:29

Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the shownotes relevant information. Now on to the show. Hello, thanks for tuning into the show. My guest this episode is Professor Gerald Epstein. He’s professor of economics at the University of Massachusetts Amherst, and he’s co director of the Political Economy Research Institute. We discuss his new book busting the bankers club published by the University of California Press. It’s a great book demonstrating Professor Epstein’s deep knowledge of the US financial system. I thoroughly recommend it. So if you enjoyed this conversation, please consider buying a copy. I’ll put a link to it in the show notes. As always, please get in touch. If you have any thoughts on this episode, guest suggestions or ideas for how I can improve the show. You’ll find my contact details in the show notes. Right? Oh, we’d better get into it. I hope you enjoy my conversation with Professor Gerald Epstein. Professor Gerald Epstein, welcome

01:53

to the programme.

Gerald Epstein  01:54

Thanks so much for having me. Excellent. Gerald,

Gene Tunny  01:57

look, I’m really grateful for you appearing on the show to talk about your new book busting the bankers club finance for the rest of us. To start off with, could you tell us what is the bankers club?

Gerald Epstein  02:12

So the bankers Club is a group of allies, very powerful allies that support the banks and the financial Titans more generally. And the reason that’s important is because the banks in the United States in the book is mostly about the United States, but I think it’s true in many other places. They’re not very popular, people don’t like banks very much as a whole. I have my students look at a bunch of American movies about banks, they say, please find me a movie that has a favourable gives a favourable impression of the banks and, and they really can’t find them. So in the popular culture, you know, banks aren’t very popular, but they’re incredibly powerful. They’re in powerful politically, they’re powerful economically. And this is, despite the fact that we have these prices that the financial institutions seem to create every 10 years or so. And so the question is, how do they remain so powerful? And my answer is that it’s the bankers club is this group of allies that support the banks politically, economically, and helps them sustain their both economic and political power? And so I go into some detail discussion of various components or various groups within the bankers club,

Gene Tunny  03:37

broad and who are they? I mean, are you able to give some examples?

Gerald Epstein  03:42

She, of course, so there’s some usual suspects as you is what anybody would think about. So they’re the banks themselves and by banks, in this context, I mean, the mega banks, like Chase Manhattan Bank and Bank of America and the large banks, then the major hedge funds and private equity firms, and the large asset management firms. So we’re talking about mega finance more generally. So, of course, they’re the head of the club, but they get politicians to help them out, then that’s well known in the US and in other countries, and they get politicians to help them out by giving them campaign contributions by offering them good, lucrative jobs when they get out of the legislature. And in a variety of ways. They find finance friendly politicians, that will help them with legislation and so forth. So that’s kind of well known in many countries. Perhaps less well known is that the our central bank, Federal Reserve Board, is what I call the chairman of the club. The central bank, is historically Since it was founded in 1914, has been a big supporter of the banks. Partly this is for structural reasons that is, they rely on the banks, when they make their monetary policy they operate to the banks that interest rates, they expect the banks to pass these interest rate changes, up or down, depending on whether they’re fighting inflation or trying to get the economy going. So they have a kind of an intimate relationship with the banks. But what it also means, however, is that they tend to see the world through what I call finance coloured glasses. And so they tend to see the world the same way the bankers do. And more than that, they help out the banks in very significant ways. And we can see that most clearly in two areas. One is when they bail out the banks, like we have this great financial crisis of 2007 2008, and the Federal Reserve along with the US Treasury, but in trillions of dollars that keep the big bankers operating. But they also do it with regulation. That is they the Federal Reserve, and I think is true in many other countries, tends to really push for fairly flexible, and even very easy forms of regulation on the banks. And I’m very reluctant to put on very tough regulations on them. So we have politicians, the Federal Reserve, and then we have regulatory agencies, in the United States, we have various regulatory agencies that are in charge of regulating the banks. And there’s a phenomenon in the US, the political scientists talk about this called capture that is that the regulatory agencies that are supposed to be regulating the industry, artefact captured by the industry and tend to operate often in the in the interests of the industry. And once again, this is a process that goes on with financial regulation, the SEC, the OCC and other financial regulators we have, and I’m sure you have some in Australia. And we have the same revolving door processes that we have with the Fed. And then there are a couple of other groups that maybe are less well known. One is lawyers, many lawyers work for, for banks, they, they when they’re working in the regulatory agencies or in Congress, they help fashion regulation and and, and regulate and laws that help the banks. And they actually help write laws that are very bank friendly. And so we have a whole group of lawyers that are that are involved. non financial corporations, you think that one thing that I started during the Great Depression when this books my book starts talking about in talking about the Great Depression, and the New Deal financial regulation put into place by Franklin Delano Roosevelt and his administration. At that time, the big companies like us steel and the big industrial companies, they kind of parted way with the banks, the banks had helped crash the economy. And the big industrial companies said, Look, we need a new path. And they supported a lot of the financial regulation, like the Glass Steagall Act that separated for a commercial from industrial banks. But these days, our biggest corporations are very supportive of the banks, they don’t want to regulate finance. And so there many of them are members of the bankers club, too. And finally, I have to admit my own profession, economists, were very many of us are very me, but many are loyal members of the bankers club, become stuck with economic theories that say low regulation is best for society. Markets are efficient. They work better on their own, and this all works in the interests of the banks.

Gene Tunny  08:58

Yeah, yeah. Okay. Look, yeah, I think there’s definitely scope for discussion about the appropriate regulation of banks. That’s right. And we might get into that a little bit later. I’m just thinking about, you know, some of the people involved, I mean, often you hear their accusations levied against people like, was it Robert Rubin. And then Larry Summers, who were the treasury secretaries in the Clinton administration. That’s right. Is there a was there a concern that they were perhaps too close to, to the banks and that yes, yeah. Yeah.

Gerald Epstein  09:35

So Larry Summers, Robert Rubin. Alan Greenspan. They are, you know, golden members of the bankers club, all of them. The major deep financial deregulation that happened in the United States that kind of took apart the New Deal, structure of financial regulation. It happened. First, slowly building up. But then it really happened with the Big Bang. under President Clinton, who was a Democrat with the advice of Robert Rubin, who was chair of Goldman Sachs, and then city city Corp. Alan Greenspan, who was a libertarian, he was a follower of the philosopher Ayn Rand. And he was head of the Federal Reserve. And Larry Summers, who was a was was a very good economist, but somehow found himself kind of, as part of his part of the bankers club. And that was, that’s what really led us down the path to the great financial crisis. And to the problems we’re still having with banking. Yes,

Gene Tunny  10:39

yeah. It’s interesting, this idea the bank is clogged because it reminds me in Australia here, I mean, we’ve had successive treasury secretaries, that’s the head of the cabinet. First and responsible the Treasury is called the treasurer, that we’ve have successive treasury secretaries who have gone on to be the chairman of a bank. And I think for years that was seen as a pretty sort of cushy job. And it was until like, we had David Morgan who became head of Westpac, and then my old boss, Ken Henry ended up head of NAB, but for Ken ended up getting grilled at the Royal Commission into banking, and I don’t think he ever expected that that because we had a whole bunch of bad behaviour. Yeah, the bank’s due to a guest lacks oversight by our Prudential regulator. So absolutely. Same kind of thing. Yeah, yeah. Okay, so I think you’ve, you’ve given us a good description of the bankers club. What’s your case? Can you state your case, please, Professor Epstein, as to why the bankers club should be busted? Well,

Gerald Epstein  11:51

yeah, the title of the book is busting the bankers club finance for the rest of us. And the problem with the system as it is, is that our, our financial system has been has become incredibly bloated. It’s much too much too large. It uses way too many of our financial and human resources, it sucks in some of the best and the brightest of our young people, I can tell you, from my classes here at the University of Massachusetts, when I teach classes, a lot of our best and brightest students want to go into finance and banking. And they want to go in to the mega banks. And you know, the really the really lucrative ones. And there’s a whole literature, which I registered my built on, which is called too much finance. It’s an economics literature, which shows that its financial sectors get too large relative to the size of their economies. And this is a cross national study, that after a while, they’re they’re too big, or they’re structured inappropriately, or they’re doing negative things in the economy. And they actually contribute, after a certain point to lower economic growth, lower national income. And there’s something about having a bloated, an excessively large and complex financial system, which really harms everybody. So that’s, that’s one problem. But we have that’s just one of the problems. Another problem is that it’s bad for democracy that is, you know, Australia’s democracy, the United States is trying to risk to remain a democracy. And the idea is that it’s one person, one vote. But the process I’ve described, where the, these large institutions of powerful institutions are able to, by essentially legislation, regulatory practices that benefit them at the expense of the rest of society. That’s a major problem. But it’s, it’s even worse than that in the United States, because people understand that, that the whole process is unfair. When we had the great financial crisis, the Federal Reserve the Treasury, the government, and this was under both W Bush and Obama bailed out the banks. But they didn’t bail out the people, people lost their homes, people’s jobs were lost. And this made many Americans, understandably, very angry. And I think this turn to this very anti government kind of politics in the United States. That started with the so called Deep party at that time. And it’s now morphed into very, very extreme right wing populism that we had, that has kind of organised around and been organised by Donald Trump. Really stems I think, from this sense that our system is not fair. And so yeah, well understand that it’s not democratic. And I think it’s really poisoning our politics.

Gene Tunny  15:06

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  15:12

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Gene Tunny  15:41

Now back to the show. Well, I think this idea of this, too much finance literature, I’m gonna have to have a look at it or a closer look, I’ve seen some of it, I think. I mean, obviously, we need banks. Okay. I mean, we’re not necessarily any banks, because banks do play an important role in providing credit and supporting businesses. I mean, you asked most bankers, they will think they’re adding value to society. What are the activities where there’s this so called too much finance? I mean, how, like, what how does that manifest? Yeah,

Gerald Epstein  16:18

excellent question. Well, I start off my book with a chapter called the Jekyll and Hyde finance. It builds on this idea from the Robert Louis Stevenson story, which some some of your listeners might have heard of, this very upstanding doctor, Mr. Dr. Jekyll, who was a pillar of the community and really supported the committee and did all kinds of things with it. But we had another base hidden inside of him, this Mr. Hyde, who was who was a criminal, and murderous, and so forth. And, and these different phases of this one entity would show itself depending on on the conditions. So our financial system is kind of like that, you’re absolutely right. We need a financial system that works for the everybody that works for the economy, we need to be able to finance people’s retirement be able to finance people’s ability to buy homes, we need to finance credit for businesses to invest in new plant and equipment. And the list goes on and on and on. The problem is that our current financial system in the United States, which I call roaring banking, it’s kind of comes from the bill boring banking idea of the 1950s and 60s that was very regulated, and morphed into roaring banking as a result of this deregulation, it led this financial markets and these big financial institutions to engage in more speculation taking on more and more risks, to invest in speculative bets and derivatives and other kinds of speculative activity. Yeah, and it resulted in them taking on much more risk, which allowed them to increase the profits and wages, going to the major investors, and to those at the top, without, at the same time, investing a lot in in new plant and equipment for businesses and so forth. In the United States. Many big corporations do not rely on the banks or even the financial markets for their major investments, they get most of the financing from the major investments from their own retained earnings, their own profits. And so it raises the question, well, what are these these big banks, hedge funds, private equity funds, what are they really doing? And many of them are not really supporting the real needs of the economy. In the United States, we have a lot of smaller banks and community banks. And they’re the ones who are much more likely to give home mortgages to give to lend to small businesses, and so forth. And the problem is, in the United States, we have a particular system, your system is different in Australia, what we have is these very speculative mega banks that are driving out to smaller banks. Part of the reason that happens is that when there’s a financial crisis, our government has a too big to fail policy. That means if you’re a really big bang, chances are you’re gonna get bailed out by the government. Whereas if you’re a mid sized or smaller bank, and you get in trouble, you’re not going to get bailed out or you’re gonna go bankrupt or get merged into another bank. And so depositors and investors don’t feel that safe, putting their money in the smaller banks. They Put them in the big banks as well. So the cost of capital for the smaller and community banks is higher, because of the too big to fail subsidy that the big banks get. So it’s an unfair competition. And it’s not a one of the things that I propose in the book is a set of policies that help make this competition, more level more, more fair, so that we have a whole variety of financial institutions that provide the needed services, as you said, that our economy needs. Okay.

Gene Tunny  20:36

Now, in your book, you talk about issues with mortgage backed securities, I suppose one of the things that people, you know, they were most critical of some of these major investment banks was there, you know, they’d be packaging up, or creating these mortgage backed securities and then selling them around the world. But at the same time, I forget which firm it was, but was one of the banks betting against products that was actually selling or one arm of Goldman Sachs. Yeah, Goldman Sachs was one of them. Yeah. So it’s, it’s,

Gerald Epstein  21:09

you know, it’s not really taking care of your clients. And it’s really betting against your own clients. And that’s kind of one example of a behaviour that this all allowed. Yes. Yeah.

21:23

And another. Another good point I think you make in the book.

Gene Tunny  21:29

And this gets to the fact that you argue that the Federal Reserve is at the head of the bankers club, you talk about the impact on of quantitative easing and the the adverse, or the unfair impacts of that. Could you elaborate on that, please? Professor Epstein.

Gerald Epstein  21:47

Yeah. So when the great financial crisis hit Central, the Federal Reserve and other central banks, were trying to revive the economy, understandably, that’s what they should have been doing. Interest rates were already in almost zero. So they wanted to come up with another tool to put liquidity in the in the economy and reduce the cost of investment, cost of capital and so forth, while helping to sustain the banks that were in trouble. So they engaged in what’s called quantitative easing. They put liquidity in the economy by buying up not just government securities, which is the typical way that they do open market operations. But they bought up asset backed securities, mortgage backed securities, this kind of thing from banks, which ended up increasing the value of these assets, which helped the banks because they had these, these assets on their balance sheets were which were not worth very much. So it helped the banks. But the the idea is that it was there hoping that it would also lower the cost of capital to borrowers and investors, and then to generate more employment, and so forth. So my graduate students, and I looked at whether what the impact was in the United States. So there could have been, there was this asset in value increase, which increases the wealth of asset holders, the banks and others, there was cost of capital mechanism that would have possibly lowered the cost for homeowners and others who were borrowing money. And then there was the impact on the interest rates that the consumers get on their savings in banks and banks. So we had a various impacts going in opposite directions, the asset value increase, we’re going to help the wealthy people because they’re the ones who have all the assets, reducing the cost of capital, would help those homeowners who needed to get their mortgage cost down. And the lowering of interest on savings might have hurt middle class and working class people because they hold their money in savings in the bank. So we have these different possible impacts. So we tried to figure out what the net effect was. And what we found was that in the case of the United States, during this period, the main impact was on increasing the wealth of the wealthy, that the other impacts were relatively modest. So there have been other studies of quantitative easing in other countries during this period, and most of them find something similar that it had a relatively small impact on employment and cost of capital for borrowing and a much bigger impact on the value of assets which helped primarily the wealthy. There’s some counter studies, but most of them go in that direction. Now. It’s not necessarily the case. But we weren’t arguing that the Fed was trying to do that, per se. I I think they would have liked to have seen the economy get going more. But that was the impact of the policy that they pursued.

Gene Tunny  25:05

Yeah, yeah. Okay. Why was Dodd Frank? So there were there were some changes to legislation, post financial crisis. So as a result of the financial crisis, why were they insufficient. So Dodd Frank in particular,

Gerald Epstein  25:22

right, so what what really needed to happen after the financial crisis, in my view, and in the view of other others who were looking for some big changes, first of all, these mega banks, Goldman Sachs, the Bank of America, and so forth, they’ve gotten too big to fail, too big to manage. Oftentimes, the people at the top didn’t really understand what the heck they were doing. The big jail that is, the government didn’t even put any of these people who ended up taking on fraudulent activity, they never made them have any consequences at all. So they were just too big. And so there were proposals during the Dodd Frank process, to shut down these big banks that one was to implement a new Glass Steagall Act, which was kind of a modern version of the separating commercial and investment bank, another was putting an asset cap on these banks to try to get them into a size that couldn’t run the economy that can be managed better, and so forth. That was never put on the table. Another thing that the some of us argued for, were consequences for the bad behaviour of the decision makers or the wrong decision makers. When these Goldman Sachs was selling these securities to their clients and betting against them. And then they they made a lot of bonuses and profits, and then the bank threatened to collapse. They didn’t have to give back their salaries, they didn’t have to give back their bonuses, they were able to take the money and run, there were attempts to put in so called law backs into the Dodd Frank legislation. So that we didn’t have moral hazard that is, so we didn’t have a situation where people didn’t have to pay the consequences of their bad behaviour. That was never really put in as in in a significant way. There were conflicts of interest all over the place, including with credit rating agencies, we had the credit rating agencies that were rating the securities, the asset backed securities and so forth, that were full of really dicey mortgages, they rated them leave parts of them triple A, which is this, which is the same as the US government securities, triple A ratings. And why? Well, because the investment banks demand that they rate them triple A, the veteran banks paid the rating agencies, if they didn’t rate them, triple A, then the investment banks would take their business elsewhere to another rating agency. So there are all these kinds of conflicts of interest. They weren’t really dealt with either the list could go on. We needed more regulation for derivatives, derivatives are relatively unregulated. And again, there wasn’t much done there is Well, the question is why? Why wasn’t there better regulation? And the answer is bankers club. Dodd and Frank were both very weak members of they had very kind of weak backbone for really taking the banks on both Republicans and Democrats in the Senate and the House of Representatives. Many of them were were on the take from the banks. Tim Geithner, who was Treasury Secretary, Larry Summers, we talked about before Ben Bernanke, head of the Fed, they didn’t really want to shake up the financial system. They just wanted to get it back up and running again. So the bankers club really did a number on Dodd Frank. Now, there were a few things that were done, and they were good, but they weren’t enough.

Gene Tunny  29:08

Yeah, okay. Okay. And did Trump do anything when he was in office?

Gerald Epstein  29:12

Yeah, Trump’s an interesting story. He ran on a platform when he was running against Hillary Clinton, a very populous platform, who said, All the banks are terrible. They really messed everybody up. Probably Clinton makes money from the banks as she terrible. I’m really going to do a number on the banks. But then when he was elected, he immediately put a bunch of Goldman Sachs people in his administration. And he appointed people to try to dismantle the Dodd Frank Act. And among the things that they did was to raise the size that banks could get before they were subjected to special capital requirements or liquidity requirements. The so called mid size banks, were set free to kind of do what they want and The result of that is we had the Silicon Valley Bank that went under, in 2023. Because they were a bank that had been subject to special reg regulation. Under Trump, they were, they were let go and not have had to be subject to this regulation. And they got in trouble. In the end, the government had to bail out the financial markets again. So the question is, you know, what would trump do if he got into power? Again, you know, it’s probably going to be a similar story, where he’s going to rail against the wealthy and the banks and so forth. But chances are, they’ll do more of the same and it will be kind of this the supreme member of the bankers club if he ever gets back into office. Okay. Do

Gene Tunny  30:43

you see a greater role for publicly owned financial institutions?

