Bitcoin – a threat for future electricity consumption?

Veronika Tomilina

Bitcoin is currency that can be traded and held electronically. It has some advantage; you can transfer from person to person without involving financial intermediaries which usually charge commissions, you also can use it in every country and you do not need to think about exchange rates. Also, your account cannot be frozen and there are no arbitrary limits.

On 27th November, Bitcoin reached its new high of $10,000, up tenfold in just a year. When everything seems so perfect there should be some danger in this currency. This currency might raise many problems for banks and the financial system as it cannot be regulated; however, in this report I want to look at Bitcoin from another angle – how it affects the consumption of electricity.

Firstly, where does Bitcoin come from? The answer is quite easy, Bitcoin is made by mining. ‘Miners’ use a special platform to mine Bitcoins with mathematical algorithms. Anyone can do mining, and as miners need to secure transactions it means it is a fair, stable and safe network. In the beginning, miners were using computers and processors for these processes, but then they realised that graphic cards used for gaming were much better for this type of work. Graphic cards are faster, but they consume much more electricity and create much more heat than computers.

The popularity of Bitcoin increased so fast that more miners try to join network and use different types of graphic cards to mine. As more people are mining Bitcoin, and demand for it grows, there is a huge amount of electricity used not only for producing Bitcoin but for other cryptocurrencies as well.

According to Digiconomist, the estimated electricity power used for generation and transactions of cryptocurrency is now 30.14 TWh a year; this is 0.13% of total global electricity consumption, and this share is growing rapidly. Each individual Bitcoin transaction uses 300KWh electricity – which is enough to boil 36,000 kettles of full water.

Only in the past month Bitcoin’s electricity consumption increased by 30%. If it continued on this trend, then it will consume all of the world’s electricity by February 2020.

Even though Bitcoin is mined in places with cheap annual electricity costs, with an average cost of around $1.5 billion for electricity. The US average retail price per kilowatt-hour is 10.41 cents, which means using 28.05 TWh would cost $3.02 billion (£2.28 billion).

We need to think about what this means for our future. Consuming more electricity means even more damage from climate change; therefore, there should be new technologies developed for this kind of process, which will affect technological companies.

Bitcoin will affect markets in the future as its price grows. This idea seems very new and many people do not trust it, but this is a process of changing to something new. It could also arguably be described as a new bubble that is doomed to crash as the ‘Dotcom bubble’ did.

Can cryptocurrencies rival gold as a hedge?

Alexander Le Grys

With growing geopolitical tensions, rising economic risks associated with higher inflationary expectations after a lost decade in the developed economies and many unstable currencies in the developing world, people have increasingly been searching for hedge investments to act as security. This has coincided with the exponential increase in the value and acceptance of cryptocurrencies, particularly bitcoin. As a result, the headlines are probing the idea that cryptocurrencies will replace gold as a financial hedge. Whether we accept cryptocurrencies as a financial product or as a financial hedge, there are serious issues to be addressed. Three notes of caution should be made when considering them as a serious option for a financial hedge which could challenge gold.

The first cautionary note is that cryptocurrencies are more similar to a fiat currency than most believe. Fiat money is any currency a government has declared to be legal tender, but is not backed by a physical commodity (and thus usually holds no intrinsic value). Although cryptocurrencies are not legal tender yet, they are also not backed by any sort of physical commodity. In addition, cryptocurrencies’ supply is artificially constrained. This opens the door to hacking and predatory coin offerings. In contrast, the global supply of gold has a physical constraint and, thus, its value provides more stability.

Secondly, gold is probably the most liquid commodity asset in existence. You can convert it to cash at its spot price on demand, and its value is not bound by national borders. This contrasts with cryptocurrencies, which have yet to achieve mainstream acceptance. Having only taken off in 2016, there is little data for the cryptocurrency market and insufficient evidence backing them to be a sound financial hedge in times of economic turmoil. A further key point is the size of the gold market. The World Gold Council values the cumulative quantity of mined gold at $7.8 trillion. In comparison, the cryptocurrency market stands at only $170 billion, with this value split over 1,170 different cryptocurrencies.

