All is vanity

Depending on your point of view, Twitter is either a moral cesspit or a source of great inspiration. I can see both sides but as a free source of insight from some outstanding academics and journalists it is hard to beat (though sometimes you do have to wade through a lot of nonsense to find it). The news this week that Elon Musk’s $44 billion bid to buy Twitter has been accepted has raised more than a few eyebrows, generating concerns that the self-styled “free speech absolutist” will turn the platform into even more of a hell-hole than many people already believe it is.

Musk has not always been such a fan. Some years ago he was quoted as saying, “I don't have a Facebook page. I don't use my Twitter account. I am familiar with both, but I don't use them.” When he did finally venture onto Twitter in 2018, his Tweets suggesting that he was contemplating taking Tesla private earned Musk a $40 million securities fraud charge from the SEC. Undeterred by his past experience, the online payments guru turned car-maker cum space explorer appears to be following in the footsteps of 1970s entrepreneur Victor Kiam whose memorable marketing catchphrase for Remington shavers was “I liked it so much, I bought the company.”

Twitter's glory days may be behind it

The motivation for Musk’s involvement remains unclear. The social media segment is increasingly competitive and depending on how it is defined, Twitter does not even rank in the global top 15 most popular social networks. Growth in the number of active Twitter accounts has slowed sharply in recent years, having grown at single digit rates since 2015. Twitter’s preferred metric these days is Monetizable Daily Active Usage (mDAU) which is a measure of users who have logged into the platform and been exposed to adverts. After global mDAU gains of 21% and 27% in 2019 and 2020 respectively, this slowed to 13% in 2021 (chart). More worrying is that growth in the critical US market slowed to 2% last year versus 15% elsewhere. Twitter has been tight-lipped as to whether the slowdown in US activity is anything to do with the January 2021 ban imposed on former President Donald Trump. Whatever the reason, Twitter recorded a second consecutive annual loss last year, with cumulated losses of $1.36 billion over 2020 and 2021.

 

Financing the deal 

The financing arrangements of the buyout are also worthy of comment. Under the terms of his proposed deal, Musk will finance the buyout with $13 billion of debt, $12.5 billion secured against Tesla stock and $21 billion of his own equity. Musk is thus financing more than 70% of the deal from his own funds which runs contrary to standard LBO wisdom in which borrowing is mainly secured against the assets of the target company. There are suggestions that the lending banks are limiting their participation due to concerns that Twitter’s revenue stream has limited growth potential. Moreover, the company’s debt ratio, calculated relative to shareholder’s equity, has been creeping up since 2019, rising from 0.46 to 1.29 by Q1 2022. Even though the debt component of the deal is relatively limited, adding $13 billion of liabilities to the existing $4.2 billion of long-term debt would raise Twitter’s debt ratio to 3.5 which is significantly above the S&P500 average of 1.5 (chart below). Conducting a buyout in a rising interest rate environment will pose additional problems.

A highly indebted company with limited revenue growth potential does not look an attractive investment proposition. Moreover, the fact that the portion secured against Tesla stock takes the form of a margin loan means that if a margin call is triggered, Musk could be forced to sell Tesla stock to meet his commitments. This risks putting downward pressure on Tesla’s price. Roughly speaking, Musk would be on the hook if Tesla stock fell by 43% from the price prevailing on the filing date of 20 April. For the record the price is down 12% in a little over a week, and the trigger point is consistent with the price prevailing in November 2020. The plan to buy Twitter thus poses unnecessary risks to Tesla, which is now a very profitable business with one of the widest profit margins in the auto industry. But if Tesla is so successful why might we expect a price fall? For one thing the rally over the last couple of years has been remarkably strong, which is always a reason to be concerned about a pullback. Second, if Musk becomes distracted by running Twitter and takes his eye off Tesla’s operations there is a risk that any problems experienced by the carmaker are initially missed or become more difficult to fix.

Can Twitter be monetised?

Aside from concerns about the financing of the deal, the episode raises a lot of interesting questions about the valuation of digital content. For a platform such as Twitter, its value is embodied in its network. In theory, Metcalfe’s Law states that a network’s value is proportional to the square of the number of nodes in the network. Thus a network like Twitter with 300 million users has an inherent "node value" of 90 quadrillion. If these were dollars, Musk would be laughing all the way to the bank But monetising Twitter's reach will prove extremely difficult. Even a small subscription fee is likely to deter many users - demand is highly price elastic. Besides, imposing a fee is inconsistent with the vision of Twitter as a “digital town square” as former CEO Dick Costolo once called it. According to media reports, Musk told banks that agreed to help fund the takeover he would crack down on executive pay to slash costs, and would develop new ways to monetize tweets. Maybe Musk does have a plan to generate money from Tweets, but it is not immediately obvious to the many analysts who follow the company.