Gerald Epstein  30:47

I do. And so it’s time I think, to raise the point of about the others theme in my book, I talk a lot about the bankers club. But I also talk a lot about group I call the club of busters. That is, there are many legislators like Elizabeth Warren and others in our in our government, there are activists, there are economists and lawyers and regulators, who really do want to try to do the right thing. They really do want to try to regulate the financial institutions properly, and are pushing for legislation and regulation to do so Gary Gensler, for example, the head of the SEC, really wants to regulate crypto very strictly, as an example, is giving the crypto people a lot of headaches. He’s a member, he’s what I call a club buster. And what we need, I think, not only tighter regulations, and this is what most people argue for, but we need a whole ecology a whole set of public financial institutions. Now by public, I don’t necessarily mean government owned. But what I mean is financial institutions that have a public orientation, that is making the maximum profits is not their only goal. It’s not their goal. They have missions, public mission, social missions. So some of them can be owned by the government. And the United States, we have some community banks, state banks, and so forth. There are many government owned banks around around the world, but they can also be public private partnerships. They can even be privately owned, nonprofit, non nonprofit nonprofits, who have a social mission. We need many more of these financial institutions to provide low cost mortgages, and loans for small businesses, investment in deprived communities that need more investment, help with transition to a greener economy, at the local level, and the regional level. So we need what I call banks without bankers, that is, banks who don’t have typical bankers in them, they have to have skilled people, technically competent people. But for whom maximising profits is not the main goal. And in the United States, we have a very active public banking movement of activists around the country pushing for public banks of various kinds. Their major obstacles, like once again, is the bankers club who was trying to prevent them from from succeeding, but they’re, they’re these bank posted this quote, officers are working very hard.

Gene Tunny  33:29

Gotcha. Okay, I’ll have to look into that public banking movement. That’s interesting. I like your point that, look, it doesn’t necessarily have to be publicly owned, because like where I’m coming from, as in Australia, we’ve had some, we had some really colossal state bank collapses in the late 80s, early 90s, tri continental state bank of Victoria, and Bank of SA South Australia, if I remember correctly, so we’ve got a bit of a, an aversion to publicly owned banks here, because of the risks to the balance sheets. I liked how you describe that. And I think I’ll have to look more into that at public banking movement. It looks interesting. The one concern I would have is, is there a concern? Is there a risk that maybe, maybe they’re too cautious or they’re not innovative enough? Have you thought about that? Right?

Gerald Epstein  34:16

So, you know, there’s, there is an upside and a downside. As a graduate student, I study the cyclical behaviour of publicly oriented banks in different countries relative to the purely private for profit banks. And what we found was that they were much less cyclical that is they went up much less than the upside and went down much less on the downside. So it’s can be a stabilising force in the economy. But I think what you’re going to getting errors don’t we need some you know, real risk takers and people who are really good, willing to go out on the limb with some some crazy but maybe great ideas. Take the risks and we Absolutely do need that in a dynamic economy. The problem is, what we don’t want is the government backstopping that we don’t want the government saying, you when you gain, you lose, we pay. We don’t want a kind of lemon socialism. So, yes, we need a risk takers, and and they have to pay the consequences if it doesn’t work out. Yeah,

Gene Tunny  35:24

yeah. Yeah, that’s a good point. I mean, that was one of the points that came up during the financial crisis that they were privatising the profits, but socialising the losses. So exactly. That’s a that’s a good point. Right. Okay. Well, to finish up, we might, I might ask you about crypto because in your book, you talk about Jekyll and Hyde. You write just as finance, as both Dr. Jekyll and Mr. Hyde face crypto has a bit of a Dracula quality as well. Could you tell us more about that, please.

Gerald Epstein  35:56

So if anybody who’s followed crypto or invest in it, they know, they know that there was a big bubble and Bitcoin and other cryptocurrencies and 2122. But there was the so called crypto winter, and when the crypto values just, you know, collapsed, and then there are all kinds of scandals with sand bank and freeze in jail and several the other main crypto people are in are subject to criminal investigation, or maybe are in jail. So it seemed like around that time, the crypto was dead. But like the vampires you stick across in them, and they somehow, you know, they revive and now crypto I think, has has had a revival. It’s still trying to push ahead. And there are a lot of crypto friendly legislative leaders in the US and in other countries. And so it’s like, yeah, we all thought it was was dead, but it’s risen from the dead. And my view on crypto, is that again, it’s fine. It’s like, it’s fine if people want to mess with it, you know, in line and death, you know, gamble with it, and so forth. But we can’t let it do two things, one, either of two things. One is infect core banking system. Once we have crypto infecting the core banking system, we’re back to where we were in 2007 2008, when these exotic asset backed securities and collateralized debt obligations, and so forth, infected the very core of the banking system. So when they collapse, they threaten to bring down the banking system with it. As long as it’s a marginal thing. Have fun with it, I suppose, as long as people are aware of the the downsides, but there’s another problem. Most crypto is very carbon intensive, the crypto mining, it’s very bad for our environment, we have this, this existential threat of climate change. And the way crypto mining is done in most cases, not all cases now. It’s really adding as much carbon to the atmosphere as a small country like Iceland or some other country. So I think that has to be taxed. And if crypto can still you know, give some thrills to the its investors in a safe way without destroying the environment. Okay, go for it. But let’s not let it ruin the environment. And it let’s not let it infect our our core banking system. Yeah, very good points.

Gene Tunny  38:27

Okay. Professor Epstein, any final points? Before we wrap up? I think this has been a great conversation. And I did enjoy reading your book. And I’m going to recommend it. And I’ll put the link in the show notes. Any final points before we wrap up?

Gerald Epstein  38:42

Yeah, the final point is that was one of the things that’s kind of obvious from our conversation, my book is, is almost entirely about the United States. So whatever, if these processes happen elsewhere, it will happen in a different way. There have been people doing work in similar kinds of work in other countries, we have Nicholas Shaxson, who’s done interesting work in in England, and we have Jim Stamford, who you might know who is then actually work in Australia and Canada. So I don’t claim that this is a universal process. But But I do hope that other people explore some of these ideas in their particular countries in particular environments to see what’s similar and what’s different.

Gene Tunny  39:21

Absolutely. Okay. Professor Gerald Epstein, thanks so much for your time. I really enjoyed the conversation.

Gerald Epstein  39:26

Thank you very much.

Gene Tunny  39:29

Right. Oh, thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating thanks So listening, I hope you can join me again next week

40:16

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Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

Categories
Podcast episode

Digital Money Demystified w/ Prof. Tonya Evans – EP216

Professor Tonya Evans is the author of the new book “Digital Money Demystified: Go from Cash to Crypto Safely, Legally, and Confidently.” She discusses the topic of cryptocurrency with show host Gene Tunny. Professor Evans argues there are many myths surrounding digital assets, including their association with criminal activity and extreme volatility. She aims to dispel these myths and provide readers with a more accurate understanding of cryptocurrencies. Professor Evans is distinguished professor at Penn State Dickinson Law and a leading expert in intellectual property and new technologies. Please note this episode is for general information only and does not constitute financial or investment advice.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple Podcasts and Spotify.

About Professor Tonya M. Evans

Dr. Tonya M. Evans is a distinguished professor at Penn State Dickinson Law and a leading expert in intellectual property and new technologies. With a prestigious 2023 EDGE in Tech Athena Award, she is highly sought-after as a keynote speaker and consultant. Her expertise spans blockchain, entrepreneurship, entertainment law, and more.

As a member of international boards and committees, including the World Economic Forum/Wharton DAO Project Series, Dr. Evans remains at the forefront of cutting-edge research. She recently testified before the House Financial Services Committee and the Copyright Office and USPTO to advise on the intellectual property law issues related to NFTs and blockchain technology.

What’s covered in EP216

  • [00:05:31] Prudent crypto investing according to Prof. Evans.
  • [00:09:18] Crypto scams.
  • [00:13:18] Peer-to-peer technology.
  • [00:17:34] Taxing crypto assets.
  • [00:22:45] Central bank digital currencies.
  • [00:29:13] Exchanging value without government support.
  • [00:38:17] The currency of outer space.
  • [00:41:10] Self-custody and centralized exchanges.
  • [00:47:48] “Not your keys, not your crypto.”
  • [00:49:17] Underrepresentation in the crypto ecosystem.
  • [00:54:07] Learning the language of crypto.
  • [00:59:47] Tracking Bitcoin transactions.
  • [01:01:57] The speed of prosecuting crypto fraud.

Links relevant to the conversation

Amazon page for Digital Money Demystified:

https://www.amazon.com.au/Digital-Money-Demystified-Crypto%C2%AE-Confidently-ebook/dp/B0BVP8GPF8

Regarding a spot Bitcoin ETF, Yahoo Finance reported on 28 November 23 that “Crypto investors are awaiting Security & Exchange Commission (SEC) approval for a spot bitcoin ETF, which could unlock a surge of capital investment in the crypto space.”

https://finance.yahoo.com/video/bitcoin-may-reach-57k-over-175421720.html

Treasury Secretary Janet Yellen on Binance:https://home.treasury.gov/news/press-releases/jy1926

Transcript: Digital Money Demystified w/ Prof. Tonya Evans – EP216

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. We then used a human application, Tim Hughes from Adept Economics, to exercise his primitive brain and see if he could successfully hunt down mondegreens. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording

Tonya Evans  00:03

Now we have web three where not only are we exchanging messages of information, packets of information. Now those packets are about value. It gets at the heart of even why governments tax, particularly in times of war, etc, and to protect borders that are now being threatened by a borderless currency.

Gene Tunny  00:32

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory, evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show.

Hello, and welcome to the show. In this episode, I talked about cryptocurrency with the author of a new book on the topic. The book is “Digital Money Demystified” and the author is Professor Tonya Evans from Dickinson Law at Pennsylvania State University. Among her many achievements, Professor Evans was a 2021 Forbes over 50 listee in the investment category. She’s on the board of directors of Digital Currency Group and she’s testified before a congressional committee on digital assets. In other words, she knows what she’s talking about on crypto. This episode was recorded in mid November 2023. Please check out the show notes for any important developments since then, particularly for any news about spot Bitcoin ETFs that may have happened. I should note that one big thing that’s happened since the interview is Binance and its CEO pleading guilty to criminal charges for anti money laundering and US sanctions violations. US Treasury Secretary Janet Yellen has said “it’s willful failures allowed money to flow to terrorists, cyber criminals and child abusers through its platform.” As always, if you have thoughts on this episode, or other episodes or ideas for future episodes, please get in touch. I’d love to hear your thoughts on crypto, positive or negative. What do you think about Professor Evans defence of crypto against the major criticisms that it faces? Has she changed your mind on crypto? What about the recent news about Binance or SBF before that? Please let me know what you think after listening to the episode. Let’s get into it. I hope you enjoy my conversation with Professor Tonya Evans on crypto.

Professor Tonya Evans, welcome to the programme.

Tonya Evans  02:42

Thank you, Gene. Thank you so much. I’ve been looking forward to this. So I’m happy to, happy to chat about my favourite topic.

Gene Tunny  02:49

Oh very good yes. You’re certainly passionate about it, I’ve been reading your book over, well the last two nights. It’s, it’s an easy to read book. And I got through it in in two sittings on my Kindle. So well done on that. So yes, your book is Digital Money Demystified from go from cash to crypto safely, legally and confidently. To start off with, what do you think needs to be demystified about digital money? Or in other words, what motivated you to write this book?

Tonya Evans  03:26

Yeah, this it’s interesting because I do so many speaking engagements, obviously, as a not only as a law professor, which is kind of a different exercise in exploring things. I know, we’ll get into some regulatory stuff later. But at a higher level, there’s so much misinformation about the nature of the assets, why they even exist, what types there are, how they’re different. Some of the most common myths that I constantly explore and help people to right size include the level of crypto involvement in criminal activity, which is actually quite low. The nature of volatility, and the the existence of volatility is not the myth. This is a nascent asset class. And so, obviously, it’s very volatile. So when I compare crypto as a nascent asset class to earlier developments of assets like the stock exchange, for example, we go back to the 30s and Buttonwood and the volatility that was involved, so many things going on behind the scenes that people weren’t aware of. And that was very problematic when you think about the asymmetry of information which is often extremely problematic in the finance lane. You really need to have the transparency and accessibility for an open market. Otherwise you don’t have an open market and people are left to their own devices. People are investing in things when they don’t have all of the information. And so that’s what made it really interesting for me to 1) start to study the area, but 2) to make sure that people understood the existing system, how crypto assets and blockchain technology actually changed that. And kind of where we go from here. As you can tell, the book is not an argument. For someone to absolutely buy crypto, I still leave that up to the person, but I want them to have a more informed body of information to draw from so that they can actually make good choices. One of the ways that I like to explain it is to say, you can actually be a prudent crypto investor, which sounds like an oxymoron. It’s like prudent and crypto investing, how do those things go together, but people are afraid of what they don’t understand. And the reality is, and we will continue to talk about this in our conversation. This technology is here, not just as a matter of Bitcoin and Etherium, and some of the other coins, but every major, not major, but every country is looking at its own version of digital currency in the form of central bank digital currencies. We have FedNow which is not in and of itself a cryptocurrency. But it’s kind of like the the framework or the platform for digital assets that I believe, my personal opinion, the government would not have this official statement today. But three to five years from now, we’ll look back on this moment in time, where FedNow, the rails, the frameworks to enable digital asset transmission, I believe will be the precursor to a central bank digital currency in the United States. And finally, when I think about the various investment products that will become available, probably, I’m pretty conservative so I would say at the beginning of 2024, we will see an exchange traded fund specifically for Bitcoin, probably 12 to 18 months after that, for Etherium. This will be an investment product that is available to investors, and also the professionals, the financial advisors that have to make sense of this, the CPAs the lawyers. So for all of these reasons, at least demystifying the space so that people don’t fall victim to the clickbait and the sensational headlines, some of which are horrible. I, there is no place for criminal activity, Sam Bankman-Fried is going to enjoy a lot of time in jail. I’m absolutely for that. But you know, that is one small part of a larger ecosystem where the great majority is used for legitimate not nefarious purposes. So for all those reasons, I just think it’s important that people level up their, their understanding, you see from the book, The glossary of terms, just helping to demystify and understand so that people will lean into the education piece to decide then if this is something that they want to add to their profession, or their portfolio.

Gene Tunny  08:04

Yeah, yeah, absolutely. So you mentioned the glossary of terms just then I think that’s one of the standout features of the book. So yeah good work on that. Professor Evans, could you just explain the difference between some of these scams until, I read your your book, I didn’t appreciate the difference between an exit scam and a rug pull. So I hear about rug pulls all the time on Coffeezilla’s channel on YouTube, could, are you able to go over what those different crypto scams are and what to watch out for? Please?

Tonya Evans  08:40

Yeah they’re quite close, right. So it’s the difference of having a team that from the beginning, knows that they are going to turn the lights off at some point, they’re gonna, you know, pump up the price, get a lot of enthusiasm. And their goal from the beginning is to scam people out of their money, right, and to set the market conditions in order to get the highest price possible to leave others downstream holding the bag. Right, as opposed to someone that at least in the beginning, has some good intention and realises at some point in time, it’s not going well. And that people who have invested fall into what we talked about earlier about not having all the information. So you have a key some key decision makers that still have an influence on a project. Oftentimes, it’s not built yet. So they have grand plans, they have a roadmap, they might have a white paper, but at a certain point they run out of gas and they disappear with everyone’s money and all of a sudden you can’t find them anymore, closely aligned but so it’s more of the intentionality from the beginning. But the end result is a lot of people get caught holding the bag.

Gene Tunny  09:51

Right so the exit scam is where there’s that intentionality at the beginning is that right and the rug pull is yeah, we stuffed up let’s just try and get out of it. And yeah well…

Tonya Evans  10:01

That’s right, that’s right.

Gene Tunny  10:05

Bad luck investors. Okay. Righto, so you’re a Gen X law professor right? So I think I read that in the book. So you’re same generation is me and I often feel I’m probably, if I was five years younger, I probably would have got massively into crypto, but I was probably, at the start of it, I was a bit sceptical of it. How did you become like, as a lawyer, as a law professor, how did you become interested in crypto in the first place?

Tonya Evans  10:34

I had a friend who was getting an advanced degree in the future of media and kind of the intersection of media and new technologies. And to take a step back, I actually am primarily an intellectual property lawyer, and law professor, I just actually celebrated my 25th reunion from Howard University School of Law. So I’ve been around for a minute, I practiced law for 10 years before I even started teaching. And now as a recovering practitioner, also known as a law professor. And I get to lean in to things normatively, how they should be rather than day to day kind of practically what they are, right? That’s really the transition from representing clients to informing law as it’s being developed. And so I was very interested in the work that she was doing at the intersection of media and blockchain. I had heard of Bitcoin at the time, this was in 2017. Bitcoin was first launched in January of 2009. So it had been around for some time, but was really relegated to the fringes of cypher, the cypherpunk movement, mostly those kind of tech men, mostly with a technology, technology background, and also in finance, and kind of like this microcosm of two microcosms is the area of cryptocurrency. So mainstream adoption or even awareness just wasn’t a thing at that time. And also, as you mentioned, I’m a lawyer. I’m licenced to practice law in four states, New York, New Jersey, Pennsylvania, and DC, I am highly revered. In my profession, I have no intention of losing my licence. And so trying to make sense of this magic internet money was not something that, that I was at all interested in at the time. But what I was interested in is her discussions around the underlying technology that was organising financial data, the transactions and the balances in a very novel way, using existing technologies. But again, organised in a novel way. So what were the technologies, are the technologies? Cryptography, which is the encrypted messaging that has been around in some form or fashion, quite frankly, for millennia, obviously, it’s digital now. But the idea of going from point A to point B, or sending a message, often in times of war and other areas, the ability to send to encrypt and decrypt messaging was critically important. But that’s been around for forever, then we have peer to peer technology. So as an IP lawyer, I’m also interested in this part, because when I first learned about peer to peer technology, it was gonna, you know, upend the media, ecosystem, and that entire industry was going to fall because you and I could be in completely different places but I could send you a perfect digital copy of a media file, and then go on the internet and send it to 1000 of my not-so-closest friends without exhausting the original. So I guess that was great if you wanted to share music, not so great for the music industry, but for everybody else. But obviously, if you are doing that with money that runs into the double spend problem, where, you know, I can say I have $100 in the bank to send it to you and also to Susan, and the first person to cash that check is the one who wins that is that’s not going to work for money. So the novel way of using cryptography, peer to peer technology, the internet, and then a novel way of coming to agreement, we would call it we call this the consensus mechanism of coming to agreement where I don’t have to trust you, but I trust a software that is pre-coded with the rules of engagement. It’s open source software, which is also lends itself to copyright, to patent areas of interest as an intellectual property attorney, where I was like, Well, I have to figure that out. I have to let my students know that this is something that is changing the nature of intellectual property. And it doesn’t, it didn’t seem at the time that I needed to also fundamentally understand cryptographically secure digital assets. But I fell down the rabbit hole, it was quickly apparent that understanding the technology I need needed to understand the nature of the assets that were being validated, verified and secured. In this type of news decentralised database, I didn’t have any appreciation for all that language at the time. But being drawn in, in my existing area of expertise, I think was the best way for me to be intellectually curious, and to really learn more.