The third and final argument, and a topic of huge debate, is that speculation is driving cryptocurrencies to a value that is completely subjective. In late September, Ray Dalio, founder and manager of Bridgewater Associates, one of the world’s largest hedge funds, called “Bitcoin a highly speculative market,” and that it was “a temporary bubble”. Although gold has been known for volatility in the past, this has usually been in response to hedging, such as in times of recession, whereas cryptocurrencies’ volatility is purely speculative and thus can outweigh the price movements from hedging.

Investing in cryptocurrencies such as bitcoin is currently considered as a leap of faith.  Whilst governments are looking to initiate their own cryptocurrencies and companies are looking at potential technological opportunities to revolutionise consumerism, it is equally possible that digital currencies could not develop any real-world value and crash. Much remains unknown about the future of cryptocurrencies, but what can be affirmed at this time is the fallacy that they can replace gold as a financial hedge.

South Africa’s need for a new direction

 

Harry Jones

The S&P shook South Africa on Friday 24th November when it announced the downgrading of South African ratings. The local currency credit rating was demoted from BB+ to BBB-, sending the Rand sliding. However, the currency rallied after Moody’s decision to place the country on review for downgrade. Despite the fact that this still presents a negative outlook for the future of the South African economy, the fact that Moody’s did not actually downgrade the country at the same time as the S&P has been seen as a positive. The country will be under review for a 90-day period before a decision is made on its rating. Following the decision from the S&P, Zuma directed his Finance Minister to identify various concrete measures which could be used to address the economic challenges facing South Africa.

The future is not looking positive for the South African economy. In September, the World Bank cut the growth outlook for 2017 to 0.6% from their previous estimate of 1.1%. Although the estimates for the next few years are slightly more positive, 1.1% and 1.7% in 2018 and 2019 respectively, this would be a poor performance for any economy, let alone a developing one such as South Africa.

South Africa has experienced weak economic growth and high unemployment which has led to a huge amount of poverty in the region. Unemployment has also dampened growth in the consumer sectors. These are not the only reasons for the downgrade, however. The country is also experiencing political and budgetary issues. President Zuma could potentially come under the same problems that Mugabe suffered recently in Zimbabwe. Mugabe’s attempt to put his wife in power was not popular and led to the soft coup, culminating in his resignation. Zuma is pursuing a similar idea and is trying to ease the way for his ex-wife to take power in the 2019 elections. However, the potential for military intervention is a lot lower than in Zimbabwe, and so it would be much harder to settle the dispute. One of the main points that South Africa can learn from Zimbabwe is that disputes are resolved much more easily within the ruling parties than out on the streets.

South Africa has not had a huge amount of luck in recent times. They have attempted to gain a major sporting event in an attempt to boost economic growth. However, they have had numerous setbacks over the years, with failed bids for the 2011, 2015 and 2019 Rugby World Cups. They recently failed to gain the 2023 Rugby World Cup as well suggesting the sport is becoming more and more dominated by money, especially due to the fact that South Africa was initially named as the favourite to host the event in 2023. This has just added to South Africa’s economic woes.

Zuma must now be extremely careful when making plans to deal with the dire economic situation. The country has had a lucky escape with Moody’s decision to only place the country under review. A downgrade from Moody’s could lead to South Africa falling out of the Citi World Global Aggregate Bond Index. This would lead to further outflows from the bond market. Therefore, Zuma’s next steps have the potential to either raise the country to new heights or lead to deeper economic problems. However, Zuma focuses on staying in power rather than using his power to the country’s advantage. Therefore, there could be a need for change in South Africa to prevent further problems down the line.

Blowing bubbles in the bond market

Richard Holland

The bond market for Treasuries has been in an astonishing 32-year bull market, outperforming corporate, high yield and emerging market bonds along the way. However, the sustainability of treasury bonds’ performance has been called into question as early as 2009, and the voices proclaiming that the ‘bond bubble’ is about to burst are as loud as ever. As a result, it is worth exploring whether utility stocks provide a suitable replacement to diversify portfolios.

