The Breakdown - Corporate Profits the Most Elevated Since 1950

Episode Date: August 27, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.   On this edition of the “Weekly Recap,” NLW looks at: A new stock settlement system The latest on the arrested Tornado Cash developer  The passing of hedge fund legend Julian Robertson    - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “The Now” by Aaron Sprinkle and “The Life We Had” by Moments. Image credit: Malte Mueller/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The Breakdown is sponsored by nexus.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, August 27th, and that means it's time for the weekly recap. One quick note before we dive in. There are two ways to listen to the Breakdown podcast. You can hear it on the CoinDesk podcast. You can hear it on the Coin Desk Podcast Network, which comes out every afternoon and features other great shows alongside the breakdown, or you can listen on the breakdown-only feed, which comes out a few hours later in the evening. Wherever you listen, if you would be so kind as to take the time to leave a rating or a review,

I hugely appreciate it. Also a disclosure, as always. In addition to them being a sponsor of the show, I also work with FTX. Finally, I'd love to tell you about CoinDesk's new event. the investing in digital enterprises and assets summit or ideas, which is designed to facilitate capital flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience, where you can source and invest in the next big deal in digital assets. Use code breakdown 20 for 20% off a general pass and register today at coindesk.com slash ideas. So, on the macro side and the crypto side, there have been big themes that

dominated the week. In crypto, the entire discussion continues to be about censorship. The tornado cash developer arrested in the Netherlands is still in prison without charges, although we have a little bit more on that later. Tether has said that they're not going to blacklist the addresses that OFAC has sanctioned until law enforcement tells them to explicitly. And then there's the discussion of how these sanctions and other theoretical actions like them in the future might impact censorship on the Ethereum base layer. In macro and traditional markets, obviously there has been tons of debate around student loan forgiveness and its implications for inflation, and for market watchers, everything this week was all about Fed speculation. I want to fill in a little bit of the picture in that macro

scene first, though. One thing we saw this week was more signs of strength than the jobs market. Applications for unemployment insurance fell for a second week in a row. They decreased very slightly by 2,000 applicants to a total of 243,000, which was also slightly below economist estimates. Continuing claims fell to 1.42 million. Also, as part of revisions, the Labor Department said that employers added about 462,000 more jobs in the year that ended in March than previously estimated. Now, that lagging jobs number matters way less than what's going on right now, but all of this still contributes to an overall narrative of a very tight labor market. That matters because the Fed is extremely unlikely to shift away from their

hawkish stance when the labor market really isn't showing any signs of softening, at least by their estimation. Speaking of numerical revisions, the decline in U.S. economic output last quarter was less severe than initially reported. Between April and June, the GDP contracted 0.6% annually instead of the previously announced 0.9%. What's more, consumer spending grew at a revised annual rate of 1.5% in the second quarter, which was up from the previous estimate of 1%. There is also the matter of corporate profits. One measure of U.S. profit margins has soared to its highest level since 1950. after tax profits as a share of gross value added, improved in the second quarter to 15.5%. This is according to Commerce Department figures that were published on Thursday.

In short, companies have been quite adept at passing on increases in the cost of materials and labor to their customers. You will not be surprised that I think this is going to play directly into the political debate. Democrats have been pushing hard on the narrative that part of the culprit for high inflation is corporate price gouging. Economists have mostly been skeptical, but the fact that this measure of profits is at its highest point since 1950 is going to be smashed into the political discourse as evidence. Now, moving past the politics of it for a second, there is a funny quirk of all this when it comes to the thing that the Fed fears most, which is the wage price spiral. A wage price spiral is basically a situation where labor demands higher wages, so producers increase the price of end products, the inflation in the price of end products and the cost of living, prompts workers to go back and demand higher wages, and so on and so forth.

This is a type of inflation that can become extremely entrenched and extremely dangerous, and in many ways it's the thing that the Fed fears most. One of the interesting aspects of these elevated profits is that, in theory, at least, corporates can absorb some amount of work or demand for increased wages without having to set off that spiral. More profit margins means more room to accommodate increasing costs. The problem with that theory, a cynical person might suggest, is that given that inflation in the cost of labor and inputs, was clearly already a cause for corporations to jack up prices as high as they thought consumers could bear. So why wouldn't more increased cost of labor just see them do the same?