Gene Tunny  15:31

Gotcha. And are there many legal cases? Is there much litigation regarding crypto?

Tonya Evans  15:38

What we’re seeing now involves, the short answer is yes. Now, but mostly at the federal and state levels against federal or state regulators and various parties or, or stakeholders, participants in crypto. I don’t know if you have a lot of them in terms of the actual number but the import of of actions with the SEC, the Security Exchange, Securities Exchange Commission against some of the big ones we have coinbase, we have the ripple case with ripple is a network that has a native token called XRP. That has been tied up for a long time until recently, when a federal court said that the SEC led by Gary Gensler had really overstepped the boundaries of their regulatory power. The way that reg, regulatory bodies in the executive actually get their power is it’s delegated from Congress. So an agency can only do as much as they are empowered to do by their enabling legislation. And the federal court said that the SEC overstepped its bounds actually making it the, clearing the pathway I should say, for those spot, Bitcoin exchange traded funds or ETFs, that are likely to be approved begrudgingly by the SEC, in my humble opinion. But as soon as November 17, perhaps in the first quarter of 2024, that is one of the most exciting and also pressing legal issues that people will start to learn more about. There’s other things going on with Treasury, trying to make sense of how to properly tax crypto, it was always a nightmare when I first started buying and exchanging crypto in like 2018, where you literally had to have a spreadsheet because crypto, all crypto assets are taxed in the United States as a capital asset. So imagine that every time I am going from cash to crypto, as I say, from, you know, $1 to some portion of Bitcoin is a taxable event, even if I’m using the dollar to get bitcoin and then within the same day, or maybe the same week, then exchanging Bitcoin for ETH. And then using that to get a stablecoin every single time there’s a an exchange, that is considered a taxable event, even if it’s negligible. So the argument before the before treasury, in general and IRS in particular is there should be some de minimis amount. In right now, the number that’s floated is about the equivalent of $600, where we, I mean, it gets to be completely impractical to have to account for every single transaction under that amount, because you’re not worried about money laundering, you’re, you know, you’re not worried about significant fraud or anything like that at that level. And so that’s a really interesting thing to watch. And then finally, there’s a lot of, I don’t think it’s going to happen in 2024, because we’re in a presidential cycle, but a lot of support for various types of legislation to give greater certainty as a matter of regulation. But greater clarity of what agency is actually primarily empowered, if at all, will there be a primary or lead regulator as between this SEC and the CFTC? That’s major. The CFTC is responsible for futures and for commodities. But there doesn’t seem to be agreement between the head of the CFTC and the SEC about the taxonomy, the characterization of various assets. And it’s problematic because most of them are programmable. They actually can change the nature of their character, they might start out as a security. I argue that Ethereum actually did start out as a security. It was, the project was not yet built, they did an initial coin offering inviting people to invest and get a return on their investment. That is, and it was not registered. That would be a classic unregistered security. But years later when it was fully decentralised there’s no central foundation or entity responsible, I argue, and the head of the CFTC would agree that that ETH is a commodity. But the SEC is the head. Gary Gensler does not agree. So I say all that to say, there’s a lot of uncertainty that is driving business away from the United States, to other jurisdictions where it may not be easier, but at least it’s clear. And that’s one of the greatest dangers in the United States is that we would not lead in this area. So those are some of the things to really look for in the headlines that have a direct impact on mass adoption.

Gene Tunny  20:54

And what jurisdictions would they be Professor Evans that the activity could be driven to?

Tonya Evans  21:01

So we see a lot of offshore stuff in and by off, sometimes, when people hear offshore, they immediately think illegal, this is literally off of the shores of the United States. So it makes me think of the Bahamas that has its own central bank currency, the sand dollar, it makes me think of Bermuda. I’m a former member of their advisory board, their financial Technology Advisory Board. They were quite forward thinking. Bermuda is particularly interesting, because it’s a jurisdiction that has a long history of well regulated very clear insurance. And so that’s an interesting place. Zug Switzerland is known as you know, like the Crypto Valley, in the same way that we might think of Silicon Valley here in the United States, quite forward thinking. Singapore is ahead of the curve. Absolutely. It’s the UAE. Despite all that is going on in that area of the world. The UAE, in general, makes me think of Dubai in particular, and Abu Dhabi. A couple of years ago, I was one of the first of Forbes 50, over 50 listees and we celebrated in Abu Dhabi, for example. And I was amazed not only how opulent and beautiful, but how progressive in terms of forward thinking with with crypto. And finally, and this is not a leader that we want to follow, but it’s a caution… not, well, I’ll say it a cautionary tale regarding central bank digital currencies, is China. China was the first country to launch a central bank digital currency, which raises in me all sorts of alarm bells, not not for central bank digital currencies in and of themselves. But the huge issues around financial privacy that people need to get up to speed on if in fact, the United States would start to publicly explore CBDC here, that you want to have the same financial privacy that you do with cash, but have the convenience and things that are better, faster, cheaper, with respect to digital assets. So there’s a lot going on in this space and a lot of activity. In fairness to the United States, there’s some countries and I’ve mentioned a few where you have just one regulator. They don’t have the alphabet soup of the FCC and the CFTC and the partridge in a pear tree right in, in the executive. They don’t have the committees and the subcommittee’s wrangling for jurisdiction and oversight authority in the legislature. However, you know, it’s more simplistic. And so it used to kind of not be a great thing, but it is when you need to be nimble and move quickly because our system is not intended to move quickly. It’s actually built this way to slow things down and be more methodical, but that doesn’t work with this type of technology.

Gene Tunny  24:16

Hmmm, yeah, yeah, absolutely. I imagine that our regulators, I’m in Australia, so I imagine they’re looking closely at what’s happening in the States to see where things land. And you Yeah, it’s fascinating about this Bitcoin ETF. And I know that there was a group in Congress that’s looking at the regulations of how they changed the regulations around the SEC yet or is that something still to do? Do they need to give SEC more powers?

Tonya Evans  24:47

They’re exploring it. The short answer to your question is yes. Because the rulemaking authority that is delegated to an agency comes from Congress and so, we call those enabling or enabling acts, there’s another term as well, but enabling act. So basically, Congress says, here’s the framework, you’re the subject matter expert executive agency. So you all kind of you’re the mortar to these bricks. And it’s the executive branch in general agencies in particular that, that put into play the actual rules and regulations and actually run the thing you think of it like as you have a CEO, the President, and then you have all of these smaller bodies that take care of the day to day functioning, based upon, okay, we have this delegated authority from the legislative body, but it’s ultimately up to Congress to say you’ve over stepped, what we asked you to do, we empowered you to do X, Y, but now you’re doing Z, or also to say, hey, when we created this enabling legislation to empower this agency, we did not have this in mind. We did not have this in mind, right. And so we’re gonna need to go back to the drawing board on this. And I am encouraged that there is in many important, for many important issues, there seems to be a bipartisan effort. I don’t think this is beholden to one party or the other, although it is certainly playing itself out that way. When I think of President Biden’s executive order to order all of the agencies to look into the space and to come up with their rules, a report outs, etc. That happened back in 2022, in March of 2022. So a year later, we have some of those reports. The concern has been, and it’s been a bipartisan concern, that and what I what I testified about in March was about what appears to be a Choke Point 2.0. Choke Point 1.0 was an actual policy under the Obama administration that was cutting off banking access to certain industries deemed to be harmful at the time. So it was like the payday lenders and things like that. Ultimately, it was overturned. But you could at least intellectually understand why that might be. But it ended up not passing muster. We don’t have something on the books, but in effect, it has been very difficult for people operating in the crypto industry to actually be banked. They said, You know, it’s basically like, well, if you want it to be off, you know, off the grid and have your own little money, then you won’t use our banks to do it. And what we’re seeing is that and that has happened in the marijuana industry as well, it’s like if this is if something is otherwise legal, and lawful, that we shouldn’t have a government operating against it to thwart its progress and kind of kill it in its infancy, which what it appears to be. And so you will see this discussion around banking and and being able to onboard meaning going from cash to crypto, and off boarding, settling out, selling in the way that you would sell stocks, and then recoup in in Fiat. So we’ll see that playing itself out too. But that’s another major issue.

Gene Tunny  28:20

Right so is that really difficult at the moment so does the government make it difficult to do that?

Tonya Evans  28:24

It has been very difficult even for someone like me, in addition to teaching at Penn State, Dickinson Law School, I have my own onboarding platform. It’s a online business, I do not sell tokens, I do not invest for other people. And I have either been debanked or had an application denied just because I am a crypto educator, which makes no sense in the world. And it was too difficult because what banks were also hearing is, the government doesn’t like it, even though banks are private, they are in general, they are inextricably linked with the government, as we always see in terms of bailouts, etc, etc. And so when you hear from on high, that this is something that the government at this point in time does not fully support, in my humble opinion, because it is a customer service issue. When you start exchanging value that isn’t beholden to a government. That’s a big deal. You know, it’s we’re basically looking at a time where you have internet 3.0 web 3.0 is what people refer to it as, in the web 2.0 version. There was great support around the globe for the global exchange of information. Yeah, we had to use the internet, you had to protect the internet. Katie Couric and Bryant Gumbel had to figure out what the hell email was because we were all going to use it. Right. And that was great. And we wanted to support innovation, blah, blah, blah, blah, blah. Now we have web three where not only are we exchanging messages of information packets of information. Now those packets are about value. It gets at the heart of even why governments tax, particularly in times of war, etc, and to protect borders that are now being threatened by a borderless currency. That’s a BFD. And so that changes the conversation even though the technology is the same. And so we have a customer service issue. And until governments can figure it out, I don’t think they’re always going to be very excited, particularly in the United States where we have the globe currently. Let’s talk about it in 10 years, but currently the global reserve.

Gene Tunny  30:42

Yeah, yeah. In your books title, you talk about going from cash to crypto. And that’s a you’ve got a registered trademark sign there, is that your platform is it Professor Evans can you explain what cash to crypto is about please?

Tonya Evans  30:56

Yeah, that’s my signature course. So I when I launched Advantage Evans Academy, my primary course and it’s still up and very popular today. It’s an on demand, evergreen version, I’m constantly updating actually, because things change every year. And it takes you in five modules from introducing folks to fundamentals or even the purpose. We start with mindset of even trusting ourselves, managing our own money, because as a Gen Xer I grew up, the minute that you had any money, you’re gonna put it in the bank. And it’s interesting to learn more, as I’ve learned more about the crypto space to really fundamentally start to unpack savings and loans, it’s like, Alright, so let me get this straight, I’m going to put a whole bunch of money into the bank, maybe you used to be able to walk down to the bank, I don’t know if people can do that anymore. And I’m gonna put my money in and it’s gonna be safe there and up to $100,000. I’ll get it back. If we all want our money, even though I plan to have way more than $100,000 stored for another day, right? But let’s say I just have 100,000, it’s FDIC insured, and I’m going to earn a pittance, if anything in interest. And then that same bank is going to loan me back my money for cars for homes, and they’re going to keep the spread. I don’t like that. I don’t like that system. I didn’t know that was a system where I was taught not to trust myself. And not to worry my pretty little head about it. Well, I’ve learned so much in the last six, going on seven years than I had, and I went to Northwestern and went to all the best schools I graduated with honours that from law school. My dad’s a doc, my mom’s a lawyer. I knew nothing about money before I really started to lean in and see how disconnected I was even from the process. Even from understanding when people ask me, what is bitcoin backed by, like what is the dollar backed by? And I don’t hate dollars, I love dollars. But we haven’t been on the global, excuse me the gold system standard for decades. Based on the full faith and credit of the government, we keep coming up against the threat of government shutdown, we’ve had two downgrades in our credit rating, because people aren’t trusting us as much as they used to. Because it’s our full faith and credit. Our word is supposed to be our bond, and it’s scaring the rest of the world. So this is an also, an alternative, alternative to that, that people need to get aware of. Not necessarily replacement in toto today. But you definitely want options in this world.

Gene Tunny  33:33

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  34:07

Now back to the show.

This is something I’ve covered on the show quite a bit because it’s obviously a huge issue in economics. And I mean the way that I think about it and that economists think about it’s well Milton Friedman in Monetary History of the United States, even you know, he acknowledged look, money is a fiction. But what will, what the question is which, which fiction is the most powerful do most believe and the fact is that with dollars, you can settle existing contracts, all the prices are in dollar terms. And you can pay your taxes to the inland ra…, internal revenue or to the Australian Taxation Office in the local currency. So that’s what gives the dollar power or means that that fiction is strongest. And I think that’s, that’s why many economists are concerned about that. And why there is that concern about well, maybe, I mean, is this volatility going to ever settle down? I don’t know. I mean, I think I take your points in your book, I think you make the best possible case for, for Bitcoin and for crypto. But yeah, I think that would be the concern of, of economists. Do you have any thoughts on that at all Professor Evans?

Tonya Evans  35:29

I think it’s important, it’s an important metric. I don’t even know if it’s a success or not, but just to understand what position crypto should have, if any, in an overall portfolio. And obviously, there is I mean, Bitcoin, for example, is up almost 70% this year. And it is one of the quickest ways over its lifecycle to get a significant return on investment as it goes through it’s bull and bear cycles in the same way that the stock market goes through bear, bullish and bearish cycles, the manipulation and I don’t use that pejoratively, but the way that monetary policy is set with inflation, we’re tweaking it’s kind of like we’re calibrating, right. And so there’s a natural energy lifecycle to assets. And as long as you are strategic, you could have something that is very, very safe and secure and predictable, offset with something that isn’t, with great risk comes greater reward, and then it’s an overall balance a balanced portfolio that I think is most important, I would not recommend, although I know some you know, Bitcoin maximalists will cash out their 401 K and put it all into Bitcoin and let it roll. They I think there’s a privilege in being able to do that, because I believe that if past is prologue, we are we will be entering a bull market soon. I think with more positive news. We’re getting past the crypto contagion, we have endured a two and a half, almost three year down cycle. And historically speaking, things have ticked upward. Bitcoin is generally the the rising tide that lifts all boats around. So even really crappy coins start to do modestly better. When bitcoin is doing better, that’s one of the many dangers I see in the space. But you know, whether or not this becomes this entire ecosystem becomes more stabilised. I believe that is possible. I just don’t know if I can read the tea leaves yet of when. But I do believe it’s not a matter of if but when giving, given the import of this technology that is just so pervasive across industry, and sector, it also makes me think of what will be the monetary standard. And this is not too far fetched to stay in space, in outer space, and we don’t have all of the sophisticated borders and things of that nature, but you’re gonna have to have a common currency that becomes more than any one government or, or country’s currency. What currency will that be? It’s probably going to be a digital asset. Which one I don’t know. It may not be Bitcoin, but it’s going to be some type of digital coin. And so preparing for that now and having a first mover advantage depending upon your risk tolerance is something that I’m willing personally to do. And I believe the first step to that is for folks to lean into education, from cash to crypto programme is great for fundamentals. Obviously, the book is a quick read that just level sets, facts so that people have a better idea of what questions to even ask, as they start to kind of become cautiously optimistic in the space, not fall victim to fear uncertainty and doubt or FUD and definitely not to fall victim to FOMO when people start talking about it and and celebrities are back in and NFT’s are all the rage and the next DOW comes out like you cannot be emotional about strategically investing for the long term. And so that’s what I want to educate and empower people to do through through my work through my courses. And certainly through the book.

Gene Tunny  39:22

Gotcha. You raise an interesting question about effectively what’s going to be the currency of the Galactic Empire. I’m gonna have to think more about that and see if any science fiction writers have thought about that. That’s quite a quite an important question. I like it. Right! With the, one thing I’m wondering is do you know how, how extensive is Bitcoin or crypto being used for actual transactions? Are contracts being written in do you see any of that going on?

Tonya Evans  39:53

That’s a great question. I’ve not quantified that yet. I love that question. You’ll have to have me back and we can uncover that. What I know for sure is that more and more legacy companies are creating opportunities for their existing customers to stay on platform and to have access, exposure or some of the the benefits of crypto and the underlying technology. So MasterCard and Visa have products now that will allow you to either earn crypto back, or to pay for things in crypto and you don’t really have to ever touch Bitcoin or whatever crypto is connected to it, because that happens behind the scenes. But you can say I offer this product, right? There’s still I don’t think they’re set their real time settlement is to the blockchain, right? They still have their legacy infrastructure, but they want to not lose customers, as people become more curious and have more opportunities. So Visa, MasterCard, PayPal, they will, PayPal first entered into the space, they would allow you to purchase Bitcoin, I don’t think it was other coins at the time, but you couldn’t take it off platform. So for me and for cypherpunks, or others, like the whole thing is your own personal self custody of your assets. So I don’t leave things on a centralised exchange, even if I trust it. Look what happened to you know, those who had left their property on FTX’s, centralised exchange or BlockFi. We saw a lot of lenders, you know, go out of business and file bankruptcy and your coins go with it. So self custody is a really important thing. But most people are not going to do that now. And PayPal knows that. So giving people the ability, they realised they weren’t going to get a lot of traction if they didn’t allow for people to take their Bitcoin off platform. And eventually they developed a product to do that. And in addition, they recently, I don’t know how to pronounce it, but they have their own coin. It’s like PY something. But it’s a PayPal, stablecoin so that they can do real time settlement within their own PayPal ecosystem, which is really really powerful Cash App, you have been able to buy bitcoin off of Cash App forever, and then transfer it off into your own self custody wallet. We have, in full transparency I am a member of the Board of Digital Currency Group, which owns Grayscale as in CoinDesk, it owns Genesis as well as well, probably 200 different projects and companies in its portfolio. And one of those is Grayscale, Grayscale has GBTC. So the Grayscale Trust, I’m sure a number of people have seen their commercials and Grayscale has petitioned or applied to exchange or change the character of GBTC into a spot Bitcoin ETF. And so there are so many companies BlackRock, one of the most prudent, traditional historical companies in the in the investment space has applied for an ETF as well. So Deutsche Bank, it just the gamut. So most of that exposure has been for high net worth individuals, but the crypto really is a democratic, inspiring currency. And that’s not a particular political party. It’s this the democratic with a little D that democratises access to, to money and not just money. Because we, it’s a bit of a misnomer to say cryptocurrencies. I feel like if we had to do all over again, we’d call it what I say as crypto asset, because some function well as currencies as we’ve talked about, but it also here in the States and around the world. In in Australia, for sure. We, it is a capital asset. So it’s not just currency. It has additional powers and properties, which is why many people right now, lending to its volatility. This idea of holding on we hoddle or huddle, you’ll see. So used to the proper word was hold and then it was misspelt and now it’s folklore to say huddle, instead of hold that holding for the long term, which makes Bitcoin in particular more valuable because it has a hard cap. Unlike many of the other coins and currencies that are more susceptible to inflation in the same way we see government issued currencies. So so so there’s a lot there to to focus on. You mentioned volatility is one thing I wanted to tie up with that as well, because it lends itself to what we’re talking about now. As more entrants come in to the space, as liquidity continues to rise, as clarity in the laws and regulations start to settle, historically speaking, the volatility of pricing starts to diminish. And the interesting question will be, how long will that take in this space? It just feels like everything is moving more quickly. I don’t know if it’s because I’m getting older or the world is moving faster or both. But what used to take decades and decades, I don’t know that it takes as long anymore, but time will tell.