In general, an investor holds bonds in their portfolio for 2 reasons. Firstly, to obtain a fixed-income stream that typically increases as they reach retirement age in order to replace their wage. According to Vanguard, bonds should represent around 10% of your portfolio up to the age of 40, whereby it should then increase steadily to around 70% at the age of 70. Secondly, bonds are used to hedge against the volatility of equities, which is why Vanguard would always recommend having at least 10% of your portfolio in bonds, regardless of your age. To illustrate how bonds and equities tend to move in opposite directions, U.S. stocks returned -37.0% while U.S. bonds actually rose by 5.1% during the financial crisis in 2008.

Simply put, a bubble can be defined as when an asset trades far above it’s true value for an extended period of time and proponents of the ‘bond bubble’ theory attribute quantitative easing (QE) as the cause. After the financial crisis, Central Banks printed new money and used it to buy bonds, pushing up fixed-income prices in the process. The price of bonds was then exacerbated by private and institutional investors, who ploughed $375bn into bonds in 2016 alone, desperately searching for yield in the bear market. In fact, such was their desperation that yields even became negative for German and Japanese government bonds.

Now, many Central Banks have changed course to unwind their QE programmes and investors fear heightened volatility, falling bond prices and even a bond market crash as a result of interest rate rises. The assumption is that once interest rates rise, they will do so relatively quickly which will remove the artificial downward pressure of QE on treasury yields, causing the yields, in theory, to rise sharply as bond prices fall. To give you an idea of the scale, the UK’s total QE programme equates to £435bn of bonds and the U.S. Federal Reserve currently has a balance sheet of $4.5tn. According to a July poll of 207 investment professionals carried out by Bank of America Merrill Lynch, a crash in the global bond market is the biggest tail risk for markets and in the same survey, 55% of the fund managers had already reduced their holdings of bonds.

Therefore, with fund managers selling their bonds, where should they put this capital?

One very plausible option is utility stocks because they achieve the same key objectives as bonds in the short-term and avoid any volatility in the bond market. For my analysis, I have looked at 4 of the UK’s largest utility stocks: National Grid plc, SSE plc, Severn Trent plc and BP plc.

One of the main aims of bonds, is to provide a constant income flow and the data indicates that utility stocks dividend yields were actually far superior to gilts. As of 2017, National Grid, SSE, Severn Trent and BP had dividend yields of 5.39%, 6.57%, 3.84% and 5.87% respectively. When you compare this to the yield of the UK’s 10-year gilt, which stood at a measly 1.32%, utility stocks look very attractive indeed.  Furthermore, utility stocks are often used as a hedge against equity volatility because they typically have a beta coefficient of less than 1. SSE plc and National Grid plc have beta values of 0.59 and 0.74 respectively, whereas the largest U.S. utility company, NextEra plc, has a beta of 0.31. Although all 3 of these stocks move with the market, they will act to dampen any market volatility on your equity portfolio because they are defensive securities.

What’s more, the capital return on your investment is often far greater with utility stocks when held for the long term. To compare, if an investor bought a 10-year gilt at issue for £100, they would only receive £100 at its maturity, plus the interest payments. Conversely, had you held £50 of shares in each of National Grid and SSE over a similar 10-year period, from 1997-2007 or 2008-2017, the initial £100 would be worth £263 and £137 respectively, representing capital gains of 163% in the bull market and 37% in the bear market.

Overall, there is a strong divide amongst commentators over the reality of a bond bubble, but influential figures have come out publically in favour of the issue. The former Chairman of the U.S. Federal Reserve, Alan Greenspan, recently stated that “we are experiencing a bubble, not in stock prices but in bond prices”. Consequently, utility stocks represent a useful short-term investment strategy to reduce exposure to volatility in the bond and equity markets, with their capital value widely anticipated to grow alongside the bullish equity markets.