Now, on top of all of this, there is disagreement about if these high levels of profits can be sustained. Wells Fargo economists wrote, We still expect the tide is turning on profits. Persistent price pressure amid our expectations for a more pronounced pullback in demand in the second half of the year will dent businesses' ability to continue to pass costs on. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexto is a security-first company that manages risk by relying on mechanisms such as over-collateralization, real-time auditing, and insurance on custodial assets.

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What about what's happening over in the blockchain space? First, a project that is very blockchain and not crypto. One of the biggest differences between crypto and traditional markets is settlement time. T-plus 2 is the standard where stock market trades are not fully settled until two days after the orders are filled. There are efforts now to use blockchain technology to bring that time down. The Depository Trust and Clearing Corp, or DTCC, announced on Monday that it has launched its blockchain system named Project Ion. The DTCC operates back-end infrastructure that facilitates the settlement of all trades. in the U.S. stock market. It settles over two quadrillion dollars worth of trades annually. It also operates

associated custody services for securities across 177 countries, custodying over $87 trillion worth of assets. Their blockchain settlement project was launched as a pilot program in 2020 and moved into development last September. The blockchain system is now active, settling trades in parallel with the DTCC's legacy system. The DTCC says that the new blockchain-based infrastructure is settling over 100,000 bilateral equity trades per day, and almost 160,000 trades on peak trading days. Murray Posmantor, the managing director and president of DTCC's Clearing Agency Services and head of global business operations said, this is a milestone achievement for the equity markets and reflects the deep level of collaboration and partnership between DTCC and our clients.

Project Ion is an important step forward in advancing digitization in financial markets and opens the door to exciting new opportunities to drive greater efficiencies, risk management, and cost savings for the industry. digitized assets in emerging technology like DLT are shaping and evolving the financial services landscape, and we remain committed to advancing innovative solutions that capitalize on opportunities, deliver new value, and drive the industry forward. Now if you'll remember, the DTCC came under fire in early 2021 during the GameStop controversy. Some, including Robin Hood's CEO Vlad Tenev, blamed market volatility in part on the T-plus-2 settlement system.

The SEC proposed speeding up this settlement delay in February as part of broader stock market reforms, which sought to limit some of the exploitative behavior that is possible with longer settlement periods. This new system is being designed to support T-plus-0 settlement, allowing stock trades to be netted and settled at the end of each trading day. Molly Elmore tweeted a threat about how this is all going to work. Trading stocks, bonds, and derivatives requires an exchange of money and systems to keep track of the millions of transactions. The DTCC clears transactions across a wide array of investment products,

totaled over two quadrillion annually. This settlement process currently in place takes two days to complete. The trade begins with the confirmation of an order and ends with the exchange of funds finalizing the transactions. Two days to settle is not ideal. There are risks that one of the steps could fall through, which means a failed transaction. The velocity of money in the system is also slowed by the wait time to complete a trade. In addition, the delay means extra paperwork to keep track of the trades that are in the

various stages of completion and reconciliation of which settled and which did not. This adds staffing cost to the back office system. Project Ion is a blockchain DLT project tasked with reducing the time to settle transactions to same day. R3 is using their Quora software and the XDC token for settlement. Project Ion runs on a private permission blockchain very different than Bitcoin or Ethereum. When people look at the current market cap of the crypto ecosystem, it pales in comparison to the traditional financial world of stocks, bonds, and derivative products. Once the infrastructure and security are in place to tokenize the entire world of financial markets, it will truly transform life as we know it. Now, this is obviously very inside baseball and kind of technical, but still, having digitally

native and automated settlement systems, which institutions can plug into, is likely a game changer. It means the market can be more capital efficient and is less likely to have situations like the Robin Hood margin call. It also changes what's possible on the front end. Now, while it's sort of easy to dismiss this as just enterprise blockchain stuff from another narrative era, it also starts to vindicate, at least a little bit, the folks in the 2017 cycle that we're saying blockchain-based settlement systems can fix a lot of the problems

in legacy financial markets. Anyway, the project still has quite a ways to go before it fully disrupts the legacy systems, but seems to be moving ahead full speed. Another intersection of Web3 with the different sector, in this case Web 2, messaging platform telegram founder Pavel Durov teased NFT addresses in a post on Monday. He said that sister blockchain protocol, the open network could begin to auction off usernames, group, and channel names for the messaging service. His post read, this would create a new platform where username holders could transfer them to interested parties and protected deals, with ownership secured on the blockchain via NFT-like smart contracts. Now, many cynical folks think this is just a way to try to increase the value of the ton