Gene Tunny  45:36

Yeah, yeah. You mentioned GBT, was it GBTC? Could you? What does that mean? Sorry, I missed that before GB…

Tonya Evans  45:46

Grayscale has a Trust Company and it sells shares of its trust, and the trust holds Bitcoin and other assets. And what and so that was permissible, but it was set up as a trust, not offered as an exchange traded fund for Bitcoin specifically, and so Grayscale submitted a proposal, an application that is sitting before the SEC currently to be approved for a spot Bitcoin ETF. So it has an existing infrastructure. GBTC is available and traded, but based upon trust interests, not as a spot ETF, and that’s what we’re waiting to see. There are 12 different applications before the SEC, an important date for approval is the first one would be November 17. So there’s been a lot of speculation, will the SEC approve one, a few, all 12? So as not to be kind of like the kingmaker to say this is the first one we will approve, maybe that would unfairly, you know, nod to one particular company over another where I believe the SEC hates them all. My opinion, not the opinion of this show. But the federal court said what it said, so we’re gonna, you know, not a matter of if but when but will it be all of them? Will it just be the one from Grayscale? Will it be the first one that they receive? But there’s some date certains that are built into the application process and that’s what the SEC is coming up against now.

Gene Tunny  47:25

Right! Okay. Yeah, definitely. Look out for that. Right I’ve just got two more questions. If you have time Professor Evans this is fascinating. Really, really interesting. And I like the point you made about how you got to make sure you actually own the the assets, the crypto, there’s a phrase you use, I can’t remember off the top of my head but something about you if you don’t own the keys, you don’t own the crypto is that it? Something like that?

Tonya Evans  47:48

Yeah, not your keys, not your crypto not your keys, not your coins, not your keys, not your cheese, whatever you fancy.

Gene Tunny  47:54

Gotcha. Yeah, the other term I learned that is the Lamb bro. So for the Lamborghini bros. And so if we do have that, the bull market in in crypto, we’ll see a few more Lamborghinis out on the street. So it’s a bit of a…

Tonya Evans  48:10

We might, and I will have to say that those who, particularly cypherpunks, hate, hate, hate this moniker, they hate it, hate it, hate it, and I get it. I will tell you, as a woman who has gone to a number of conferences, it’s rough out there sometimes. I think there are men who have the privilege of not seeing how male dominated it, certain ecosystems can be, I mean, certain conferences can be and how intimidating it can be when people are drunk and things are going on and was very flashy. I think that is a misrepresentation in general of my experience, and I’m a black woman. As long as you know, I talk the talk and walk the walk I have, generally speaking, been received well, I have to say. That being said, the Lamborghinis, the parties, the strippers like that’s a lot. So when it makes me but, you know, you think of the idea that we have the finance world, and we have the tech world. And then they come together into this microcosm. The Crypto ecosystem is a microcosm of those two spaces where women are underrepresented significantly, even though it continues to improve people of colour, etc. And so there is no impediment other than one’s own education and knowledge and awareness of the space, which is encouraging. And I think for those who have been in the space for a long time, or maybe from the Cypherpunk movement would say, we’re not keeping anybody out. Right. Many are libertarians, they were like, equal …. is good. Get yours. I’m gonna get mine. I’m not going to keep you from yours. Don’t keep me from my, and I get that I respect that. I think there are other forces that work that make me want to be more intentional. To know how much personally and professionally I have benefited from the knowledge and awareness, the professional pivot I did as a lawyer, as a professor, as an educator, that now I believe, for anyone in the world, it is the best opportunity in countries like mine, and countries like yours, to get ahead to kind of level the playing field to get get caught up as a matter of generational wealth at any other time, in certainly my history, but I would argue the history of the world, because things are digitised, we’re starting to remove like redlining and gatekeepers, things that would maintain the status quo to have the best for just a few. And then the rest left for everybody else. This is one of those pivotal inflection points in life. And I don’t think it’s hyperbole to say, because I know personally, and for those who I’ve helped educate who are like me, that this was that makes it more exciting to. And so I, it was really important for me to put that chapter in the book, because I wanted to not only say, the crypto bro thing it has existed, but it hopefully is the exception and not the rule for people who are very serious in the space. But also it misrepresents all of those who are curious and well positioned to take advantage of the space too, because the only thing that is keeping people out presently is a lack of awareness, education, and some protection as they enter an untested space in many ways.

Gene Tunny  51:46

Gotcha. And that is one of the themes of your book, you were referencing it before. It’s the idea that you see this as it can level the playing field or can provide opportunities to people from minority groups. And I know you’re not saying definitely invest in crypto, but yeah, how do you think about it? Because I see risks in crypto. And I mean, is this the right thing for someone starting out or some someone with not a lot of resources to invest in first thing? How do you think about that?

Tonya Evans  52:17

I would like to see kind of a both and approach particularly with respect to Bitcoin. When I first started in the space I, for a number of reasons, one as a professional and thinking a lot of my profession and not wanting to misguide people, knowing people would trust my voice if they heard it from me. And so I didn’t want to be in the habit of saying buy Bitcoin, buy ETH, buy this, buy that, I’ve changed my approach because Bitcoin is quite special as are stablecoins, I actually think stablecoins are the best way for people to get in. They’re not going to get wrecked by volatility. There’s some really strong ones, USDC from Circle, I have great respect for that team doing exceptional job. I know some of those folks, personally, I love USDC. We also have Tether. I don’t know who the people are. But I know Tether is very important to the Etherium ecosystem. It’s kind of like the oil that keeps things going there. When people want to jump out of the volatility of the market, but not out of crypto, they often move in the stables. And there are ways that you can earn interest and yield and blah, blah, blah. And so, I believe the short answer to your question is that this is a space where you want to start buying, you do, the best days right now are when most people aren’t there. The best times to make a sizable return if it’s to be had at all, is when most people are scared. Right? Warren Buffett says be greedy when people are fearful and fearful when people are greedy. When people start to get greedy, that’s when you know you’re probably getting to the top of a cycle and it’s time to like stabilise move things around, rebalance, reposition. And to really understand that with all of those, you know, 1000s and 1000s of tokens and coins. I hope you’re not gonna buy them all. Probably not gonna buy the overwhelming majority but they’re the you know, the top five, top, top 10 have a proven track record. That doesn’t mean they’re always going to win. But if you start now, you start learning the language. It’s what I’ve even done with stocks when I started swing trading, not day trading, but swing trading sometimes I had to start to learn how to read charts and candles and wicks and bar graphs right to start understanding. If this is the way this particular assets move, once it hits this particular range, maybe that’s a great time to buy. Maybe I’m wrong, but at least I’m using some type of disciplined, non emo…, separate, disciplined approach like separate from emotion. And that’s really important. Some of those same strategies can be used in the crypto space, but the major caveat, not only as a matter of volatility, but also this is 24/7 365. There are no national holidays. There’s oftentimes no customer service. I mean, if you’re buying and holding on an exchange, you have some additional layers of protection. But you have some risks even being on exchanges. This is the time to learn about this. Stable coins, literally are pegged to a particular asset, in most cases, the dollar or some equivalent of that as well. So you don’t have to go up and down with the market, but you can learn about the market. And then finally, back to my original point about Bitcoin because it has a hard cap of 21 million coins that will ever be in circulation, and actually 19 million are already in circulation. But it’ll be a long time after my life. And yours when the final bitcoin is actually issued for some technical reasons we can talk about next time, but it’s special. It’s special. And actually, I don’t think and I think many people would agree with me, Bitcoin doesn’t really function well as a peer to peer cash for more stable economies in Australia, in the United States, in Canada, in very various places in Europe, because it’s a nice to have for most people, not a need to have. But then you go to other nations, you go to Central and South America, you go to countries on the continent of Africa, and you start to see places, Ecuador and El Salvador, where there’s complete destabilisation, there’s confiscation, it is critically important that people have access to something that will hold its value better than the national currency, that is more trustworthy and non-confiscatable in the same way that their local currency is. And when you when you start to learn about that, like people need to travel and understand different cultures and people to really get a handle on why this even if it’s not important, and like a nice investment to have, for some it’s life or death for others. And eventually, every one of us will be touched by some catastrophe at some point that will have a direct impact on our finances, be it natural disaster, something going on, God forbid, with the government and everything in between, like, we have to pay attention to what’s going on in the world. And to, there’s 99.9% of things we can’t control, control the controllables. And one of those is your own level of education in a space that’s transformative, but has the potential to be empowering and to protect you down the road. By the time you need to figure it out. It’s oftentimes too late. So now’s really the time, the market is kind of quiet, the bad actors are starting to get routed out. This is the time when you don’t have the FOMO and FUD pressure, and you can proactively start to take some significant steps in the right direction.

Gene Tunny  58:03

Righto, okay. Final question. You mentioned about criminal activity and as a proportion of all crypto activity, the criminal activities, very small proportion, okay, accept that, but has crypto, is there any evidence on whether crypto has enabled criminal activity? So it’s expanded the amount of criminal activity out there in, so does it make it easier to traffic arms or just you know, awful things like human trafficking, etc? Do we know in drugs? Do we know anything about that?

Tonya Evans  58:37

It’s just a small, small part. There are some significant bad actors who deal precisely in the things that you’ve mentioned. But and the Wall Street Journal here. Maybe within the last, well had to be within the last month, they ran this completely error-ridden report about Hamas, raising millions and millions in Bitcoin. And there was this huge rush by Senator Warren and some other folks signing off on letters saying that needs to be immediate action taken. And it was just completely wrong. And it was scary that our legislators would rely on something that was so faulty, and with not insignificant pushback and fact checking, mostly coming from the crypto community. The Wall Street Journal had to issue a retraction and the senators had to stand down. What was said to be millions and millions that Hamas, Hamas was like, please don’t send us any more money they can track it. Thank you. Send us dollars. Send us dollars do not, send send us dollars and oil. Do not send us Bitcoin because of the nature of the tracking. You can literally go to any bitcoin tracker and see in real time. Now it’s pseudonymous, not anonymous at but with Chainalysis and some other companies use what’sapp’s called blockchain forensics. And it’s really like following the money. It’s a paper trail. But only it’s not using paper and every single transaction all the way back to the original transaction in Bitcoin issued by Satoshi Nakamoto, him or herself, is on chain visible, and you can see from wallet to wallet to wallet to wallet, and you start aggregating pieces of data. This is the way the Department of Justice here in the United States starts to root that out, and it’s just a terrible place for activity. Now, the one point is, it might be easier to get it up front. But it’s not a matter of if but when, with the right resources behind behind it, some of that stuff is going to get found and people will be routed out and they will come to justice. So this is a terrible thing for for for criminal activity. That doesn’t mean criminals won’t try. They’re very lazy. And maybe they don’t know a lot about it either. But that’s why there’s a relatively insignificant amount because, you know, it’s easy to hide physical cash. Right? It’s not easy to hide something that’s there in plain sight. So it’s tough to combat that point because of the pervasiveness of, like the sensationalised headlines, and again not to diminish what’s going on we use Sam Bankman-Fried for example, as an you know, kind of the poster boy, but it took less time because he was apprehended in the Bahamas on November 7, in like basically almost a year to the date. He’s a convicted felon, and we’re just waiting for his sentence. It took way more time to find out who was involved in the the housing crisis, way more time to take down Bernie Madoff. It’s all garden variety fraud, but it happened far more quickly in the crypto space and I don’t think that the crypto space gets enough credit for that.

Gene Tunny  1:02:00

Yeah, good point. Very good point. Okay, Professor Tonya Evans, this has been amazing. I really value your insights and your your deep knowledge of this sector. This is this is really terrific. And I got a lot out of this. And yeah, I’d love to do a round two sometime in the future. But yep, Digital Money Demystified. I’ve got it on Kindle. I think it comes out in paperback. Next year, early next year. So yep, I think

Tonya Evans  1:02:28

It’s here now, yeah now here now go to your favourite place and buy buy buy, you can go to digitalmoneydemystified.com. But it came out on October 24. So it’s available wherever books around the world are sold.

Gene Tunny  1:02:42

Okay, ah very good. I must have misread that. That’s, that’s terrific. Well, Professor Tonya Evans, thanks so much for your time. I really value the conversation.

Tonya Evans  1:02:50

Appreciate you Gene. Thank you.

Gene Tunny  1:02:53

Righto, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

1:03:40

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Podcast episode

Iceland’s Secret: The Untold Story of the World’s Biggest Con w/ Jared Bibler – EP215

Show host Gene Tunny interviews Jared Bibler, author of the book “Iceland’s Secret: The Untold Story of the World’s Biggest Con.” Jared discusses his firsthand experience during the brutal 2008 financial crisis in Iceland, where he worked at a collapsed bank and later at the financial markets regulator. He sheds light on the dodgy behavior of bankers leading up to the crisis and the severe consequences that followed. Stay tuned to the end of the episode for Gene’s interpretation of Iceland’s secret and its relevance to economies worldwide.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple Podcasts and Spotify.

About Jared Bibler

Jared started his career as a consultant for a Wall Street giant in Boston and New York until moving to Iceland to support the Icelandic pension funds’ foreign investments. He resigned from his job at a leading Icelandic bank a weekend before the 2008 Icelandic financial crisis.

He was subsequently hired to lead a special investigation team, which referred more than 30 criminal cases to the Special Prosecutor of Iceland, including the largest stock market manipulation cases to be prosecuted globally.

Jared’s insider knowledge and unwavering persistence helped Iceland to famously become the only country to jail its bank CEOs. But the real story, deeply complex and sinister, has direct relevance today as banks once again begin to tumble.

What’s covered in EP215

  • 00:02:56 Iceland’s financial crisis was fueled by the growth of banks that became Enron-sized and collapsed, causing significant damage to the economy.
  • 00:05:49 Financial industry corruption and collapse.
  • 00:11:30 Iceland’s banking system collapsed.
  • 00:19:33 Icelandic banks manipulated stock prices.
  • 00:27:26 The financial system is vulnerable.
  • 00:34:58 Banking fraud and economic collapse.
  • 00:35:58 Currency crisis in Iceland.
  • 00:47:19 Iceland faced economic crisis and unemployment.
  • 00:50:54 Iceland’s recovery transformed into something ugly.
  • 00:57:38 Lessons from Iceland’s banking collapse.
  • 01:00:16 Incentives and regulation in finance.

Links relevant to the conversation

Amazon page for Iceland’s Secret:

https://www.amazon.com.au/Icelands-Secret-Untold-Worlds-Biggest/dp/0857198998

Transcript: Iceland’s Secret: The Untold Story of the World’s Biggest Con w/ Jared Bibler – EP215

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Jared Bibler  00:04

What meagre foreign currency reserves we had at the Central Bank, were being depleted. That’s another piece of the book. You probably didn’t get to but the central bank gave away most of its FX reserves. After the first two banks collapsed, central bank gave 500 million euros to prop up the Third Bank. That money disappeared in one day and then the third bank also collapsed. And they, they have never got that money back. That was that was a substantial chunk of Iceland’s FX.

Gene Tunny  00:40

Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, and welcome to the show. This episode is about Iceland’s secret, the untold story of the world’s biggest con. That’s the title of a book by my guest, Jared nibbler. Jared witnessed the brutal 2008 financial crisis in Iceland firsthand, he worked at one of the banks that eventually collapsed, and later on he worked at the financial markets regulator. His work contributed to the prosecution and conviction of several bank executives. In his book, Jared highlights the dodgy behaviour of bankers leading up to the financial crisis in Iceland and just how bad things got stay tuned until the end of the episode to hear my interpretation of Iceland’s secret, which is relevant to economies worldwide. Okay, let’s get into the episode. I hope you enjoy it. Jared Biblia Welcome to the programme. Hey,

Jared Bibler  02:03

thanks so much for having me, Gene. It’s a pleasure to be here. Oh, of course,

Gene Tunny  02:07

Jared. So yep. I’ve been reading your book with much interest, Iceland’s secret The Untold Story of the world’s biggest con. Now, I was in the treasury here in Australia during the financial crisis. And so we had our own challenges here. And I mean, not as much as other places, but that I remember seeing the news about Iceland that I just didn’t realise just how crazy things that got in, in Iceland, and it was great. Your book, really set it all out and had all your personal stories and recollections in it too. So it’s terrific. So to kick off with, could you just give us a flavour please? What was Iceland secret?