Competition for control of the oil market

Rajinder Dhesi

OPEC’s policy of lowering output to use up excess oil inventories has resulted in a small revival of crude future prices. Brent crude is trading at approximately $64 a barrel, up from $45 a barrel in the summer. Talks were held this week between OPEC and Russia to continue production cuts of 1.8m barrels per day for a further nine months in an aim to raise oil prices further. Before the talks, Wall Street analysts suggested the tense relationship between the oil cartel, who account for 40% of world production, and Russia, the world’s single largest oil producing state, could result in a stalemate. Concurrently, there has been enormous recent growth of the US shale sector, which by 2025 is predicted to match the record Saudi Arabian growth at the height of their oil expansion. The outcome of this is uncertainty in the direction of oil prices in both the short and long term, with analysts seemingly unable to agree on estimates in this volatile market.

OPEC member states, with a few small exceptions, have been lowering output for the last 18 months. Net production is down 669,000 bpd. Spearheading this move is Saudi Arabia, who have cut production by 541,000 bpd alone. Without Russian support these measures would only be punitive, offering no real effect. OPEC requires a commitment from Russia to back an extension of cuts throughout 2018. From a Russian perspective, an end to cuts would be welcomed, given the close link between the Kremlin, Gazprom (who are majority owned by the Russian government) and large private firms such as Lukoil who recorded a profit 78% higher in the last quarter compared to the previous year. These firms it seems would like to continue an expansion of production, reaffirming their dominance in the sector. Complicating the situation further, is the Ruble’s floating exchange rate that fluctuates with oil price. Currently, the low value of the Ruble is benefitting Russian exports in the minerals and agriculture industries. As a result, OPEC and Russia will have to agree on compromises at the upcoming negotiations which are likely to result in the market remaining bearish.

Another possible outcome of negotiations which succeed in raising oil value is a negative rebound as US shale firms are incentivised to continue their dramatic rise in extraction. The USA is currently producing 9.48 million bpd of crude oil, the fourth highest monthly average since the early 1970s. If the rebound was to occur, analysts suggest that Brent Crude prices could fall as low as $45 in 2018. This reflects shale oil’s increased influence over prices in years to come. However, in-house reports by OPEC, which may have to be considered with a degree of scepticism, estimate that peak shale oil will occur as early as 2025, because producers are already focusing on drilling their best fields, where oil and gas can be extracted at the lowest cost. After this, shale will become harder to extract and consequently less profitable. After 2025, OPEC according to their own predictions, are likely to increase in market share again until at least 2040.

To conclude, there are a number of competing factors and parties involved in determining the price of crude oil. It appears that control of the oil market and the accompanied benefit of being able to dictate oil prices is what each actor would like, though recent trends suggest that is unlikely to happen. Furthermore, the nature of developments in crude oil technology and production is unknown; very few would have predicted the shale oil boom ten years ago.

South Africa’s shaky economy – the power of rating agencies demonstrated

Oliver Dyson

South Africa’s economic outlook looks dire for the coming months. On October 25th, Malusi Gigaba -South Africa’s Finance Minister – revised GDP growth estimates down from 1.3% to 0.7% in the Medium-Term Budget Policy Statement (MTBPS), firmly placing the nation as the third worst-growing economy, behind Brazil and Switzerland. This is not a developing market issue; South Africa is not following the current trend rate of growth in emerging markets, currently standing at around 3.4%. Unemployment rates of 28% also pose an issue on how to improve government finances in a situation where next year’s budget deficit is forecast to stand at 4.3% of GDP. More troubling are the recent S&P downgrades of Rand-denominated bonds to ‘junk’ grades which has worsened the options for South Africa going forward.

Slack demand for the country’s exports, along with political turmoil have culminated in an economic recession over the past few quarters, ending in September of this year. Investor confidence has remained low in the nation, spurred by several scandals involving President Jacob Zuma. The first family’s close involvement with the Gupta family, a cohort of rich Delhi-born businessmen, has created anti-corruption outcry with many suggesting that the family has been using their influence to achieve policy changes. Indeed, the anti-corruption minded former Finance minister Pravin Gordhan was one of the largest critics of the family, stating that the Guptas had bee involved in ‘suspicious’ transactions worth some $490m. Several downgrades by rating agencies were unsurprisingly made when pro-reform Gordhan was ousted by the ruling party. Zuma’s African National Congress (ANC) party has been under increasingly close scrutiny going forward; investor trust has suffered as a result.