token. But to me, it's a reminder that what NFTs will really be used for in the future is still a very open space. Finally, as promised, one quick update on arrested tornado cash developer, Alexei Perzav. It has been weeks without us having any sort of clear info about why he was arrested. Was it just his work on tornado cash or was there something else? Obviously, the cause of the arrest could have very different implications. If he was arrested just for his work on open source software, that's very troubling. If there was some other reason or accusations of other types of criminal activity, it would certainly shift the implications. According to a report from intelligence firm Karon, Perzev was formerly employed by a company that

has been linked to the Russian Security Agency FSB. Fortune rights, quote, according to the firm's findings in 2017, Pertsev worked as an information security specialist and developer of smart contracts for digital security 00,000, a Russian entity that the Treasury Department designated in 2018 as providing material and technological support to the FSB as far back as 2015. Now, Pertsov's wife, Zinia Malik, says this is not true. Alexi has never been associated with the FSB or the Russian Federation or similar organizations. We moved to the Netherlands in the hope of a quiet, stable, and free life, which is unimaginable and military Russia. So on the one hand, we're maybe starting to get a little bit more info,

but as Henry Devalence points out, generally in a place with the rule of law, the government has to explain why someone was arrested in the form of criminal charges, so it's not necessary for third parties to make random guesses weeks after the fact. Here, here. Lastly, on this weekly recap, Julian Robertson, founder of Tiger Management, died on Tuesday morning in his home in Manhattan at 90 years of age. Robertson was a gigantic figure in the financial world. He started his hedge fund Tiger Management in 1980 with $8.8 million and grew assets under management to a peak of $22 billion by 1998.

He averaged 32% annual returns, which was unmatched at the time or since. Now, he started out as a stock picker, but in the 90s, he began ramping up bets in bonds and foreign exchange. In so doing, Tiger became a macro fund. Robertson closed Tiger management in March 2000 after a bad bet on the yen in 1998 saw a wave of redemptions hit the fund, shrinking it down by three quarters to just $6 billion over 18 months. That bad bet was pretty crazy. Tiger suffered a loss of almost $2 billion in a single day. But it wasn't just that. In 1999, investors were becoming enamored with expensive technology stocks.

But Robertson turned cautious and Tiger again lost 19%. Tiger lost an additional 13.5% in early 2000. And it was on a vacation in New Zealand where he said, you know what, I'm done. Robertson recalled thinking, this approach isn't working and I don't understand why. I'm 67 years old. Who needs this? I didn't want my obituary to be. He died getting a quote on the yen. Now, Robertson's impact wouldn't end there. He went on to see dozens of new funds raised by former employees, the notorious tiger cubs. Author Daniel Strachman wrote, Julian was probably the best hedge fund manager to ever live. He essentially pioneered the hedge fund Unlike many of his contemporaries, who was renowned not only for being a successful investor,

but for paying it forward in mentorship and seed capital to his employees. Jim Chanoes said in an interview, If I had to give away my own money to any of them, I would have given it to Robertson. I knew he knew stocks better than anyone. Mike Bloomberg tweeted this week, while many people were remembered Julian Robertson for his extraordinary business acumen, mastery of financial markets, and his selfless mentoring of Tiger Cubs, I'll always remember him for his friendship in philanthropy.

He was a mensch to me and a generous friend. friend to so many others, especially young people in need of a hand up. That was the constant in his life inside and outside the office, helping others and taking joy in their achievements. He was especially passionate about education and ensuring that young people have the support and opportunities they need to pursue their dreams. He gave generously and always from the heart. Robertson ran the Tiger Foundation to support low-income New Yorkers and their families, and since 1989, it has provided more than $250 million in grants to help schools, employment training programs, childhood education, and more.

Overall, during his lifetime, he contributed more than $2 billion to charity. A final funny story on where the name Tiger came from. It wasn't some ferocious animal type of thing or a Matthew McConaughey chess beating thing. It was inspired instead by Robertson's habit of calling people whose names he couldn't remember, Tiger. Hell of a life right there, guys. Hell of a life. I want to say thanks again to my sponsors, nexus.com. chain alysis and FTX, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.