Jared Bibler  02:54

Well, I think you have to read the book to see the secret. But the the secret of the of the crash, I think was that we had these banks, which had been very sleepy institutions catering to a population of just around the time at that time in the 90s, about 250,000 people, very sleepy small savings banks, one was called the agriculture bank. One banks really financed the fisheries, and so on. But these are very small institutions. And they were able to grow a Ponzi like doubling in size every year during the during the first decade of the century, for several years, and so they they grew to each become the size of an Enron. And at that time, when they crashed, the population was still only 300. Little over 300,000 people. So we had these, we had these huge Enron sized collapses in one week, in a country with, you know, one 1000 for the size of the US. When Enron collapsed, it was a it was a big story, you know, and it was, there was a task force of 600 federal investigators, I believe, looking into Enron, and there were movies, there were five or six books, there was an Enron musical, I don’t know if you remember. And I was talking to a reader the other day, and he said, Look, this Iceland story was just so much bigger. And what why is why is your book deal now there are a few other books about it. There’s a lot of books in Icelandic about it. But there’s not that much talking about it. I didn’t really want to write this book. But I felt like after a few years, I have to tell this story. And I actually really struggled to tell the story. But first because I was trying to tell the story as an outside, outside, you know, so third person just here’s what happened in Iceland. And a very good friend of mine who helped me with the book. She said, No, you have to tell it through your own, you know, your own walk through the crisis. So that’s, that’s what we ended up doing. Yeah,

Gene Tunny  04:52

because you had experience in a bank, one of the big banks in Iceland prior to the crash, and then you ended up as a regulator, didn’t you investigating what went wrong? Could you tell us? I mean, how did that transition go? How did you go from being the banker and then leaving just before the crash and then to the, to the regulatory agency? Well,

Jared Bibler  05:16

my wife who the book is dedicated to, she had a dream. And, and a prophetic dream, as I think you see in the book, and she told me just to get out of the bank, and I had been in an asset management role, we had been managing money for mainly the pension funds in Iceland. So we had we had funds of private equity funds and hedge fund to funds was my main product. But I was really unhappy with the things I was seeing around me in the asset management department. You know, it’s the standard asset management stuff that people do, you know, if you want a big client to come in you, you price things in a way that all the existing people in the fun pay for that person that come in, and they never know it, right. So there’s a lot of that stuff. And I guess that’s pretty endemic, still in that industry. But that really bothered me. I mean, I was really, I was studying for the CFA, I was signing these ethics statements, and I was saying, so my wife knew that how upset I was, she told me to quit. So I just quit, I didn’t have a job to go to. And that was a Friday that it was my last day the all the banks collapsed, the next two of them collapsed on Monday, and one of them collapsed on Thursday of the next week. Right? Then we were just really, almost penniless. Because at the time, I mean, the crash, how it felt to live through that cannot be overstated. It was it was a horrendous experience. Because we didn’t it at some points, we couldn’t even access the money in our bank accounts. And almost everything that we had was frozen and later hair cut and discounted, we ended up losing our house in the end. And a lot of our friends did as well. So I mean, it was it was a horrendous time, the British had invoked terrorist legislation against the whole country of Iceland, declaring Iceland a terrorist organisation. And, you know, and this is what was barely reported, you know, we were sitting there being called terrorists by Gordon Brown. And that meant that all the payments into the country and foreign currencies were frozen for weeks or months. So that was a very dark winter, people were out on the streets. And the winter in Iceland is not that cold, but it’s dark. You know, it’s in Reykjavik, it’s about zero degrees, most of the time in the winter, but it’s dark. And people would be out on the street in the dark banging pots and pans and in front of the parliament building. And so I finally I didn’t have a job for the for all these months, my wife had a new job. And so we were trying to live on what she was making. And in Iceland, your mortgage payment goes up every month. So the principal balance is recalculated with the inflation of the preceding month, and then the the monthly payment is recalculated each month. So our payments went up something like 40% 50% in a very short time. So then I got very luckily, hired by the regulator, they said they wanted to hire one investigator to help them untangle the mess of the collapsed, you know, the three Enron collapses that we’d had ended up hiring to others, they hired me, another guy who had been in the banks and a woman who was a lawyer. And they just said to us, you know, go investigate the crisis. And so that was about six months after. I eventually, as you see in the book, I eventually got more people. But it took, I think it took 12 months to get my first person to add add to my team. And then eventually, we got we got a nice team together to do these investigations. So yeah,

Gene Tunny  08:48

so I’ve got sort of halfway in the book. So I apologise I haven’t read it all. And I’m still learn Iceland secret. I thought I’d died. Yeah, yeah. What What I found fascinating about the book is just because you’re American, aren’t you? You’re You’re you’ve studied in the States, and you end up in, in Iceland, and the, the culture is different. And yeah, I thought some of those recollections were terrific. And you’re talking about, you know, working with your, your fellow team members, so that that was great. So it’s worth reading for that. So yes. Can I just fix it in time? So we’re talking, we’re talking about October 2008. Is that right? That’s right. Yeah. Yeah. And Lehman Brothers had collapsed a couple of weeks before so you weren’t worried about that?

Jared Bibler  09:40

Oh, everybody was ever Yeah. So for? Well, to put a timeline on the whole on the whole episode, from 1998 was the beginning. I believe of the banks being privatised in Iceland. So the banks had been government owned, more or less. And they were still Hold off in pieces, but not in a, in a way that’s still being criticised today, and in Iceland and still hasn’t really been fully investigated today. Because basically, the powerful politicians gave bank a lot of banks out to people affiliated with those political parties. And so there wasn’t a lot of transparency, there was no, there was apparently foreign interest for lunch bunkie which was the oldest bank, but then the guest that bid was never even really considered. They just wanted to keep it in the family. Keep it keep it national, you know, Icelandic owned. And so that was 98 203 was a sort of beginning of the privatisation wave. And then in oath 203, they floated the ISK on global currency markets. So it was an exchangeable currency. And when that happened, it just things just took off. Yeah, so So the boom years was really I moved there in oh four, which was maybe one year in one, two years into the boom. And the whole thing lasted only a couple of years, really. Because by oh five, according to one, former executive, I believe oh five, he said, a quick thing, bank was already insolvent. And so the only you know, they, they weren’t doing great banking, at any, in my opinion, in any of these years, the banks were not the only way to escape the bad decisions of the year before was to double the bank in size, the next year, and they had a they had big foreign lenders just pumping money into these banks, so that it for a few years, they could borrow as much as they wanted. From European and later American lenders, there was already a mini crisis in 2006, where the currency crash stock market crashed and everything was a bit a bit, you know, up in the air, what would happen. And at that point, the banks actually started open retail savings accounts for retail customers in Europe, in order to collect the funding that they needed. And they were able to then keep the party going. So then I started in LHINs. Bucky in the Asset Management Department in early oh seven. And the subprime in the trade press, people were talking about subprime already, January Oh, seven, I was started to follow it. And things got more and more. At first, we thought this isn’t gonna, this isn’t going to touch us. Now, Icelandic banks barely invested in subprime. They weren’t doing much, they were just making bad loans to their friends, more or less. But though eight was when things were getting more and more dicey in the bank. And by the end by, I think, looking back when Lehman collapsed, the credit markets between banks in the world really froze. And those weeks and the Icelandic banks were on writing on just fumes anyway. And so that was the final straw, but they were not healthy. Now, this is not the story that I’ll tell you today. By the way, my book is not so popular in Iceland. Because Because the story now is that we had a great banking system, even though it was 11 times bigger than our GDP, but we had a great banking system. And and Lehman killed it. When otherwise it would have been fantastic. But yeah, it was Yeah. Yeah.

Gene Tunny  13:26

What I was asking was because you you quit in a period where I mean, did you? Did you ever you had a parent or your wife or her or your partner had a premonition that the bank was just going to go down and you wanted to get out? You should get out as soon as possible is that is that she

Jared Bibler  13:45

actually said? And she never talked like this. She said, Don’t let those eight holes fire you. You need to get out of there. She said, she had a dream that I was being fired and something bad had happened. And she said you need to be the one to quit to get out of there first. So as soon as she said that, I I I went, you know, I think I quit within a couple of days. So yeah.

Gene Tunny  14:09

So it’s interesting you talking about the rock the fact that Iceland floated, visit the kroner the corona, was that in early 2000s, that late in I think it was oh two, I think oh two, right. And so probably liberalised capital flows. And, yes, so you’ve got all of these, all of this lending, what to have any idea what was in the minds of the lenders? I mean, what were they seen in Iceland? What is the story they’re telling themselves? I

Jared Bibler  14:44

have a thought experiment for you imagine if a small Caribbean nation with 300,000 people went to Deutsche Bank just to pick on them because Deutsche lay a lot of money and lost a lot on the Icelandic banks. Majan if a 300,000 person Island went to Deutsche Bank He said our main exports are fisheries and tourism. Yeah. And we’d like to have a great banking system. But they would have laughed, right? They would not have probably went into that. But because it’s this, especially in German because now we live in Switzerland, especially in the German speaking imagination, Iceland is really to lay Iceland is really the, the mythical land of of, well, well, it is. It is the mythical land of the Sagas and Vikings and so on. And so the they were happy to, to to lend into this. They said, Oh, we’re liberalising our banking system were developed Western economy. The interesting thing about No, I, I am an Icelander. So I have, you know, I have the passport. And, you know, we we have probably socially one of the very most developed countries in the world. Certainly for women’s rights, gay rights, it’s it’s, it’s, it’s, it’s leading edge. But the economy is not developed to match that. So the economy in those days was a lot of fishing, fish exports, and heavy power exports. And today, we’ve added huge and disgusting levels of tourism onto on top of that, so the cup before the pandemic, I think there were 10 tourists per year for every man, woman and child and in Iceland. And so that has become the, that has become the biggest export, I believe. Gotcha.

Gene Tunny  16:30

And can I ask you about? Yeah, that all of this lending, and where was it going? Was this going into your, into the property market in Iceland? Or what was what was being done with all the money that the banks were borrowing?

Jared Bibler  16:45

Yeah, the first thing they did is, is inflate all the bubbles they could domestically. So property bubble, they had a they had a little mini private equity boom in Iceland, maybe in? Oh, 304 I think where they, you know, did sale and lease backs of, I think who says Smithian, which is the it’s a home improvement chain in Iceland, but like a chain and Iceland maybe has only five, five locations or 10. You know, there’s really only one city in Iceland, which is Reykjavik. Yeah, most people live there. And so, so they did a sale and leaseback of these five or 10 properties, and you know, they did things like that. But then by Oh 405 They were increasingly looking to do investments abroad. And so there was a there were private equity style investment groups in Iceland that went and bought up things like European airlines. They bought a lot of high street shops in the UK, for example, they bought famously based on the really based on the historic relationship between the two countries. This was a big, this was a big win for Iceland. We bought Denmark’s Copenhagen’s most prestigious department store became Iceland owned, which was kind of a big, big faced, because Denmark had been the colonial masters for 700 years and just treat it still today that Danish tend to come to Iceland and bark orders at people on the street and so on. So to buy their department store was just seen as you know, the crown jewels, so they did a lot of very expensive deals in those years. You know, we had pretty low interest rates in those years, and there was a lot of a lot of these deals going on. But a lot of them ended up not being not being great. And so, yeah, so it was it was kind of a family family game where bankers made made loans to their colleagues in this in this connected private equity world of Iceland and they, you know, they went and did deals. The banks, the banks also bought other banks. So, they expanded hugely into Scandinavia. They bought some of the oldest London banks, singer and Friedlander inheritable and you know, they were by the time I think in oh eight, my bank lens bunkie had even opened a branch in Hong Kong, I believe, or Singapore. I mean, they were really they want it to be these globe straddling behemoths.

Gene Tunny  19:13

But a Yeah, yeah, but what happened? I mean, they, they borrowed too much from abroad. They learned domestically and in the, their, their data is they just, they couldn’t pay it back. And then the banks crash, they ran out of cash or liquidity. I mean, well, so what actually happened?

Jared Bibler  19:32

The first thing that I discovered as an investigator, which is which is how the book opens, is I get this letter from the stock exchange. Yeah. And the Stock Exchange says saying, hey, look, on the three days before these banks collapsed, they each seemed to be buying their own shares up on the exchange, and they seem to be doing it with with bank money. And I thought that’s a little bit crazy because they hadn’t announced any Any share buybacks, right. And the volumes on the last three days were huge. It was effectively, they bought the whole market. Every trade that came across the exchange was the bank’s cash on the buying side, keeping the price up. And I thought this is crazy, right. So as you saw in the book, I tried to figure out when that behaviour had begun. So I went back to the Lehman and went back a few weeks to cover Lehman because I thought, okay, probably after Lehman, they got really nervous, and they started trying to manipulate their own stock price, you know, I just wanted to put a book end on the activity, before I wrote up, you know, a criminal case to send to the prosecutor. And I had to keep going back and back and back. I went back to first I thought I was being very bold when I when I covered a six month period. And then it turned out that the activity was the same for the whole for basically the whole six months of April, oh, eight to the to the crash, more or less, they were in the market every day. And many days, they were buying more than 75% of the market for their own shares. And so I went back, we ended up going back to 2004, which is coincidentally when I had moved to Iceland, so for five years, they had been doing this behaviour. Later, when I was closing the research for the book, I came across some court documents where and we had seen indications of this. But there’s court documents where some of the traders openly talk about this behaviour going back to 1998. So from the first days of the banks being privatised by the government, they were already intervening in the market to to and so with my perspective, and of course, I’m biassed because I was the investigator who developed those cases, my perspective is without that share price manipulation, the banks could never have grown the way they did. Because they had such healthy performance on the equity market. One of them was dual listed in Stockholm and and Reykjavik. And so whenever they went to lenders, they could say, look at how great our results we will look. The markets love us, you know, look at our stock is up another 20% another 30% this year, or 100%. I mean, the markets, the Icelandic stock market in those boom years, it was going up 60% A year the whole market only Wow. Right. And, and the bat and that was that that lasted for several years, that was the broad market was 50 to 60% a year. And the banks, but the banks grew so fast, that they ended up becoming seven year 80 or 90% of the market cap because they crowded out everything else. And so when they collapsed, of course, the stock market lost 93%. In 2008, it was basically closed for equity trading after the bank collapse. And so all of our, for example, if you talk about damage to the people of Iceland, all of our pension funds had to be in the equity market. Right. And so, and basically that meant they had to be in the, in the banks. When when I was investigating the the manipulation that the banks did was looking at lists of buyers of the shares. And there were some periods in Oh 708, where the only legitimate buyers of the banking of the bank shares were the Icelandic pension funds. And all the rests were, you know, because, yeah, they were accumulating so many of their own shares each quarter that, you know, and that they were going to be in they had, you know, the big four auditors were, were their auditors. I mean, all this is all big names. You know, the Stock Exchange was called NASDAQ, oh, MX, Iceland, you have KPMG you have EY you don’t have the the big four auditors are in Iceland, they knew that when their books were audited, they couldn’t be sitting on, you know, $200 million worth of their own shares, which they had just bought on the exchange. So they did these complex and runs style machinations at the end of the quarter to offload the, the, the shares. And so they would create, I would find a shell company that British Virgin Islands that had just bought 100 million worth of shares. And so to answer your what one of your questions a few questions ago, what were they making loans to well, by the by Oh 607 their loan book was almost entirely to these bogus companies that they had just created to buy the shares from them. Yeah, so So you know, it doesn’t make any sense at all, but it was uh, I think fake wanted to keep that, that that. I call it shear laundering. I think they wanted to keep that scheme going as long as they could. Yeah. Now

Gene Tunny  24:59

is that all Iceland secret or is Iceland secret something far worse that I’ve yet to discover?

Jared Bibler  25:04

I think I’ll tell you that secret, if you want. I’ll do a spoiler alert. I don’t know. This. That is the secret is the share is certainly a big secret. Because you know, that that was never really reported. This is one of the reasons I wrote that was like, I have to tell this story. I mean, yeah, they basically deceived the whole country. And all the investing world, I mean, London, all the big markets knew about these Icelandic banks that were lending to them, they were doing business with them. And the whole time they had created, you know, an illusion of success based on this market manipulation that they were doing daily behind the scenes, you know, the guys who were doing the manipulation had to do it so much that if if there’s a famous phone call, and one of the court documents where the guy’s late for work in the summer, and the price in Sweden has already dropped a couple of percent, and his boss is calling him saying, Get in here, man, we’re losing, like, you know, if they had to be in there on every trade, to keep up this illusion, and they did this free for for a decade. So I think that’s, that’s, that’s one of the secrets of the book. Well,

Gene Tunny  26:14

I can we can leave it under wraps. Okay, because I don’t I don’t want to ruin any potential sales of your book. And I don’t want to spoil that for myself, too. But I was just wondering, because when I when I saw the title, and then I started radio, then I that must be the seagull you’re talking about. But if there’s something far worse that that really gets me interested,

Jared Bibler  26:35

there is something far worse. Okay. And I would, you know, go ahead. Well, I just want to make the point that a lot of people say, Who cares about Iceland, and I, of course, I love Iceland. So I care about it a lot. But, for example, when people here in Switzerland, read the book, or hear me talk about it, I get a lot, there’s a lot of scared faces in the crowd. Because a lot of a lot of the world’s financial markets are are subject to the same forces and incentives as we had in Iceland, which led to this incredible collapse, which devastated the country. And I think it’s really the story again, I’m biassed, of course, but I think this is really kind of the story of what we may be all facing in the next couple of decades. Because we, we haven’t managed yet. And that and I also people get offended when I say this, but in two or 300 years, I think people will look back on us and the way we structured our financial systems and laugh at the way we laugh at Dutch tulip mania, or, you know, because we have kind of no put in no incentives, or no structures to keep an Iceland from happening elsewhere. Now it’s going to be maybe the nice thing about Iceland is it’s such a small place. It’s such a small population that the scam is very easy to for me to describe to you. I think in a bigger market, it’s going to be more it’s gonna be more subtle. But But still, all the incentives are on the side of of cheating, and building in, in sustainability to our markets. And nobody is really paid good money to, to stop these things can mean you have some window dressing like you have comply. I mean, they stopped some things. But in my experience, when senior management of a bank wants a big deal to go through, that deal is gonna go through nobody’s sitting, nobody’s gonna get paid have a 5 million franc bonus to stop to stop to stop something. This is not how it works.

Gene Tunny  28:41

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  28:47

If you need to crunch the numbers, then get in touch with Adept Economics. We offer you Frank and fearless economic analysis and advice. We can help you with funding submissions, cost benefit analysis studies, and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world. You can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.

Gene Tunny  29:16

Now back to the show. One of the interesting stories in the book is where you’re having to clear or run a transaction, aren’t you or make a transaction or deposit two was at a bank in Europe and trying to remember exactly yeah, it was trying to remember the details but in your manager, he initially said I Yep. Sounds fine to me. Just let it go through then. Later on. Oh, that must be it’s Jarrettsville. Sir, could you tell us about that?