Zuma’s economic policies going forward are also giving cause for concern in markets. The President told his Presidential Fiscal Committee to reduce spending by 25 billion rand ($1.8 billion) in next year’s budget and to find ways to add 15 billion rand to the nation’s revenue. This is likely to lead to tax increases, which may dampen economic expansion for a country that just exited its second recession in a decade. Ratings agencies have severely downgraded their outlook for the economy as well; S&P stated last week that “South Africa’s economy has stagnated and external competitiveness has eroded”. The institution downgraded Rand-denominated debt to one-level below investment grade at BB-, with Fitch following suit. This move has contributed to the nation’s economic woes by ensuring that SA bonds have been expelled from the Barclays Capital Global Aggregate Bond Index (which only trades S&P investment-grade bonds). With access to $2tn of capital now cut off, the government’s borrowing costs are set to rise, as a rise in issued debt is expected in the near future to plug the deficit gap. As evidence of this issue, yields on 10-year bonds have increased from 8.4% to 9.4% since October, reflecting investors’ waning confidence in the economic performance of the nation. The rand also fell by 2% after the announcement.

However, the rating agency Moody’s has decided to keep local-currency bonds on its rating of Baa3 (the lowest investment-grade rung above ‘junk’) for the next 90-days as it revises its decisions. This decision has enabled SA bonds to remain in the Citi World Government Bond Index (with access to a much larger $8tn of foreign capital), while Citigroup economist Gina Schoeman has estimated outflows of 100 billion rand ($7 billion) from the bonds if they are allowed to fall to ‘junk’ grade. Clearly, the government has been thrown a lifeline from Moody’s decision, which has given it the opportunity to turn the economy around in the next 90 days. Indeed, this took the rand’s year-to-date carry return against the dollar to 5.7 percent (up from a negative rate in early November), meaning more investors performed carry trades (borrowing in rand to buy more dollars) following this announcement. Reinforcing the gravity of this decision, previous Finance Minister Gordhan stated that if Moody’s downgrades the country to sub-investment grade, it could take up to 10 years to recover.

Going forward, both ratings agencies and investors will be looking at the ANC party conference in December, which will pick Zuma’s successor. Many argue that the role is only truly contested between Zuma’s ex-wife Nkosazana Dlamini-Zuma, who argues for a more equitable distribution of wealth in the economy, and Cyril Ramaphosa arguing for reigniting growth and restoring investor confidence. Investors may have several opportunities present with this conference. Firstly, prices of options for dollar-rand volatility remain around the highest in a year for one-month contracts. That suggests that traders are anticipating big market swings when the ANC decides who will replace Zuma as party leader. Moreover, Toronto-based bank Toronto-Dominion says the Rand may rally by almost 10 percent to 12.55 next year if Ramaphosa or another candidate outside Zuma’s faction wins the vote, especially if they push the president to resign from his role of as head of state before the end of his term in 2019. This would be a great improvement for the economic outlook of South Africa, as growth-based policies would be put in place once more. This party conference on 16th -20th December should therefore be watched closely by FOREX traders.

Yet it is hard not to forget about the fundamentals of the economy. The same issues of low growth, large inequalities, high unemployment and low investment still remain and it is unlikely that these will be resolved soon. Low growth and poor credit/bond ratings may be here to stay for Africa’s largest economy, which is why a favourable Moody’s rating on rand-bonds in the next few months is vital to lifting the economy out of a low-confidence malaise.

Flotation of Siemens’ healthcare unit to be the largest German IPO in two decades

Hyesung Lim

On Wednesday, the European engineering conglomerate Siemens AG announced its plans to list its diagnostics technology division Healthineers on the Frankfurt stock exchange during the first half of 2018. The partial flotation of this €40bn medical solutions business is anticipated to be the largest public offering in Germany since the €13bn listing of Deutsche Telekom in 1996.