At this stage of proceedings the financials of Musk’s Twitter deal do not look compelling. Short of a radical overhaul of the business model it is difficult to see how the company can generate the returns which would justify paying $54.20 per share. The fact that the board is prepared to sell at a price 25% below last summer’s high may tell us something about how they view the future. If the deal does go ahead – although it is far from certain that it will – it may go down in history as a vanity project demonstrating the old adage “buy in haste, repent at leisure."

Encore M. Macron

The media focuses on identity politics …

Large parts of the western world breathed a sigh of relief that Emmanuel Macron was yesterday re-elected French President, thereby avoiding the prospect of a far-right leader in the form of Marine Le Pen whose Eurosceptic views would have posed a threat to the integrity of the EU. Macron’s victory margin of 59% to 41% was narrower than the 66% to 34% margin achieved five years ago, prompting a lot of media discussion as to why some voters have switched their allegiance to a more radical candidate, but it was still wide enough. Today, the moderates can celebrate that the worst-case geopolitical outcome has been avoided – for now. For my own part, Macron’s victory fulfils the prediction I made at the start of the year that he would be re-elected to the Elysée Palace.

Much of the commentary in the UK reflects the view I expressed five years ago – “a tinge of envy because it represented everything which is lacking from the UK scene.” But like the US and UK in recent years, the defining feature of the electoral debate in France was identity politics – something which is not likely to go away. Having lost two consecutive elections in the final run-off, Le Pen may not be the go-to candidate for French voters dissatisfied with the status quo but there is no room for complacency. Indeed, she may well have polled better had her links with Putin not been quite so close. The fact that large numbers of voters spoiled their ballot papers, reducing the turnout to 63%, suggests that voters were not particularly enthused about either candidate.

… But the economy matters more

One of the problems with identity politics is that it deflects attention from substantial economic issues, and it is the economics which ultimately matters most in the long-run. Macron may be able to consolidate his position over the next five years if he is able to give the French economy a boost from which voters can benefit. Failure to do so may mean that a centrist candidate is presented with a more difficult challenge in 2027. Recall that Macron was elected in 2017 on a promise to "liberate work and the spirit of enterprise." He has certainly attempted to liberalise the economy but as the gilets jaunes protests showed in 2018 there are limits as to how much voters will accept.

On the surface the French economy has performed reasonably well, the pandemic notwithstanding, with the unemployment rate by the end of last year falling to its lowest since 2008 (7.4%). But the figures are not what they appear on the surface, driven in part by a fall in labour participation, whilst the average number of hours worked per week is still 3.5% below pre-pandemic levels. The government has also relaxed labour laws, allowing companies to make lay-offs more easily. As a result, the proportion of workers on temporary or short-term contracts has risen and as of 2020 it stood at 12.3% of total employment. Macron also presided over an end to the wealth tax, replacing it with a fixed one-time levy on capital gains. The upshot appears to have been a rise in income inequality over the past five years. According to a study by the Institute for Public Policies, the top 1% of wealthy individuals enjoyed a 2.8% income gain (after taxes and benefits) whilst the bottom 5% saw incomes fall by 0.5%. Increasing the extent to which the French economy copies these aspects of the Anglo-Saxon economy is not universally popular with voters. They may not wear more of the same policies over the next five years.

In the near-term, the survey evidence suggests that as in other western economies, cost of living issues are at the top of the electorate’s agenda. Macron has already placed curbs on the extent to which domestic energy bills can rise, with the burden falling on the profits of state-owned utilities, whilst some households will receive an energy rebate. However such measures will add to the fiscal burden, whilst plans to reduce carbon emissions which include the construction of new nuclear facilities will further add to the deficit. This comes after the IMF called in January for a plan to gradually tighten the fiscal stance.

All this raises the question as to how Macron intends to pay for his fiscal largesse. His policies are predicated on strong growth but following the downgrade in the latest IMF forecast for GDP growth of 2.9% this year (from 3.5% in the October projection), growth is likely to slow further. In common with nearly all western countries, trend growth in France is set to decelerate with the IMF’s forecast implying a potential growth rate of just 1.3% per year in the medium-term – considerably below the average of 2.1% estimated over the period 1990-2008.