Jared Bibler  29:49

Oh, yeah. So I tried to sprinkle in actually, my dream is to rereleased Iceland secrets sometime in the future with with more of the stories in there but my publishers said, you know, you’re a first time author, you only get 300 pages. Sorry, Jared, but, but I had more of more of those things have I tried to sprinkle in stories in the beginning, which are representative of the culture within the bank? And when actually when other bankers and other countries read this state, none of them says, They all say, oh, geez, yeah, that’s exactly how it is where I work, you know, none of them says, oh, Jared, this, this only happens in Iceland, they all say, Oh, yeah. So the story you’re referring to is we had a, some guys who call themselves a hedge fund. And they wanted our bank. To be basically we were the administrators of the fund, and the custodians of the funds, assets, but they were going to trade. And they had, they had got the investors, and they had, I think 120 million euros come into the fund. And they, as far as I could see, they weren’t hedging anything. They were just buying long positions and in equity, and very few companies. And I think they, I think they had some inside information, basically, on these few of these companies. But as the, as the saga went on, they did more and more crazy things. And one point they said, We’re, we’re investing in a shipping portfolio. I don’t even know what that means. And I was waiting for like the paperwork about because when you do an investment, you know, you know how it is. I mean, there’s there’s a contract, and there’s there’s there was nothing. They said just Just what please, they wrote me like, please help us wire 5 million euros to this account in Norway. Yeah. At at such and such bank, it was one of the biggest Norwegian or Scandinavian banks. So it was a reputable bank, but we didn’t count just had a person’s name. All I had was like an AI ban and a person’s name. And I went to my boss, and I said, I don’t think we should send 5 million customer money out of this fun to this account. We don’t have anything. He said, Why are you always making problems? You know, bring the solutions. And so I just decided, eventually I did it. I sent the money. I mean, I copied him on and and in an email to cover myself. And I said as as we discuss, you know, and as soon as I sent the 5 million, as soon as that went through they, they wanted another five. I mean, within within, as I remember it within a day. I mean, it was very quick. They ended up they ended up sending out 15 in cash. And the other weird thing about this was that it was such a, you know, when you’re looking for fraud, usually round numbers is a good flag, because most things don’t. There’s always a commission or you know, taxes or something, or exchange foreign exchange differences. Things never come out or rarely do they just come out to like 5,000,005. So yeah. So then the fund within a couple of weeks, got into trouble for some other things. Now, I had been trying to warn these guys about about the problems with this fund for more than a year. And they just said, you know, making problems just it’s going to be fine, you know, let it ride. And so you can see more of that in the book, but that they were going to scapegoat me then for this 15 million they went out. Because yeah, when his boss looked at it, and all the transactions that just jumped off the page, they were the biggest ones. And you know, all these zeros, they just jump off the page at you. He said, he said, What’s this? And my boss said, Oh, I don’t know, that looks like something that Jared did. That was that was the weekend. I think that happened on a Sunday. If I recall correctly that night was when my wife had the dream. And that Monday, she woke up and she said you have to get out of there. Yeah.

Gene Tunny  33:53

Was very smart. And that was a Friday. So yeah, there was the Friday that.

Jared Bibler  34:00

Well, I quit. So I put me so that was a Monday in Monday. Yeah, that. Well. That was right after Lehman. I have to go back. And look, it might have even been the Lehman weekend that that happened. It was in September, then I quit when you resign in Iceland, you you resign on the on a month end. Gotcha. So I put in my resignation for 31st of October. Sorry, 35th of September. So I probably put that in within a couple of days, effective 30. September, then I would have needed to work three more months, according to my contract. So So I should have been there October, November, December. But they was that stories in the book too. They basically let me go on the Friday October 3. And then the banks collapsed on the seventh eighth and the sixth, seventh and ninth of October.

Gene Tunny  34:58

So the banks collapsed. This is a day that was at the three biggest banks in Iceland collapsed. Yes. Right. Yeah. And you talked about the the hardship before. But so what did it mean, you know, one could get people weren’t able to get cash they the economy basically stalled? Yeah, it

Jared Bibler  35:18

was. So I’ll try to walk you through it. I mean, it was, it was frightening, because for months, the currency of the currency against the euro had been depreciating. So it’s through the, through the crisis week, the currency depreciated so much that it was it had lost half of its value, since maybe five, six months before that. So everything we were used to like flying to Europe and having vacations and things, everything was now double in price in a very short time. So that had already been going on. And the politicians were just saying, well, the currency will come back. There’s, there’s nothing on the other side, it’s never come back, of course, still today, and then what happened in the crisis is that it actually just, they just stopped trading. Nobody. So outside of Iceland, during the good years, it was 60 or 70 krona to the dollar. And then the offshore rate became something like two or three or 400 to the dollar raw. So anybody offshore who had ISK, they just wanted to dump it, they didn’t care what the rate was. So you had this offshore rate of two or three or 400, whatever it was. And then onshore, we had capital controls, which lasted a decade. So in Iceland, you could buy euros for, you know, for a predetermined rate set by the central bank. And they would basically give you the euros that they had against ISK. This lasted for a long time. And but you couldn’t get them you could only get them if you were travelling. Or if you hadn’t, if you had an invoice. That’s it. Yeah, there was no way to get dollars or euros or anything else for a long time. And of course, that that begat a huge new scam industry. All the bankers who had just been laid off from the banks, not all some of them started faking invoices from foreign companies. And you know, get if they had a relative in the UK, they have the relative send an invoice which said so and so’s consulting company 50,000 British pounds, they would get the, the onshore Icelandic rate, they’d wire the pounds out to the foreign account, the foreign guy would would take the British pounds and buy some Icelandic government bonds from a British guy who didn’t want them and would take the offshore rate. And they’d send the bonds back in in one in a one or two day round trip. They could double their money or triple their money in local currency terms. So that became a whole industry, which ran for about six. Yeah, to try to profit on the capital controls and but what it was really doing was depleting. The what meagre foreign currency reserves we had at the Central Bank, were being depleted. That’s another piece of the book. You probably didn’t get to. But the central bank gave away most of its FX reserves. After the first two banks collapse, central bank gave 500 million euros to prop up the Third Bank. That money disappeared in one day. And then the third bank also collapsed. And they they have never got that money back. That was that was a substantial chunk of Iceland’s FX. Yeah.

Gene Tunny  38:56

And you mentioned the the exchange rate and prior to the crisis, and you tell a story about how I mean teachers and people you would normally expect would be going they’ll be travelling overseas for shopping trips. Yeah.

Jared Bibler  39:10

Yeah. Because I just realised I didn’t really answer your question, the last one about how to live through it, but but to come to the teachers. Yeah, I mean, for those few years after the after the FX trading was free, you know, globally available. There was a huge demand for ISK assets among investors around the world because the yield was so high, you could get an eight or 10% and it was perceived to be a safe place to invest. And so a lot of money just flooded into the country. And that meant that the exchange rate went, the ISK got 20 3040 Maybe 50% stronger in a very short time. So people felt very rich and Um, but things in Iceland are still very expensive because you have almost no competition on retail and wholesale and, you know, maybe one wholesaler for anything you might buy. And so the currency was very strong. But that doesn’t mean that domestic prices are going to go down. They should, but they’re sticky. They don’t go down, right? Yeah, but that means you can go abroad and for and for the savings that you will have on buying, like, say, a laptop computer, you go to Boston to buy it would pay for the trip, the savings would pay for the trip. So that was a calculation that many of us made, people would just go to buy. I was in Boston once and someone had bought four big tires for his SUV in Iceland, and he was putting them on the plane they were putting them on, it’s just luggage with, you know, with a tag just wrapped around the tire and putting them on the belt, he probably saved enough on that to pay for a weekend in Boston. So as if it was a calculation a lot of us made. And so yeah, we felt super rare, we felt like the world was our oyster. And when we would go, also things seemed very cheap. So I went to Boston, and I took out my mom and dad, my brother and his wife for a meal. And even with a generous tip for a meal for the five of us, it cost only a little more than a meal for one person would have cost in Reykjavik at that time. So we just felt they felt like for me, it only lasted maybe 36 months or 24 months, but we felt like kings. Yeah. And then And then yeah, the the, the loss of that was that the times were very desperate in, in especially the autumn of Oh, eight, we had no idea what what the next week was going to bring. I mean, we had the terrorist thing from the UK, which really, that meant that all the companies in Iceland, let’s say that you had a fishing exporting fisheries company that was expecting to be paid for fish that they’d already exported to the UK or to the mate or mainland Europe. The payment would be just frozen in Swift, it would just have to be blocked somewhere in the UK and not allowed to go through because the whole country was considered a terrorist organisation. So

Gene Tunny  42:16

what was going on there? Jared? Was Was there any? Was that legit? I mean, what what’s going on? What were the banks? Did they have? Did they take deposits, so facilitate transactions for some shady people? What was actually going on?

Jared Bibler  42:31

That was just to punish Iceland? There’s many there’s different explanations? I’ve never heard a great one. I mean, Iceland, in England have a long standing tension are overfishing actually, there’s something called the cod wars in the 70s. Which Iceland one. But it meant that the fishing grounds that the English had been using, were no, we’re now claimed by Iceland. So some people say that this was retribution for the cod wars. Others say that, you know, it was retribution, because there was a lot of misunderstanding around savings accounts. And, and, and more generally bank products in the UK, that the Icelandic banks had offered. And so for example, there’s something called Icesave under under EU law, a bank in one country can open a branch in another country, and not be regulated by this by the new country. So so the Icelandic banks, when they were running out of money in oh six, they decided to use this to open online savings accounts in the UK. And take money from retail depositors in the UK, pay them higher interest rates to to lower them and take the British pounds, because they needed, they needed FX they needed foreign currency to keep to keep going. And so there was a there was a big misunderstanding between the two governments on the eve of the crisis, where famously the key was the finance minister, but he was a veterinarian, and he did not speak very good English, he should have had a interpreter. And he also should have had a UK cultural interpreter. Because as you as you know, you know, when, when an Englishman says I’m very concerned, that means like, you’re dead, you know. And so Alistair Darling was on this famous phone call. He says, I’m very concerned about the status of these deposits and so on, you know, I can’t remember the exact words, but the Icelandic guy just as well, well, we’re looking into that. And, you know, dollar darling is like, look, we’re going to talk tomorrow at eight in the morning, I’m going to call you but if this isn’t done, you know, we’re going to take we’re going to take measures, and I think I can’t remember the days how they played out but it was that day or the next that, because they had after 911, they had these new terrorist powers in the UK where they could put on her majesty’s treasury, they could put like al Qaeda on there, and that would just freeze all payments. Okay. So Gordon Brown just decided to put, so they put. So it was like al Qaeda, al Qaeda in Syria, I want to say or al Qaeda in Iraq, there was a whole bunch of terrorist names. And then it said republic of Iceland, Central Bank of Iceland. Financially, they even put the Financial Supervisory as a separate separately from the Republic as its own its own line item. But that just killed us, man, because that was in the middle of it. These countries are ostensibly NATO allies, right. And that just that just devastated us. And so yeah, so those months were just super dark we. Because they’re because of the freezing payments, there wasn’t like no food being imported. So we were eating more and more just locally, and we were anyway, for price reasons, eating only locally grown stuff. We just, I mean, we stopped driving the car. I mean, just I don’t want to sound like these are not complaints compared to what people have going through in Gaza right now, for example, but I mean, our lifestyle just was cut down to just the just getting through which we lived like that for years after, after that. Because the SAT and what is also sorry, the salaries were the same, but the buying power of the of the salary was half of what it had been in real terms. And then they they also raised taxes, the government raise taxes so that the income tax was almost 50%. In the years after the crisis, so I mean, I always tell Swiss people living in Iceland is like paying Zurich prices, but getting a Lisbon salary, you know, you have a quite low salary with high taxes, but then you have one of the most expensive cities in the world. So it’s all, even in the even in the good years. It was a struggle. Sometimes. Things are just unbelievably expensive. And even Swiss people today who go to Iceland as tourists, they say, Wow, it’s so expensive there. Then I say, Yeah, imagine living there and an Icelandic salary. It’s, you know, it’s not easy. Yeah. So

Gene Tunny  47:19

yeah. So during the crisis, you had a big increase in unemployment. Didn’t y’all have to look at what the stats are. But it was a huge economic shock. And it went

Jared Bibler  47:28

up four or 500% the unemployment rate. Right. Yeah, it was a huge shock, because the banks had employed the banks for so huge. I think they employ between them 10 or 12,000 people in a country of only at the time, 300,000 or so. And then you have all the you know, the follow on effects of such a big layoff. So, yeah, the unemployment rate was just just rocketed. And we just tried to Yeah, we just somehow got through it, everyone somehow got through it. But a lot of us lost our houses and, and all the pensions, pension savings that we had thought we had was was was decimated when the stock market dropped like that.

Gene Tunny  48:14

Right. So people are still feeling the effects of it. 15 years later, I would just I mean, people

Jared Bibler  48:20

don’t talk about it. Well, actually, they do. They do talk about it. Yeah, they are. Because they were they were projects like infrastructure projects. It’s almost like it’s, it’s almost though, like if so friend of mine was in Iceland, and said she was trying to talk to people about the crisis, and that nobody would talk about it still, like, people want to forget about it. Basically. There were infrastructure projects and ideas that we desperately need, like expansions to hospitals. There’s no rail infrastructure in the country at all. And the International Airport to Reykjavik is like a, it’s like an hour drive, it should have a train link. So there, there were things that the country needs that have just never been executed. And now they’re put on the back burner for 50 more years or something, who knows. So that’s definitely an effect and they actually closed some hospitals and some birthing centres, which forces people to drive over these, you know, really dangerous mountain passes and stuff in the winter to get medical care. So there were effects like that. And a lot of people lost their family businesses and, and so on. So the biggest effect is that when when the currency lost half of its value, Iceland suddenly became a tourist, you know, hotspot and, and Iceland marketed itself as such. And so that that that began the tourist wave, which continues today, but it’s like, it’s like what’s happened in other European cities but on steroids because the city of Reykjavik, the old towns centre is really only five or six streets. I mean, it’s a very small village. And now and that had very cosy things there like, like an old cafe with doily lace doilies, where the grandmothers drank coffee. And, you know, there was some classic things of old Reykjavik that were there. And almost all of that is gone now. Because it’s all just t shirts stores, or they’re selling like stuffed animal puffins, you know, and at the end, all the neighbourhoods around the old centre, including where I used to live, have become dominated by Airbnbs. So you can even walk around and not even hear the Icelandic language in the nation. And the, the old neighbourhoods are very giving because it’s just become tourists defied. And so that was the response. So people, often I face resistance, people say, Oh, Jared, come on Iceland recovered. And I’m like, well, first of all, nobody, nobody knocked on my door and said, Here, here’s the keys back to your house. But the other thing is that it all it only recovered by transforming into something pretty ugly for my from my eyes. Yeah, yeah.

Gene Tunny  51:19

Yeah, yeah. Yeah, it’s. Yeah, I mean, it really was a huge shock. And I mean, I didn’t appreciate like we we sort of sailed through it. Reasonably. Okay. Here in Australia, there was a little bit of a slowdown, but then we were insulated from a lot of it partly because of mining. Right? Yeah, it was extraordinary to see just how bad things were there. So I’d recommend the book on that count, for sure. Just a couple more things before we wrap up. What happened to the perpetrators? Were some of the people do jail time. Is that correct? That’s,

Jared Bibler  51:51

that’s part of the secret at the end. Yeah, they some of them actually did a few months here and there. We, because the headline of Iceland was it was the only country that prosecuted bankers after 2008. Yes, and that is true. And the cases that you read about in the book are the reason the main reason behind the big prosecutions, but in the end, so in many European, I’m not a lawyer, so this surprised me. But in many European legal codes, you can’t get charged for multiple counts of the same crime. So if you if you did market manipulation, but you did it every day, for 1000 days in a row, which is what they did, when I and the max penalty, if you read the way the law is written, which is a European legal code that Iceland imported. But clearly, the spirit of the law is for someone who did a manipulation, maybe for a day or two or a week or like a single event. And then in Iceland, its maximum of six years in prison for that. So I was naively thinking, Oh my God, these poor guys, like they did it every day for 1000 days. It was gonna be, yeah, up to 6000 years in prison. And people said, No, charity, don’t be silly. Like it’s market manipulation. That’s one thing. And so the sentences that the so we were able to show that a lot with emails and internal documents, we’re able to show that, of course, the knowledge of this multibillion dollar manipulation went all the way to the CEOs of the of the banks, and even higher into the boards, and the ownership. But we were able to show that that went up in the biggest bank to the executive chairman of the board that he was getting daily reports on the manipulation directly from the traders. So they were they were writing these things, and I’m paraphrasing here, but Hey, boss, you know, we bought another XYZ number of shares today, the price is up 1.2%. You know, so that was a daily update to the chairman.

Gene Tunny  54:10

And did they not just not appreciate what they were doing was? I mean, I presume this I mean, this is illegal in Yeah, it sounds it sounds healthy, go. Did they just not appreciate it or they?

Jared Bibler  54:23

That’s what I think the book is, of course, I’m biassed again, but I think the books super important because it gets into a little bit. And you see this now with Sam Backman freed and the FTX trial and so on. The behaviour of white collar scammers, part of their shtick is that they can’t even admit to themselves that they’re doing criminal things. They, even after they’re charged, convicted and they serve jail time. My experience with the Icelandic situation would would lead me to believe that Sambac been freed for example, will probably never have a moment of clarity He, where he says I did some bad stuff. I mean, he should because it would help his soul it would help him like karmically to, to release that right. But he, I hope he does, but he probably will not. Because So, for the very top people who are masterminding the scheme, their justification is always like, Well, we were doing great things with the bank. So whatever it took to keep the bank alive is good. And then the people lower down in the scheme are just following orders. You know, like, like the guards that Auschwitz or something, you know that, and, and many of them are naive. So, some of them knew it, but some of them in my experience actually didn’t even think about. Because Iceland can also sometimes be very hierarchical culture where if your boss tells you, hey, buy all the shares on the market today, you’ll do in, it’s like, oh, my boss told me, you know, I’ll do that. So I think this is kind of a good template story for how these frauds go on. And, and I don’t know if I say this in the book, but the entire business of the of these banks, by the end, was perpetuating, perpetuating the buying of shares in the hiding of shares offshore. And they involved every department. And so, a lot of those people, I think, just just were just doing their job.

Gene Tunny  56:34

That’s how they see it. And so this was an important or this was an essential part of making the banks look much better than they were, and attracting the letting them borrow more from overseas, and then they lend that onto their, their friends or cronies. Okay, that’s

Jared Bibler  56:52

right. That’s yeah.

Gene Tunny  56:55

Yeah. Yeah. So the untold story of the world’s biggest con so. Yeah, I mean, that’s a big call world’s biggest con, but you, you’re confident it is. So you think

Jared Bibler  57:05

maybe it’s maybe it’s been outpaced now by crypto or, you know, but but certainly in the sense of a con that takes down a whole country. I think that scale definitely is still the biggest.

Gene Tunny  57:18

Yeah, yeah. It’s pretty extraordinary. Yeah. Okay, so, Jared, this terrific. It’s really, this conversation has really motivated me to finish the book and make sure I understand all the details as best I can. I think it’s yeah, it’s just extraordinary. What happened, I guess, to end on what do you think the lessons are for the rest of the world? I mean, we talked about how the, you know, you mentioned there could be a certain type of person who’s a white collar criminal, and there’s the quite brazen, I guess, you’ve got to look out for those people. I don’t know how you do that. I mean, you obviously need some sort of regulation. It sounds like the regulator in in Islan, Mae, it probably wasn’t doing the job it should have been doing beforehand. I mean, you discovered that you could actually go and visit these banks and force them hand over documents, which are was very good. So yeah, what are the lessons for the rest of us? Now for the rest of the world?