Michael Sen, a member of the Siemens supervisory board overseeing the Healthineers IPO, described Frankfurt as “one of the world’s largest trading centres for securities [whose] importance will continue to increase due to Brexit.” In explaining the board’s decision to favour Germany over other perhaps more popular cities like New York, Hong Kong, and London, he said “As a highly liquid trading venue, Frankfurt is attractive for investors from around the world.” And indeed Frankfurt has a special edge over exchanges in other financial hubs when it comes to its strong appeal to Asian investors and its perception as being “truly global.”

In the third quarter of this year, Healthineers was the best performing of Siemens’ nine divisions. Offering a wide variety of products and services in healthcare IT, laboratory diagnostics, medical imaging, and therapy systems, the unit reached a quarterly sales of €3.7bn. Besides contributing the largest fraction to its parent company’s €21.4bn revenue, it was also the most lucrative unit with a profit margin of 19 percent. Siemens did not provide further details about the upcoming flotation of this medical solutions unit, but persons familiar with the company predicted the size of its listing to be a slice of up to 25%. The IPO of this minority stake, which could be worth anywhere between $6 billion and $12 billion, will be ranked as one of Europe’s biggest listings over the last few decades.

The Healthineers IPO is thought to comprise a part of the industrial giant’s latest move to revamp its wide structure of four sectors—industry, energy, healthcare, and infrastructure—and transform itself into a holding company. In 2014, Siemens chief executive Joe Kaeser unveiled the group’s Vision 2020, which sets forth a central mission to “strengthen core.” The plan seeks to gather the firm’s focus on its core industrial operations by spinning off other less relevant units in a business model described as a “fleet of ships.” As a direct consequence of this huge restructuring movement, there have been a multitude of M&A and sales activities along the peripheries of Siemens. In April, the group’s renewable energy unit merged with the Spanish wind turbine company Gamesa. The engineering group holds 59% of the shared capital while Iberolda holds 8% of the sum. The rest has been listed separately in Madrid. In a similar fashion, the lighting business Osram, the household appliance division Bosch Siemens, the chipmaker Infineon, and a range of other telecommunications units have all been sold off. The next in line is the rail division, which is set to merge with the French company Alstom before being listed in Paris.

Kaeser emphasised that “The individual Siemens businesses must be able to keep up with the specialists in the industry and be at least as good as their strongest competitors.” With a firm conviction that “conglomerates have no future,” the engineering firm has been reinforcing a strategy that seeks joint ventures or partnerships where it can act as an investing partner or a holding company. With the growth of IT and automation causing multidimensional disruptions across the industrials sector, Siemens has been truly diligent in their efforts to break away from the outdated structure of a conglomerate and generate smaller specialised entities that can respond faster to the rapid changes in consumer and market sentiments.

“It won’t be the largest or the most diversified companies that will be successful in the era of industrial digitisation, but those that are best adapted to the rapidly changing market conditions.”

Uber Data Breach Scandal

Olivia Warwick

Uber revealed last Tuesday that it paid a $100,000 ransom to hackers in an attempt to cover up a data breach that impacted 57 million accounts in October last year. Uber said they had identified the hackers and ensured they had destroyed the stolen data.

The names, emails, and phone numbers of millions of customers and drivers, and the licence plates of 600,000 drivers were taken. Financial information such as credit cards and social security number were not accessed. Uber is offering free credit monitoring for drivers, and fraud monitoring for those customers affected.

Former CEO Mr Kalanick discovered the breach in November 2016, a month after it happened. The company took immediate steps to secure the data, shutting down unauthorised access and strengthening its security controls. It did not, however, report the breaches to the authorities. After Mr Khosrowshahi, newly appointed CEO, learned of the cover-up he ordered an investigation. Chief Security Officer Joe Sullivan and Craig Clark, the deputy, have been fired for their part in the cover-up. Uber has hired cyber security expert and former general counsel of the National Security Agency, Matt Olsen, to advise the company.