One plan under discussion to free up resources is reform of the pension system with suggestions that the retirement age could be raised from 62 today to 65 by 2031. This will be a hugely contentious policy which will almost certainly result in significant opposition. Towards the end of the election campaign Macron was already backing away from his original position, suggesting a longer transition beyond 2031 and increasing the age only to 64. It is, however, clear that some form of fiscal action will be necessary. According to the IMF’s latest Fiscal Monitor, the French debt-to-GDP ratio is set to edge up to 114% by 2027, putting it significantly behind only the traditionally indebted economies of Italy and Greece amongst EMU countries.

Final thoughts

Macron’s re-election is good news for an EU that is seeking to tighten ties in the response to the military threat posed by Russia and the economic challenge posed by China (and to some extent the US). In many ways he represents the political centre with ambitious plans to modernise the French economy and reinvigorate the EU. But many French presidents have talked about the need for economic reform only to find that their policies were derailed by domestic opposition. Some of Macron’s economic agenda is very radical and we can expect significant pushback from an electorate that is already feeling the squeeze. If he pushes ahead with plans that alienate voters – notably on pension reform – there is no guarantee that a moderate will necessarily win the 2027 election, particularly if the challenger is someone other than Marine Le Pen.

Boris of the Thousand Days

Boris Johnson today celebrates 1000 days as Prime Minister. A lot has happened in the 28 months since he won a whopping majority in the 2019 general election. An opinion poll published in The Times yesterday asked a nationally representative sample of the public what they think of the Prime Minister with 72% of the responses portraying a negative view of him (the results are portrayed in the word cloud shown above, source here).

It is difficult to articulate the sense of division within the UK that has grown during his term of office as the government deviates further from the norms of fairness and adherence to the rule of law which have traditionally underpinned the British state. Some of the actions by members of government in recent months were reminiscent of what the British media used to gleefully refer to as a failed state. This excellent blog post by Chris Grey got as close as anything I have seen recently to putting into words the current state of the nation, arguing that post-Brexit Britain “is going metaphorically and literally rotten.” For an audio description articulating the views of many, I recommend this BBC clip (starts at 33:57) reflecting the barely suppressed anger felt by the constitutional historian and peer Peter Hennessy who called Johnson “the great debaser of public and political life” who has turned the office of prime minister into “an adventure playground for one man’s narcissistic vanity.”

Quite how we have got to this point reflects a complex mix of factors. It is easy to point the finger at the Brexit referendum as the primary trigger but in some ways this was merely a catalyst for the discontent that had been burning for many years. The Euroscepticism inherent in  the Conservative Party perhaps reflected the frustration that the Thatcherite revolution was cut short by the defenestration of the Blessed Margaret in 1990. After all, she became a virulent Eurosceptic just before her departure from office and maintained this view throughout her post-Downing Street political life. Discontent was further stoked by Tony Blair’s ill-judged decision to commit military forces to the US invasion of Iraq which did a lot to undermine trust in government. The parliamentary expenses scandal of 2009 and the failure of the economy to rebound quickly following the GFC in 2008-09 were further triggers of discontent, whilst the misguided austerity policy of the post-2010 Cameron government did much to erode the living standards of the less well-off in society.

But Brexit did give the keys to the kingdom to a new generation of politicians determined to overthrow the status quo and not be bound by the conventions of the past. This has resulted in apparent disdain for the principle of personal accountability with no actions apparently deemed out of bounds unless expressly proscribed by the law – and often not even then. Boris Johnson clearly has no intention of resigning despite the fact he has lied to parliament, the sanction for which according to the Ministerial Code is that “Ministers who knowingly mislead Parliament will be expected to offer their resignation to the Prime Minister.” It does not say what happens when the PM is the miscreant. Furthermore, Johnson has now become the first prime minister to be found guilty of a criminal offence whilst in office after he breached the Covid restriction laws that his government implemented. 

I have argued previously that Johnson is merely a symbol of the rot at the heart of the system rather than the primary cause. Indeed the credibility of the man tasked with overseeing the nation’s finances has also been battered by recent events. In addition to being fined for breaching Covid restrictions, it has emerged that Chancellor Rishi Sunak’s wife, Akshata Murty, was registered as non-domiciled for tax purposes. This means that she does not pay British tax on her considerable foreign earnings – estimated at £11.5 million per year at the last count. Whilst her actions are not illegal, this is a PR disaster given that her husband has just raised taxes on working people following the recent rise in National Insurance Contributions. Sunak tried to argue that it is not fair to use his wife as a political pawn. However, non-dom status is granted on the basis that Ms. Murty does not consider the UK to be her permanent home (she is an Indian citizen) which would be fine except she is married to a man who has ambitions to be prime minister. To add insult to injury, it emerged that Sunak himself was the holder of a US Green Card, one of the conditions for which is that applicants must declare an intention to eventually become a US citizen. 