Jared Bibler  58:15

I think we need to. So this pattern keeps repeating. And my point with the book is that if you let this thing get out of control, it can take down your whole country, because our financial system is not just a playground of of, you know, Sam Backman, freetds and billionaires. But it’s also how we pay for things. It’s also how we save money. And we rely on it to it’s, you know, we take it for granted. But it’s kind of like the air we breathe in our daily lives to get to get groceries to, you know, buy a car or house, whatever. And so those two things, unfortunately, are connected. And the incentives for for having a system that that works well, and is not subject to gaming and collapse, I think are not. We have we have plenty of we have too many regulations probably, you know, we have a lot of people who spend their days checking boxes and things like that, both at regulators and within these institutions. But we haven’t really yet thought about what structure do we want the market? The markets to have? Markets are always created by us, you know, they’re not we, you know, people say, oh, you know, that let the market sorted out. But markets always have rules. You know, I used to work at the Swiss stock market here you have an opening time and closing time you have a cloud closing auction, how that works. I mean, you have the whole thing is rules. And we need to think more about as citizens I think we need to think more about what do we want our banking system to do, what are the outcomes we want? And then how can we best get those incentives, incentivized and I think and again, I’m biassed, but And this is very controversial, but I would like to see someone try this, I would like to see what happens in a country where the country’s regulator regulators would be incentivized to bring in the biggest cases they could, or prosecutors, right? Imagine, imagine if the incentives that bankers get, because if you do a $10 million, or $100 million deal, you get a piece of that as a as a bank employee, if you bring in that business, if I bring in which in Iceland, I brought in three, I don’t know, you can measure the cases different ways. But let’s just say conservatively, three $4 billion frauds. Each of the banks, for example, if you just take the last year, each of them spent about a billion US dollars or more just buying up their own shares on this tiny Icelandic stock market that you’d never heard of. Right. So but my team doesn’t get any, we don’t get any team dinners or anything for that, we just get a salary. So there’s actually, it’s even worse in most regulators. If you are someone like me, who’s a bit of a maverick, who wants to go after things, you don’t last, you won’t have a job, because that’s not the personality that anybody is looking for in those in those institutions, unfortunately. So we need to incentivize that we need to have the same type of risk taking and so on, on the regulation side that we have on the banking side, because otherwise you have a and the same thing with salaries. I mean, if you’re a great regulator, you know, you can always walk across the street to a bank and double your salary. So, so what’s going to make you you know, go after people at that bank or or look too deeply into anything you don’t. So the whole system is kind of really tilted. One one way. I don’t have all the answers to this, but I would really like to have this be in the conversation. And I suspect that after the next financial crisis, which I think is coming, I think it I hope, my hope with writing the book was to get this out there so that we could start to have that conversation. Because since 2008, we haven’t changed enough to keep that from happening again.

Gene Tunny  1:02:10

Yeah, absolutely. Fully agree with you there. Have been talking about this on my show from time to time, so absolutely, fully agree there. Okay, Jared, is there another book coming out anytime soon? I

Jared Bibler  1:02:23

have one but I’m, I’m not sure what I’m gonna do with it. But I’m working on one.

Gene Tunny  1:02:26

Okay. Okay, so

Jared Bibler  1:02:28

you keep that under? Yeah, under under wraps. It’s another secret, it might have secret in the title.

Gene Tunny  1:02:35

If they’re sick if they’re if I still don’t know, Iceland’s secret, I’ll put a segment at the end of this episode just for those who want to know, but I’ll encourage people to read the book. Because I think it’s an enjoyable read. And I love the all the stories and just how you learned about the issues in Iceland’s before the time before you saw teachers going by on buying trips overseas, people were importing BMWs and Mercedes while you are importing your rav4. Stories. Thank you, Jared. That’s, that’s great. Right. Any any final thoughts for wrap up?

Jared Bibler  1:03:13

No, I just really appreciate the time to talk to you. And that was it was lovely to be on your show. Very

Gene Tunny  1:03:20

good. Thanks, Jared. Thanks. Okay, I hope you enjoyed my chat with Jared. Thanks got pretty messed up in Iceland didn’t that. According to Jared, things aren’t much better today. Jared left his job at the regulator in late 2011. After there was a reduction in the resources he had to investigate the misdeeds of the bankers. Unfortunately, the response to Iceland’s financial crisis ended up being inadequate. Several wrongdoers were punished, but they received relatively light sentences and many bankers got away with it. In Jarrods opinion, the regulator’s still don’t have enough power in Iceland. Politicians were unwilling to make tough decisions and apply the level of oversight and enforcement that is required in Jarrods view. That’s possibly because of the close relationships between politicians and bankers and business people in Iceland. Iceland is still experiencing financial scandals. For example, in October 2023 Bjarni Bennett Dixon, a former Iceland Prime Minister, he had to resign as finance minister, there was an irregularity with the privatisation of one of the banks that was taken over by the government during the financial crisis. It turns out is a company owned by his father was one of the purchasers of shares in the bank that was, that was privatised, so that raised a few eyebrows. Okay, Mr. Bennett Dixon, he has a reputation for being a Teflon politician. Though and only a few days after resigning he was appointed as Iceland’s foreign minister. That’s an impressive comeback for sure. From what I can tell what Jared thinks is Iceland’s big secret is this ongoing permissiveness regarding dubious financial dealings. It could be a big secret in in many other countries too. So for those of us in Australia, the US, UK and elsewhere, we need to be vigilant and watch for any signs of financial shenanigans in our countries. Finally, I’d encourage you to pick up a copy of Gerrard’s book, Iceland secret. There’s a lot of fascinating and intricate detail about the various financial shenanigans that occurred in the lead up to Iceland’s financial crisis. Jared did a great job with his book, and I’m very grateful to have had him on the show. Thanks for listening rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

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Carbon as an emerging, liquid asset class w/ Michael Azlen, Carbon Cap Management – EP212

With carbon prices becoming more common globally, carbon is an emerging, liquid asset class, according to Michael Azlen, CEO and co-portfolio manager of Carbon Cap Management. Michael shares his insights into investing in carbon markets with show host Gene Tunny. Michael, an experienced investment professional and regular speaker at investment conferences, shares his research on the benefits of diversifying investments across multiple carbon markets. Tune in to learn more about the potential of carbon markets as an investment opportunity. Disclaimer: This is for general information only, and does not constitute investment or financial advice. 
Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple Podcasts and Spotify.

What’s covered in EP212

  • Carbon markets and investing in an emerging asset class. (0:03)
  • Carbon markets and their correlation with other asset classes. (2:57)
  • Carbon markets and impact investing. (9:20)
  • Carbon markets and emissions trading schemes. (13:42)
  • Carbon market mechanisms and their effectiveness. (20:52)
  • Carbon markets and their potential for investment. (28:19)
  • Climate change impact on asset management industry. (33:35)
  • Final thoughts on carbon markets and investing with Michael Azlen. (38:25)

Links relevant to the conversation

About Michael Azlen and Carbon Cap:

https://www.carbon-cap.com/about-us

Michael’s article on “The Carbon Risk Premium”:

https://www.pm-research.com/content/iijaltinv/25/1/33

Transcript: Carbon as an emerging, liquid asset class w/ Michael Azlen, Carbon Cap Management – EP212

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It was then checked over by a human, Tim Hughes from Adept Economics, to see if the otter had missed anything, and with all respect to otters they do miss quite a bit. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Michael Azlen  00:03

By investing across all five of these markets, your overall portfolio volatility really comes down of course because your your nicely diversified, while it doesn’t necessarily impede your return expectations so that’s that’s one of the key observations of our research paper was this this very low cross correlation between carbon markets.

Gene Tunny  00:27

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory, evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show.

Hello, thanks for tuning into the show. In this episode, you’ll learn about carbon as a liquid emerging asset class. Emissions of carbon dioxide are increasingly being priced globally through various emissions trading schemes, or through other mechanisms that impose carbon prices. To explore carbon markets I talk to a fund manager who is investing in carbon markets globally. My guest is Michael Azlen, CEO and Co-Portfolio Manager of Carbon Cap Management. Michael has 25 years of experience as an investment professional, and he’s a regular speaker at investment conferences worldwide. Also he’s been a guest lecturer in graduate programmes at London Business School for more than 15 years. I’m really pleased to have been able to interview Michael because he has some great insights into carbon markets. For instance, he explains how carbon markets are generally uncorrelated with equities, bonds and real estate, and hence they can help investors diversify in uncertain times. For the lawyers, this is for general information only and none of this should be interpreted as investment or financial advice. Okay, let’s get into the episode. I hope you enjoy my conversation with Michael Azlen on carbon markets.

Michael Azlen from Carbon Cap. Thanks for joining me on the programme.

Michael Azlen  02:20

Pleased to be here Gene, thanks for inviting me.

Gene Tunny  02:22

Oh, of course. I’ve covered climate change quite a bit on the show. But I haven’t had anyone who has the expertise in the carbon markets and investing in carbon as an emerging asset class or, or another way I’ve seen it expressed as a liquid asset class. So Michael, to start off with, could you tell us a bit about Carbon Cap, please, you’re the CEO and Co-Portfolio Manager there. What does Carbon Cap do exactly?

Michael Azlen  02:57

Sure. So So Carbon Cap runs the World Carbon Fund. It’s a climate change impact fund. And the Fund invests into the regulated compliance carbon markets around the world. The fund has two objectives. The first objective is to generate a positive return over any rolling 12 month period. So we don’t want to be up every month or every quarter. But over every rolling 12 month period, the objective is to be positive, regardless of the performance of carbon itself. And the second objective of the fund is to have an impact, a direct impact on climate change. And we do this in a number of ways. But the hardest impact is achieved through our commitment to take 20% of the performance fees that are generated. And we use those to purchase compliance carbon permits, again in the regulated market Gene. And we cancel those permits. And in the fund has been running for three and a half years, the total return net of fees to our clients is in excess of 100% now, so very strong returns over this three and a half year period. And therefore, you know, the nice thing about performing it is aligned with direct climate impact. So higher performance means more impact. And that creates a nice alignment of interest between between the investors ourselves as the manager and having an impact on climate change. The fund has grown significantly from the launch, we launched with only 10 million the fund is now $280 million in size. So we’re approaching 300 million and our client base is now moving much more institutional in nature. In terms of impact allocators. The fund holds Article Nine status here in Europe and that that status, Article Nine is the highest level of impact under the European taxonomy. So it’s an uncorrelated absolute return fund with climate impact. So it’s quite a quite a unique fund and I think you know, more and more clients are seeking uncorrelated returns as we’re, you know, the global macro situation is becoming quite difficult. I think the forecast from here out.

Gene Tunny  05:14

Okay, so yeah, I’ve got a few questions based on that. Michael uncorrelated, do you mean uncorrelated with the business cycle with the stock market? What do you mean by uncorrelated?

Michael Azlen  05:24

Yeah, so the background to to Carbon Cap Gene was after I built and sold my previous asset management business to a public company, I then became deeply involved in research onto the into the science of climate change, so nothing to do with carbon. And that led me to enrolling at the London School of Economics and their climate change programme. And this is where I learned about carbon markets. At that time, this was in 2018, carbon was trading in the different markets around the world about half a billion dollars daily. So it’s quite liquid. And I was quite surprised by that. And my first question as an investment professionals was, was your question. What are the what are the statistical properties of the asset class, you know, return and volatility and correlation. When I looked for the research Gene, there was no research on carbon. So I hired a PhD student from the LSE, myself, we collected the data, and we analysed and wrote that up as a full research paper. Now, it did take three years in the peer review process with academic papers. But I’m very pleased to tell you the paper was published last year in the Journal of Alternative Investments. So, so coming back to your question, when you’re asking, you know, what do we mean by correlation? In this sense, if you take the, you know, the daily, weekly or monthly returns of carbon, which is a liquid tradable asset class now, I should mention that, that that liquidity where it was trading half a billion a day, that was in 2018, now we’re trading 4 billion per day. So the liquidity has increased significantly. And and when you look at those correlation numbers over rolling periods, carbon just exhibits effectively no correlation at all to equities, to bonds to real estate to other commodities, it has very unique correlation properties

Gene Tunny  07:18

Right and what about the volatility is it much more volatile than those other asset classes?

Michael Azlen  07:24

So it varies between markets. So you know, today in the World Carbon Fund, we invest in five different liquid regulated carbon markets. And those volatilities vary from probably the lowest volatility market is between 10 to 15% volatility, and the highest volatility market maybe is about a 60% volatility. So there’s quite a difference in volatility in the different carbon markets.

Gene Tunny  07:48

Okay, so I might ask you about those different carbon markets in a moment, there are just a few other things to clear up. You talked about institutional investors, so you’re talking about, what investment banks, so the Goldman Sachs, or Morgan Stanley, you’re not okay, who are you talking about there? Pension funds, perhaps?

Michael Azlen  08:10

Yeah, exactly. So generally, you know, high net worth investors, and then retail investors would be non institutional, and then kind of in the middle ground, you would have family offices and multifamily offices in the middle ground. And then you would move into more institutional, which would be, as you say, professional investment management organisations. So this, these could be other investment management firms that have maybe a multi asset product, or they might run a fund of hedge funds product, and they would be an investor into our fund. And finally, the classic, you know, asset holders like in Australia, the super funds and other big pension funds. So we’re seeing also interest from the bigger pension funds now, because there’s an interesting aspect, not only the return and the low correlation, but the climate impact, and the potential for carbon exposure to give you somewhat of a climate hedge in your portfolio is another another interesting aspect. If you understand that climate change is now impacting equity and bond portfolios by having some carbon it’s somewhat of a hedge against some of those impacts.

Gene Tunny  09:19

Yeah, that makes sense. And can you explain, you mentioned this Article Nine, in the European taxonomy? I’m completely unfamiliar with that. Sorry. Could you explain what what that’s about?

Michael Azlen  09:32

So, Europe a couple of years ago, launched a new taxonomy to identify the level of transparency and impact for funds and they set minimum standards, reporting standards in order to achieve those different article levels and the highest level there of impact is Article Nine. So you know, in an in an effort to create an environment that kind of weeded out greenwashing, they said, let’s put some standards in here. Because you know, I mean, three years ago, every single fund was green in some aspect, right? Even if it really wasn’t green, it could be labelled green. And so Europe brought in this taxonomy and said, now, unless you meet these very strict reporting requirements, you can’t make a green claim. Or more importantly, you know, your fund will be ranked Article Six, Article Seven, Article eight, Article Nine. So there’s a varying degree of reporting, and you it to achieve Article Nine, you must demonstrate meaningful impact in terms of the activities of the fund have to be reported in detail, and you have to demonstrate impact. And so in our case, we have now a three year audit trail where we have purchased carbon permits with those performance fee amounts, and then we just cancel them. And that’s all audited and documented.

Gene Tunny  10:57

Okay, okay I’ll have to look more into that, that’s interesting. I mean, yeah, there have been a bit of concerns about greenwashing, or concerns about just how effective some of these carbon offsets are, whether they’re actually legitimately reducing greenhouse gas emissions. So I think that’s, that’s fair enough. Righto! I’ve got to ask you about this $4 billion a day of trading. And I mean, you’re involved in this sort of thing. And oh, can I ask first? Actually, you might have mentioned it before. Assets under management, are you do you disclose the assets under management of your of your fund?

Michael Azlen  11:36

Yeah so as I mentioned, we are currently running 280, two eight zero million dollars in the World Carbon Fund.

Gene Tunny  11:44

Gotcha. Because I latched on to that there’s that four billion dollars a day that’s being traded, who’s trading it, and who ultimately needs these carbon permits or these assets? So we’ve got, I mean, what is it that’s being traded? There’s the permit. So in Australia, we I think we call them Australian carbon credit units. So they represent what is it a tonne of co2 equivalent? And then there are also offsets. Can you tell us a bit about that market, who’s in it and what’s been traded, please, Michael?

Michael Azlen  12:13

So this, this is a real area of confusion Gene. So it’s really important that we clarify the difference between various carbon markets because there are actually three very distinct carbon markets. And they’re very, very different. So this is very, very important. So the first market that most people are actually familiar with, and let’s leave the Australian ACCU market. Let’s leave that to the side for a minute. I’m talking globally now. Most people are familiar with what’s called the voluntary carbon market, voluntary, because it means it’s a voluntary participation, a corporate can choose to buy these credits, can choose to buy these offsets. And here Gene terminology, we use the term credit and offset. In the voluntary market, it’s a carbon credit or a carbon offset. In the markets in which we invest, we invest in a completely separate market, the regulated market, the compliance carbon market, where companies must comply, and those are called carbon allowance permits. So in the voluntary market, most it’s called a carbon credit or offset. The normal project here Gene is planting trees, or trying to protect a forest or a mangrove swamp. It’s some type of project related activity. And then an independent party will calculate how much carbon is sequestered from the activity. They give it a rating, and they calculate the tonnes and they issue these credits and offsets. I’m going to give you five key bullet points about this voluntary market very, very important. Number one, it is completely unregulated. Number two, it’s illiquid, it’s it’s not a liquid asset. Number three it’s very small in size. I’ll come back to that. Number four, because it’s all of these different methodologies. It’s very opaque and complex to figure out, well, how did they calculate these credits, how many credits? And number five, I think very important, in the voluntary market, there is effectively an unlimited supply of these credits. This is where Gene you mentioned in the last ,just the last nine months, this year alone, there have been a number of investigative journalist articles that have uncovered practices in that market that have proven to show that some of the projects have not actually sequestered any carbon at all. And I think the key here Gene is that in any market as an economist, you’ll know this when you have a financial asset without any financial oversight, this brings moral hazard into the equation right? So if we can create more credits or offsets through a different methodology, we all benefit within that ecosystem. But there’s no independent oversight of that. So the problem of over crediting and sort of supply has become an issue. And so I think what we’re seeing is corporate buyers of wanting to make a climate impact are now somewhat shying away from that market, because they don’t want to be involved in these in these scandals. So that’s the voluntary market. If I move the lens to the regulated markets Gene, I want to give you five key bullet points about the regulated market. The first one, of course, it is highly regulated, because it is run by governments. Number two, it’s it’s very liquid, it now trades $4 billion every day. Number three, it’s large. So when we compare the size, this market is traded, last year, about 1 trillion with a T dollars, and the voluntary market did about 1 billion. So this is a 1000 times difference in size, not 10 times or 100 times this is huge. And number four, it’s very transparent. Of course, these these markets, because they’re run by the government, so they put all the rules on the website, it’s transparent. And number five and most important Gene, in the regulated market the supply of the permits is capped and every year that supply lower and lower and lower. So in one market, unlimited supply just keeps increasing, and in this market it’s capped and it keeps going down. So it’s quite, there’s quite a big difference between these two markets.

Gene Tunny  16:28

Yeah, gotcha. So you’re talking about the permits that are part of emissions trading schemes, or cap and trade schemes or whatever you want to call it. So what are the major markets, Michael, which economies have these schemes and which economies therefore have these regulated markets, there are these permits that you’re involved in investing in and trading?