Uber disclosed the breach ahead of a tender offer from SoftBank as it could influence the decision of investors. Mr Khosrowshahi has spent weeks negotiating with SoftBank in an investment deal upward of $10 billion. It is unclear whether SoftBank may use this disclosure in negotiations.

The scale of the breach, though not as extreme as the recent Yahoo and Equifax disclosures, raises questions as to who else knew about the cover up, and who else was involved. A spokesperson for Uber declined to reveal who authorised the $100,000 ransom payment.

This adds to the string of scandals and legal troubles Uber faces. A prominent revelation in March 2017 was that Uber had secretly designed and used software called ‘Greyball’ to evade the sting operation of city officials who were attempting to catch Uber drivers that violated local regulations. Bloomberg reported this most recent data breach cover-up is an additional challenge for Mr Khosrowshah, who has been trying to bring stability to the firm in his first three months of the role. Mr Khosrowshah has inherited multiple federal investigations into the company’s programmes aimed at regulators and competition, in addition to violations of the Foreign Corrupt Practices Act. Additionally, Uber is currently in a heated legal dispute with Alphabet (Google’s parent company) who accuse Uber of stealing trade secrets on self-driving cars. Uber denies the allegations. Uber is also still recovering from a legal dispute with a female engineer over the neglect of complaints of harassment and sexism towards her and other women.

Currently valued at $68 billion, the company has developed a reputation for pushing the limits of the law in their aim of being the market leader in the ride-hailing market.

Tesla production slump — Can they stay afloat?

Olivia Warwick

The electric car maker Tesla has hit snags in its attempt to become a mass market player through production of affordable Model 3 automobiles. Quarterly results released 1st November showed a rise in post-tax losses by 67% to $671m. Tesla’s shares fell by 6.8% on the 2nd November partly due to US government tax changes that reduce incentives for electric car buyers; a significant blow to the appeal of affordable electric cars including the Model 3. Other contributing events add to the struggles Tesla are facing. Holdups are partly caused by the company themselves, with bottlenecks in the production line causing serious delays to their short-term targets, resulting in only 260 Model 3s being produced out of the 1,500 target from the last quarter. This has led the company to push back its target of making 5,000 Model 3’s a week by three months. Tesla has so far produced 250,000 cars in its 14 years, and aims to make 1m cars by 2020.

Problems include workers manually operating robots that should be automated, multiple cost overruns, in addition to delays from suppliers due to last minute changes to design specifications. Further difficulties in sequencing parts once they arrive at the plant has led to unfinished cars at the end of the production line. Expert automotive manufacturers describe the operational problems Tesla are facing as ‘basic’, that come from the fixation on speed, in both product development and the manufacturing process.

Regarding production bottlenecks, delays in Tesla’s Nevada battery factory are to blame, where workers build battery packs by hand instead of using the automated systems installed, a situation Elon Musk has described as being “really inefficient”. Nevada is not the only plant experiencing difficulties with manual operation. Witnesses of the production process in the Fremont assembly plant in California have observed the newly-installed Kuka robots (designed to increase speed of production) being manually operated. One visitor, who inspects car plants across the globe, claimed they had “never seen so much manual labour on a line”.

Another potential weakness is Tesla’s supply chain. In at least one instance, Tesla has made alterations to crucial components mid-production which has meant re-starting the process, causing a ripple effect of hold-ups down the production line. These late alterations may well have resulted from Tesla skipping a manufacturing prototyping stage. When questioned on automation, a Tesla spokesperson said that the production line contained both manual and automated elements and that there are no fundamental issues with the supply chain nor production of Model 3s, adding that they have always anticipated time taken to fine-tune the production line and that they are confident in addressing the current bottleneck issues within a timely manner.