It is not a good look for a man seeking to occupy 10 Downing Street and called to mind Theresa May’s 2016 Tory Party conference speech: “if you believe you’re a citizen of the world, you’re a citizen of nowhere.” Whilst I do not agree with May’s sentiment, I recognise irony and conflict of interest when I see it.

The current government’s signature policy was to “get Brexit done.” However there is no evidence that it is working as its proponents intended. The subsequent behaviour of government can thus perhaps be explained by its efforts to distract opponents from policy failures by throwing up a smokescreen of outlandish policies to appeal to its supporters which in turn is bolstered by the loud opposition this generates. Its most recent plan to deport refugees to Rwanda has stirred up a huge furore – not the least of which is the cost – which continues to distract attention away from other big policy issues (managing the fallout from the Ukraine war, relationships with the EU and the state of the economy to name three).

All this matters – as I have said many times before – because effective governance is the bedrock of a representative democracy. It is also a crucial underpinning for a market economy. Governments perform a wide range of functions, even in economies which pride themselves on their adherence to market principles. They regulate financial markets; manage the monetary system; oversee market competition laws; protect consumers; negotiate trade agreements and enforce technical standards for products. And that is before we consider their role in collecting taxes and overseeing the infrastructure on which we all rely. How governments act and the signals they send are thus important. Obviously it is impossible to keep politics completely at arm’s length but the more political interference, the less efficiently the economy operates. It is important to highlight that this is not an argument for an absence of government regulation: It is an argument for minimising the impact of politics on the operation of governance.

It is rather depressing to have to continue pointing out basic failings in the conduct of the British government, particularly when there is no indication that matters are about to improve anytime soon. Despite 1000 days behind him as Prime Minister, Johnson still technically has 1012 days until the UK needs to hold another general election. Whether he can survive that long is moot. Quite how much difference it would make to the quality of governance if he were to be replaced is also questionable.

Germany's energy dilemma

Western European politics is in a state of flux, the like of which we have not seen in the post-1945 era. The hapless machinations of what passes for the British government (the collective noun for which is “an embarrassment”) will be the subject of a future post. France, too, is suffering its usual quintennial bout of angst as the commentariat worries about the prospect of the extreme right snatching the keys to the Elysée Palace following last Sunday’s first round of voting in the presidential election. But perhaps one of the most intriguing issues is what is happening in Germany where the Ukrainian war is having a profound economic and political effect which will force it to face up to some hard truths.

The economic challenge

More than most European countries, Germany is highly dependent on imports of Russian energy. This is one of the legacies of Angela Merkel’s energy policy which attempted to phase out coal and nuclear electricity generation in favour of renewables but which required the use of gas as a transition fuel. Germany currently imports 60% of its energy needs with half of its gas and coal requirements and one-third of oil coming from Russia. It thus faces a dilemma. If it stops buying Russian energy the economy will take a considerable hit. If it continues to buy, Germany is merely directing additional funds towards Russia which can help it prosecute its war with Ukraine.

In a fascinating paper by Rudi Bachmann and colleagues[1], who are to be congratulated for getting their analysis out within two weeks of the outbreak of war, a group of nine German economists constructed a simulation of what would happen to the economy in the event that Russian energy supplies were brought to a halt. Their analysis points out that in the short run, a cessation of Russian imports would require significant substitution effects, either in the form of energy requirements or alternative supply sources. Given the importance of Russian gas supplies, it will prove difficult – if not impossible – to cover all of the shortfall. It is reckoned that Germany could cover around 20% of the gas from other sources and another 20%-30% from energy substitution and agreements with other EU countries. Nonetheless, this would likely entail a 50% shortfall in gas demand with consequent big price rises: “switching from comparatively cheap contract prices with Russia to world market spot prices would imply a substantial (currently five-fold) increase of the gas price.”

According to the simulation results, the cost to the economy would be “substantial but manageable. In the short run, a stop of Russian energy imports would lead to a GDP decline in range between 0.5% and 3% (cf. the GDP decline in 2020 during the pandemic was 4.5%).” They go on to point out that in the pessimistic case where it proves very difficult to substitute Russian gas in the short-run “the economic costs would rise to … about 1000 Euros per German citizen over 1 year. This comes potentially on top of a large increase in energy prices for household and industry even without a shortfall of gas deliveries.” The authors recognise that the poorest households would be the hardest hit which would require significant fiscal support in the form of lump-sum payments, increased social assistance, reductions in the electricity tax or raising income tax allowances.