Michael Azlen  16:53

So the good news here, Gene, is that not only is there, are there current, currently multiple countries and jurisdictions, but there are at least a dozen new countries that have announced they’re going to launch full Emission Trading Systems, cap and trade systems as you as you correctly identified, so the growth of the asset class is going to be tremendous in the next five years. The current markets that we invest into today are the European emission trading system. Number two is the UK emission trading system, which was established after Brexit more than two years ago. When the UK left Europe, they launched their own emission trading system. The third market is the California carbon market, which is in the state of California. Fourth market is the regional greenhouse gas cap and trade market, which is on the east coast of the United States. And it consists of 11 states together on the East Coast in one block carbon market. And the fifth market we invest in is the New Zealand carbon market, which has been around for a long time, it’s gone through transformations. It’s a small market, but it’s we think it’s quite a well run market and and that’s the fifth market. Um, one thing I want to point out, Europe has is the most liquid market, it trades probably half of that 4 billion daily, 2 billion a day is the European market. So very, very liquid and it was launched in 2005. From 2005 until today, emissions in Europe have dropped by 1 billion metric tonnes per year. That is a big success. And and for this reason, I think because of that success, obviously without impeding economic growth. I mean, that’s quite important, right? I think that is why we’ve had these big announcements in the last well, even the last three months, Brazil is moving legislation to launch a full cap and trade market, India and Japan, Japan, the third biggest emitter in the world. China, of course, launched after doing extensive research on the European market and the California, China launched the world’s biggest cap and trade market two years ago, covers 4.5 billion tonnes of carbon. So it’s massive. South Korea, Mexico should go live next year, they finished the two years of their pilot programme. So we’re expecting that may be the next fund that we could add into the fund. But there’s there’s many more countries I was recently in Singapore three weeks ago and Indonesia just launched their cap and trade market. Most of the Asian Tigers, Vietnam, Malaysia, Indonesia, they’re they’re all have plans at various stages, it’s taking time to, but they all have plans to launch cap and trade carbon markets, which is great news.

Gene Tunny  19:51

Right. The US is obviously a major omission from that list of countries. Do you think there’s any prospect of the the US, there are some states out there that you mentioned, is that right? But the whole US there’s no federal cap and trade scheme in the US is there?

Michael Azlen  20:09

No, and I think it’s unlikely we’re going to get a federal scheme, because of the, you know, the polarisation, you know, at the federal level, but but what we’re seeing Gene is, you have the state of California, and then you have 11 states on the east coast. So we already have those 12 states. Three months ago, the state of Washington, the 13th US state launched its own carbon market. That market launched three months ago. And in the last six months, New York State has announced it’s going to launch a full blown cap and trade carbon market probably within 18 months. So things are happening at the individual state level, but I think it’s unlikely we’re going to get federal carbon pricing.

Gene Tunny  20:52

Gotcha. And where’s Australia sit in this? So do you have any thoughts about these, these A double C Us or ACCUs that we have here? Is that something you’re not interested in investing in?

Michael Azlen  21:04

So in the fund, we have a market entry framework that has a number of criteria that a carbon market must pass in order for us to onboard that into the fund. And there’s very practical considerations like access to that market. But then there’s there’s other considerations such as, you know, transparency, country risk, policy risk, currency risk, and items like that. So, you know, on many of those, of course, Australia being a, you know, a Western democracy, there’s no issue, but the actual structure of the ACCU market in Australia is somewhat of a hybrid between the regulated market which has, you know, a cap which gets lowered every year, and the voluntary market, which is unlimited supply effectively. And, and therefore, when we apply those market, market entry, that market entry framework against the Australian market, it simply doesn’t pass it, it’s it doesn’t meet the stringency test, because of the fact that it allows voluntary project supply units to come in of very questionable calculation methodologies. And and really the other thing is Gene, durability. When you have a project that it I think we can measure that it may have sequestered carbon, but but it what is the risk of reversal? And how long will that carbon be stored, if it’s only stored for 10 years and then released back into the atmosphere, well, then you know, that that perhaps hasn’t been a very valid carbon credit. So durability and risk of reversal of the carbon then being re re emitted is very high. And so projects, such as soil carbon and whatnot, they do have this potential for risk of reversal and therefore low durability. Most projects now that I think more corporate buyers are looking at more permanent removal, such as, you know, direct air capture, and other strategies where you can prove long term, you’ve pulled the carbon out, you’ve injected it deep underground, you liquefy it, inject it into a storage well, for very long term durable storage, over 100 years, or maybe even over 1000 years. So you can really demonstrate storage.

Gene Tunny  23:21

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  23:26

If you need to crunch the numbers, then get in touch with Adept Economics. We offer you frank and fearless economic analysis and advice. We can help you with funding submissions, cost benefit analysis studies and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world. You can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.

Gene Tunny  23:55

Now back to the show.

Now, who ultimately needs these permits, it’s emitters isn’t it? It’s big companies that are polluting. So smelters and power generators, fossil fuel generators. Is that right? They’re the ones who ultimately need it. They’ve got the demand.

Michael Azlen  24:17

Yeah, so in a cap and trade programme, the government controls the total quantity of emissions. But because there’s a limited number of permits, exactly, as you said. And the way they decide who’s in is they normally set a threshold Gene. So in most markets, it’s a 25,000 tonne per year threshold. So any company that emits more than 25,000 tonnes per year they’re notified by the government they’re in, they don’t have a choice. So that’s why we we call it a compliance instead of a voluntary market because you must comply. It means that the government audits you every year, and you must give the government the permits based on the audit. So if you we audit you and you met 2 million tonnes by April of this year, you have to give the government 2 million permits and the government controls the supply of those permits. So that’s a cap and trade. Every year the government, in the case of Europe let’s say, we, we sell at auctions 1.3 billion permits, at the end of the year the companies are audited. And if the total emissions are also 1.3, the companies then give those permits back to the government who destroy them, they they destroy the permit, and that that compliance cycle for one year has now been completed. The second year now the government sells 1.2 billion, destroys those then 1.1, then a billion then 900. So every year the supply of permits is going down. So we know within the ecosystem 1000s of companies, someone must select themselves to stop emitting carbon. And that’s the beauty of the mechanism Gene, it allows the price, the market sets the price of carbon, and that price signal is taken by participants and internalised. What do I mean? They compare the market price of carbon to their internal cost of abatement. In other words, the CEO calls in his head of engineering and says, John, you know, we’re emitting 2 million tonnes a year, it’s $100, that’s costing us $200 million a year. Can you get her emissions down? He says to the head of engineering, right? He’s profit motivated. And the head of engineering then looks at the latest technologies for that industrial process, and comes back and says to the CEO, yeah, we can get it down. But it costs $160 a tonne. Well, that that CEO has a very clear decision, then he’ll he will simply buy the permit for 100. But there will be another company in the ecosystem, where the head of engineering says it’s $40, we can reduce our emissions for 40 bucks a tonne. That’s a no brainer. The CEO chooses then to invest in that low carbon technology and they choose to cut their emissions. So this is the power of the mechanism. It forces what we call the three magic words, least cost abatement. Right, that those are the three magic words, tap and lower the emissions. That’s good, but we want to achieve it at the lowest possible cost. As an economist you will appreciate this is you know, this is a parsimonious solution to to this quite difficult problem.

Gene Tunny  27:17

Oh, yeah, absolutely. I mean, I think, yeah, that’s that’s something that economists would would agree on. I mean, one of the things that’s happened in Australia is because we, we don’t have a carbon price, but yet the politicians have made commitments to try and get emissions down, we end up doing all sorts of things that may not end up being that that least, what is it the least cost of abatement?

Michael Azlen  27:41

Yeah to achieve least cost abatement. Yeah, yeah. So because we want to we all want to cut emissions of course, we’ve seen the terrible impact, but we don’t want to do it at any price, right, we want to do it at the lowest possible cost. And so in a carbon market, as we keep lowering the number of permits, the supply, we know we as long as we have liquidity and price discovery taking place in that market, that that is important. We can be quite confident it’s the companies with the lowest cost they self select themselves to choose to reduce their emissions. And the reason they do it is they make more profit. I mean, they they’re not being green or ESG. They simply are reducing their emissions because they make more profit.

Gene Tunny  28:19

Yeah. Okay. I’d like to ask you a couple of questions about the market some of the technical details. Is there a futures market in, in these permits, the derivatives? I mean, what’s the, what’s the market look like?

Michael Azlen  28:34

So in each market that we invest in is slightly different in four of the five markets Gene, there is exchange listed futures and exchange listed options that trade like many other commodities, like oil, or wheat, or corn or, you know, other commodities. And most of the liquidity is in that exchange listed futures market. Most of the trading activity in carbon, probably no one knows the exact number, but I would say 70, or 80% of the trading activity, is those big end users hedging their carbon obligation. And as you said, it’s the power sector. electric utilities, steel, cement, chemicals, glass, these high emitting sectors are the main participants in, in carbon markets.

Gene Tunny  29:18

Gotcha. Gotcha. But they’re not your investors are they or are they? Oh, you’ve got no, no, no. Okay. So, but you’re you are participating in the market, but they’re the ones who ultimately need the permits. Okay. Gotcha. That makes sense. What about foreign exchange risk you mentioned? I mean, what you’re saying there, it sounds really embarrassing for Australia for our ACCUs, those criteria that you set out and how we don’t meet them over here. That’s, yeah that’s quite embarrassing for us, I imagine. You mentioned foreign exchange risk, do you hedge that foreign exchange risk?

Michael Azlen  30:00

In the fund? We do yeah. So where we invest in, you know, in a carbon market and in another currency we hedge that out. That’s, you know, quite common in our industry.

Gene Tunny  30:11

Gotcha. Okay. So we’ve, we’ve talked about, you know, regulated and you’re in the regulated space versus voluntary. I was surprised just how much larger the regulated is than the the voluntary, I suppose it makes sense if it’s, if it’s compulsory. You talked about a euro, the European scheme, and then the UK scheme. To what extent are these markets connected? Can I buy permits in in one scheme and use them in another? I mean, how does that how does it all work? Are they are these markets connected in any way?

Michael Azlen  30:48

So the long term plan, Gene is for carbon markets all to link together. So to give you an example, you know, four or five years ago, Switzerland had its own separate carbon market, and then it chose to link with the EU carbon market. And that is the long term trajectory. I think if we look 10 or 15 years into the future, hopefully, we initially will have maybe regional carbon markets, Asia, North America, South America, that kind of thing. And then eventually, one would hope, one global carbon price and carbon market, and we believe the asset class, you know, now is trading about 70 billion a month, as I mentioned, we think that, you know, when when China, South Korea, Mexico, Brazil, Japan, when all these markets spin up in the next three to five years, we’ll be trading probably well over, you know, half a trillion a month, I mean, it’s going to be a huge asset class, probably overtaking crude oil as the most heavily traded commodity in the world, probably within five to 10 years. So strategically, I think it’s a very important asset class. One of the very unique things is Gene, they’re not linked yet. So even though the California market the permit covers one tonne, same same commodity as the one tonne in the European market, because there’s no fungibility you can’t bring the permit and hand it in, in Europe, from California. When you look at the cross correlation. It’s zero, effectively. So to give you an example, this year, year to date performance, the European market is about flat on the year, the UK market is down 40% on the year, the California market is up 20% on the year, and the RGGI market on the east coast of the US is up I don’t know about 5% on the year. So you can see just from these numbers, very diverse performance, there’s no cross correlation. So by investing across all five of these markets, your overall portfolio volatility really comes down of course, because you’re, you’re nicely diversified. While it doesn’t necessarily impede your return expectations. So that’s that’s one of the key observations of our research paper was this this very low cross correlation between carbon markets.

Gene Tunny  33:03

Gotcha. Okay. Yeah, I’ll have to, I’ll put a link in the show notes to that. Michael, yeah this has been fascinating. I’ve learned a lot about about these markets. And it’s, it’s, there’s a lot I’m gonna have to follow up on just to make sure I’m as across it as I can. Can I ask you about your, your story how you ended up at Carbon Cap? I mean, you’re you’re in the UK now, aren’t you? You’re, so you’re based in London, you’ve got an office in Mayfair. But you’re obviously, I mean, you don’t have a British accent do you so what, can you tell us a bit about your story?

Michael Azlen  33:35

Yeah, so I’m a Canadian, and worked, began my career with two of Canada’s banks as a proprietary trader. After, I then came to London to do my graduate degree at London Business School. And I’ve actually been teaching now for 18 years on the graduate degree programme at London Business School. The last five years, I’ve been teaching a segment on the impact of climate change on the asset management industry, which is a very, very interesting and fast moving area. I worked in the hedge fund industry here in London in a number of roles. And then I set up my first business, regulated investment management business in 2005. And I was very fortunate Gene to grow that business to a decent size. And we were approached, and I managed to sell the business to a Swiss public company. And it was after that sale, and my earn out period, I had a little bit of time off, but that’s when I became deeply involved in research into climate change itself, nothing to do with carbon, I was, I was quite sceptical of the whole area of climate change, you know, because, to me, the you know, the temperature and weather didn’t seem that bad. And I also had known that the climate had always changed prior to humans being on the planet, quite dramatically right? Humans have only been on the planet 250,000 years or so. And we’ve got paleo climate records way back before then showing great variability in weather and the climate system. So I just sort of wanted to bottom out those two questions. And I’ve now read more than 200 Peer Reviewed papers, I was I was in a fortunate position because I didn’t have to work, I could simply focus on that. And I’m a bit geeky, you know, I like to read these these peer reviewed academic papers, and I fairly quickly, over about two or three months became convinced that the problem is extremely acute. If you’re an empirical person, you just weigh evidence, you just base your decision on evidence. It’s, it’s, you know, the concentration of co2 now in the atmosphere at 425 parts per million. I mean, it’s increased by 50%. And it just keeps climbing higher and higher. And the impacts, I don’t know, if you, you saw the data that came out just a few days ago, on September, me, not only was the month of September, the hottest September on record, but the deviation above the previous record was enormous. So the impacts that we’re seeing now are becoming, you know, massive. I know, in Australia, in particular, there’s been, you know, some some very big impacts both in fires and flooding events. And those are unfortunately likely to continue. So hopefully, you know, we can address this so that, that, that spurred my passion to do something Gene and I was fortunate to be able to get a Swiss private bank to back me to launch my second business. And now we have a very interesting Climate Impact Fund.

Gene Tunny  36:26

Hmm, good one, good one. Can I ask you about this course you are teaching, the impact of climate change on the asset management industry, I mean, I mean, you’re a case study of that, I mean, yes, obviously, you know, carbon now is a liquid asset class or an emerging asset class, as you call it. But are there other impacts that you that you consider in that course? I’m just just interested in what the content of that is broadly and what you see is the, those impacts.

Michael Azlen  36:54

Well, I mean, it’s a, this is a massive area now for, for academic investigation. It began with things like, for instance, looking at a diversified equity portfolio and trying to calculate initially, you know, the carbon footprint of that portfolio as a proxy for you know, the emissions. And then academics began to research well, what is the difference in performance between a portfolio that has a bigger carbon footprint, they call that a brown portfolio, versus a portfolio with a with a less carbon foot a green, and this Brown versus green, if you just Google that, that spread of performance in equities, and in fixed income markets, has been an area of very great research. But things have moved on since then. And now, what the research is looking at is trying to really identify with the actual climate risks that individual corporates are exposed to, either insurance companies in their in their insurance portfolio right with regard to flooding risk, fire risk, things of this nature. You can imagine banks, their lending risk. So in terms of a kind of Basel three stress test, but, but instead of looking at credit quality, we’re now trying to assess are they lending money to companies where those companies have undue climate risk, and therefore, you should factor that in? So it really extends to a pretty wide range. It’s a really fast moving and interesting area.

Gene Tunny  38:25

Gotcha. Okay, I’ll have to have a look at that. I mean, that might be a topic for another episode, I won’t to go into it now because you’ve, you’ve given me, you know, lots of good stuff to think about already, Michael so that’s been that’s been terrific. Any final thoughts before we wrap up?

Michael Azlen  38:42

No, I would just like to say, you know, I think everything begins and ends with education and learning about a topic, if you’ve got questions, if this has interested you today, I would direct you to our website, we have an open access website with a research library and we have a section on the website of little educational videos, short snippets, to help people understand how does the, you know, what do you mean by voluntary carbon market? What do you mean by regulated carbon market? And we have information, of course, on the latest science on what’s happening on climate change. So I would encourage people to, if you found today interesting, to you know, do your research and and please use the resources that are available our research paper, I think it is not available on the website, but I would happy, anyone who emails me, I’d be happy to send it and for any, you know, Australian based investors that would be interested in thinking about our fund, you know be of course very happy to have that conversation too.

Gene Tunny  39:43

Yeah, absolutely. I mean, I imagine it could be of interest to with yeah, super funds. I mean, we’ve got some big, obviously some big super funds here and we’ve got, I mean, I’m in Queensland here we’ve got a Queensland Investment Corporation, which is owned by the state government. I know that they’ve got, they’re interested in alternative investments, I’m not sure to what extent they’re interested in the carbon market, but anyway, it’s uh, yeah, absolutely if there is a, if there is someone listening right now and investors in Australia or anywhere, yeah, I think I think definitely check out your website, Michael and you know, this is obviously not financial advice, I can’t, this is general information only. But, you know, certainly, this is, it, I think you’re right. It is an emerging liquid asset class, and it’s something that really has to be considered in future portfolios. So, Michael Azlen that’s been terrific. I’ve really enjoyed the conversation. So thanks so much for your time and for your insights really, really thought it was great.

Michael Azlen  40:46

Gene, thank you very happy to participate today. Thanks for inviting me.

Gene Tunny  40:50

Cheers.

Michael Azlen  40:51

Cheers. Bye bye

Gene Tunny  40:53

Righto, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

41:40

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Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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Podcast episode

EP96 – Managing Government Budgets

Rachel Nolan, a former Queensland Government finance minister, speaks with Economics Explored host Gene Tunny about how government budgets are developed and just how much flexibility governments actually have.

Rachel Nolan is Executive Director of the McKell Institute and is an honorary Senior Lecturer in Philosophy at the University of Queensland. Rachel was a member of the Queensland Parliament for eleven years from 2001, when she was elected as the youngest woman ever. She is a former Minister for Finance, Transport, and Natural Resources and the Arts. Rachel was a member of the Queensland Government’s central budgetary decision making body, the Cabinet Budget Review Committee.

Links relevant to this episode include:

Budget of the U.S. Government

The Federal Budget in Fiscal Year 2020: An Infographic

Economics Explored EP31 Paying for the Coronavirus rescue measures with Joe Branigan (Note we’ve changed the name of the show since we recorded this episode so it doesn’t clash with a popular YouTube channel)

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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