Having a high level of automation is part of the company’s efforts to streamline production. Elon Musk highlighted the aerodynamics of robotic arms as an area for increased efficiency. He thinks “speed is the ultimate weapon when it comes to innovation or production”. It is not unusual for Tesla to take unconventional approaches in the interest of saving time, for instance in the shipment of incomplete vehicles to Tesla-owned dealers, who finished assembly before delivering the vehicles to customers. This practice, though an unorthodox process, does not break with regulation. It does however encourage questioning of the adequacy of vehicle checks and calibration before being delivered to customers, particularly at higher volumes of production.

As aforementioned, Tesla is also facing problems with its ‘sequencing’ of components (matching up parts with their intended vehicles once they arrive on site as fast as possible). Tesla’s inefficient sequencing has led to the pile up of components coming into the factory to be stored, along with incomplete cars coming off the line. Analysts have calculated that Tesla’s ‘work in progress’ (costs tied up in unused goods and materials) is 14% of its total sales; significantly higher than other more established carmakers, such as BMW (2%) and VW (4%).

There is now a greater risk that some of the nearly 500,000 waiting customers with $1,000 deposits will withdraw their deposits and choose a different car manufacturer after those who have reserved Model 3 cars received emails this week informing them that their orders would be delayed.

Federal Reserve Rate Hike and its Implications on the Global Economy

Jonathan Eng

After the release of the Federal Open Market Committee (FOMC) minutes on the 22nd November, there has been a mixture of reactions to the signalling of an increase in the Federal Rate. The minutes reflect a more positive atmosphere in the US economy; with a strengthening labour market and a gradual increase in household spending and business investment. A streak of hurricanes drove up gasoline prices in September, fuelling short-term inflation. However, little has been done to impact medium- to long-term growth, with expected longer-term inflation targets remaining unaffected.

The FOMC expect that such economic activity will prevail, which warrants a gradual increase in the federal fund rate—henceforth, Rate—but will remain at levels lower than what is expected to prevail in the long-run. This sentiment has had several repercussions in the dollar, gold, Treasury Bonds and Foreign Exchange markets.

Theoretically, any rise in the Rate would result in the appreciation of the dollar as there becomes fewer dollars in the market due to a higher Rate. However, the dollar currently remains at one its weakest levels since mid-October and has fallen 0.9%. This is mainly due to the fact that markets have already priced in the potential hike in December into existing prices. However, beyond December 2017, the minutes appear vague and uncertain; compounding this with a flattening of US yield curves which only points to short-term Rate hikes and the result is a defensive dollar to protect domestic interests.

This uncertainty in the medium-to-long run in monetary policy has also been reflected in the price of gold and Treasury bonds. Gold went up 1% and traded at 0.8% higher and yield on 10-year Treasuries dipped slightly after the release of the FOMC minutes. Gold is generally perceived as a ‘safe-haven commodity’ whilst US treasury bonds are secure investments with sure-returns; essentially a ‘safe-haven investment’. The fact that gold and Treasury prices have risen reflect cautious investor confidence in the market. This attitude in investor confidence will result in 1 of 2 outcomes; either the price of gold continues to rise while treasury yields fall, or an influx of FDI will go towards China.

Attitudes across the Pacific contrast the defensive reaction in the West. The Yen and Australian dollar went up 0.3% against the dollar while the Dollar Index, which tracks the dollar against a basket of global peers, was down 0.2% in Asia. The index had moved down as much as 0.8% on the day, ahead of the release of the minutes. A weaker dollar remains favourable for China, which pegs the yuan against the dollar. Given China’s current appetite for exports and reputation for cheap labour, a lower dollar will relieve pressures on Chinese exports to the West for the time being.

Despite uncertainty in the medium-to-long term, what is clear in the short run is that the US economy is showing signs of being on track to recovery, with historic quantitative easing being rolled back and Rate hikes being back on the discussion table. What is less certain is how rates will change in the long run, as US inflation is expected to fail to meet its 2% target. How markets will price the dollar and yields accordingly is also undecided. For the time being however, China would almost certainly welcome a weaker dollar, as it continues to leverage cheap exports and extensive FDI to fuel its economic growth.