The political response

The political response was dismissive. In a TV interview on 27 March, Chancellor Scholz responded to the analysis contained in the Bachmann et al paper by saying: “They get it wrong! And it’s honestly irresponsible to calculate some mathematical models that then don’t really work. I don’t know anyone in business who doesn’t know for sure that these would be the consequences.” This reminded me of Michael Gove’s comment ahead of the Brexit referendum that “the people of this country have had enough of experts” when economists pointed out that there would be considerable economic downsides to leaving the EU (remind us again, Mike, how did that work out?). We can argue about the magnitude of the hit to the economy but what enraged large parts of the academic community, in Germany and elsewhere, was the nature of the dismissal. The paper was rational, well thought-out and addressed many of the concerns subsequently raised by the critics. It was not rebutted on the same basis. It was simply trashed as cover for the fact that politicians are not prepared to take the big decisions that will have major electoral consequences.

Perhaps even worse is the hypocrisy of the German government’s position. In the TV interview Scholz pointed out that the financial sanctions imposed on Russia mean that “Putin cannot do anything with the money he has in his accounts.” To put it bluntly, Scholz is suggesting that Germany can carry on buying Russian energy but the funds Russia receives in return cannot be accessed. This is a having-cake-and-eating-it argument reminiscent of Boris Johnson’s Brexit nonsense. Like Johnson’s argument, it is not true. As Robin Brooks at the Institute of International Finance has pointed out, “if you sanction some Russian banks … but leave energy exports and thus the current account surplus untouched, foreign asset accumulation shifts from sanctioned to non-sanctioned banks. Russia's export machine re-jiggers, but still works” (see chart below taken from Brooks' Twitter feed).

This is not a moral judgement about whether Germany should continue to buy Russian energy. That is a decision for the government to take on behalf of the electorate. It is, however, a criticism of the German government’s claim to be taking steps to impose sanctions whilst continuing to fund the Russian government. The position of voters is more nuanced. According to a survey conducted for the briq policy monitor, “two-thirds of the German population would be willing to pay higher prices for gas and heating if this were to increase pressure on the Russian government ... And more than half of higher-income households would be willing to spend some of their income to help poorer households cope with higher energy prices.” Whether that view would survive the huge rise in bills that would result from a Russian energy embargo is moot. As Mike Tyson once said of boxing, “everyone has a plan until they get punched in the mouth.”

Wider implications

Although the EU has now imposed a ban on Russian coal purchases, Germany continues to resist efforts to ban Russian gas purchases which undermines EU efforts to impose more effective sanctions. This has not gone unnoticed in Ukraine which this week snubbed a planned visit by German President Steinmeier who previously adopted a conciliatory stance towards Putin. The reaction by the SPD’s parliamentary group, which suggested that Ukraine should not “interfere unduly in our country’s domestic politics” was not exactly a dignified response.

Germany’s position has also attracted criticism from another source with its actions to impose austerity on smaller EMU nations in 2011 contrasting with its current unwillingness to impose similar medicine on itself. As the French economist Thomas Philippon put it: “Eleven years ago, Greece experienced a sovereign debt crisis. The causes were irresponsible fiscal policy and bad luck. Today Germany is experiencing a geopolitical crisis. The causes are irresponsible energy policy and bad luck.” Paul Krugman made a similar point: “while Germany was willing to impose economic and social catastrophe on countries it claimed had been irresponsible in their borrowing, it has been unwilling to impose far smaller costs on itself despite the undeniable irresponsibility of its past energy policies.”

Whilst Germany undoubtedly finds itself in a difficult position, its problems are partly of its own making. The policy establishment essentially allowed Russia to take a stranglehold on its energy policy and is not prepared to take the hard choices which result from that. If that seems an unduly harsh assessment, it is nothing compared to the criticism I have heaped on various British governments. But having watched the German government dish out prescriptions to southern Europe which caused considerable economic hardship, it is difficult avoid the charge of hypocrisy as the (perhaps understandable) Germany-first policy holds back EU efforts to find a common response.

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[1] Bachmann, R., D. Baqaee, C. Bayer, M. Kuhn, A. Löschl, B. Moll, A. Peichl, K. Pittel and M. Schularick (2022) ‘What if? The Economic Effects for Germany of a Stop of Energy Imports from Russia’, ECONtribute Policy Brief No. 028 (available here)