Microfinance 2.0: By the People, For the People

            This is the second of a three part series. Part 1 can be found here and part 3 can be found here. 

            Last week we talked about the savings groups that allow individuals living in poverty to be able to get periodic access to more liquidity than they would otherwise be able to get.  At some point, a Bangladeshi economics professor named Mohammad Yunus realized that the amount of money required to make some simple life improvements was as little as a few dollars.  These could be the same things as the savings groups facilitated but also might be things on a larger scale.  In Bangladesh, the “larger scale” could indeed be the equivalent to just a few US dollars.  In other words, an insignificant sum in the developed world might be a huge sum of money in the Third World.  This reality became an important feature as Mr. Yunus innovated the microfinance machine: a platform for allowing philanthropically minded individuals who could spare a few dollars to pool their resources and fund loans to the poorest of the poor.  These loans, which range from $25 to a few thousand dollars, are used in some capacity to help a person who does not have access to a commercial bank’s credit to make some investment that would help them work out of poverty. 

This “investment” is usually related to their line of work such as seeds, tools, and livestock for farmers, input factors like raw materials for manufacturers, and goods to be sold at a grocery store or restaurant.  Having thus borrowed a sum of money, the person taking the loan directs the resources in an appropriate value-adding way and pays back the loan.  He is able to keep the profits to fund further expansion, sending children to school, or improving life in some way.  It is not uncommon for individuals and groups to take increasingly larger and larger loans as they build up a good reputation for repayment and expand to bigger and bigger projects.  While outliers exist, the soft cap on microfinance loans tends to be approximately what can be repaid in a couple years and in practice has been a few thousand dollars.

There are several organizations that facilitate the creation and repayment of loans, but their particularities are beyond the scope of this piece.  The prominent ones are Grameen Bank, the first microfinance organization, and Kiva, a San Fransisco based non-profit that streamlines the lending experience for anyone who has a desire to be their own “banker to the poor” (as Yunus phrases it).  While almost all finance institutions build pipelines between those with money and those who can utilize it, Kiva has been unique in microfinance circles as it sources funding from small-scale investors rather than institutions like banks, pension funds, governments, or high net worth individuals.  Kiva does not only empower the poor in developing nations, it gives anyone with $25 dollars the opportunity to help change someone’s world.

Interjecting with a personal note, I’ve had an overwhelmingly positive experience lending through Kiva.  The interface is informative, beautiful, easy to use, and that’s not even mentioning their mission. 

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Microfinance 1.0: Bootstrapping from the Bottom

            As we are all aware, hundreds of millions of people are living in poverty all over the world.  While many societies have been able to build their way to modernity since the Industrial Revolution, there have been many others that have not.  Sometimes this is due to lack of natural resources.  Other times it is due to ongoing regional conflict, and still other times cultural or religious norms inhibit growth.  The state of the world’s poorest is a tragedy of the human condition but much progress has been done to alleviate it in our lifetimes.  Globally, poverty is at an all-time low and its rate, according to the World Bank, has dropped from 43.1% in 1900 to 20.6% in 2010.  This is a testament to the “rising tide lifts all boats” adage, but it also often due to the sheer ingenuity of the poor themselves.

            Such evidence of the poor building themselves out of poverty can be seen in the innovation of informal savings groups.  This is the idea that a community of individuals get together periodically (daily, weekly, monthly, etc) and pool savings to distribute to a member of the group.  The recipient of that meeting’s proceeds gets to take advantage of a big inflow of money to make a relatively large purchase or some kind: tools, seeds, and the like.  Ultimately each member pays as much into the system as they receive but the arrangement works well because it allows each individual to have that access to a large cash flow all at once rather than having to try to save for n number of periods.  Other features include enforceability because members of the groups can visibly check to see that the other participants are contributing as their arrangement requires.  Anyone who shirks the responsibilities is visibly noted.  It might seem like one could forego the group and just save the same amount that they pay every period until the needed amount for some given purchase has been saved.  That does happen most of the time, but the reason that people sometimes chose to forego pure savings and opt for this system instead is the reality that frequent small cash outflows and a large inflow periodically is more palatable than trying to keep cash on hand, for security or any other given reason.

What we witness in this primitive capital market is a simple and yet unquestionably effective way of facilitating access to money.  The particulars of each group, pay-in rates, payout periods, and other factors vary from group to group.  But the general concept stands at the base level.  You can read a more thorough explanation of savings groups here (starting on page 7) if you’d like.  Though it is a limited solution, it is particularly beautiful because it can be implemented with no more than willing participants and the infrastructure of a record keeping pen and paper.  For want of a pen and paper, good memory can suffice. 

This is the first of a three part series. Part 2 can be found here and part 3 can be found here. 

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What the Price Says: Facebook brings WhatsApp into the fold

            Right in the wake of a failed Snapchat takeover bid, the M&A folks at Facebook are the toast of the business world and the founders of WhatsApp, Jan Koum and Brian Acton, are the debutantes of Silicon Valley.  I’m sure you’ve read the headlines: Facebook buys WhatsApp for 19 billion dollars.  That’s four billion in cash, 12 billion worth of Facebook stock, and three billion in restricted stock to be paid over the course of four years.  And that’s billion with a “B”. If you glazed over seeing three big numbers, let me put that in real terms.  19 billion dollars, as TechCrunch contextualizes, is: four times the market capitalization of BlackBerry, one third the market cap of Ford and Hewlett-Packard, and 25 times the size of Facebook’s last in-the-public-eye acquisition, Instagram.  I’ll add anecdotally that the London Olympics of 2012 cost 15 billion dollars, as did NASA’s Mars rover program.  I could go on… 

            Let’s not forget that at their last round of fundraising, the company was valued at 1.5 billion dollars.  So the question on my mind, your mind, and everyone else’s mind is: what possible reason could Facebook have to spend such an immense amount of money on a texting app?  With a claimed 400 million active monthly users, that’s $47.50 per account.  For comparison, it takes a decade to get that much nominal ad revenue from a Facebook user.  It would be even longer if we were discounting to the present value.  At the current subscription price of a dollar per year, whatever the discount rate is, Zuckerberg will be lucky to see the break-even point before retirement.

            While all those numbers are true, and our friends at 1601 Willow Road deserve all the funny looks they’re getting from pretty much everyone else, two sentiments seem to float to the surface that explain this occurrence.  The first is, as one can imagine, a desire to expand into different markets.  Most of WhatsApp’s users are in emerging markets like Mexico, Brazil, and India (countries with lower adoption rates of Facebook itself).  These days, the sun never sets on the Zuckerberg empire.  The second sentiment, and this might explain the magnitude of the deal, is a fear of obsolesence.  From niche news sites like TechCrunch to mainstream sources like ABC and The Guardian, the consensus seems to be the same: the people Facebook is meant for, the “cool kids”, are browsing elsewhere.  Time will tell whether the acquisition was worth the cost, and with over a billion users already, Facebook has quite some time before it goes away.  Yet it must be in the back of Mr. Zuckerberg’s mind that a decade ago, one Harvard student single-handedly took down the incumbent social network: MySpace.  

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The Case of the Missing January

            We in the finance major learn about something called the “January Effect”, where an investor can theoretically earn outsized returns by buying securities in January versus other months.  Why is that?  There is a matching phenomenon that there is a big sell off of securities in the previous December because investors are eager to take the tax advantage associated capital losses on investments that are performing poorly.  The intuition makes sense but in the past decade, the market has been down in as many Januaries as it has been up.  In fact, the average month increase when the DJIA was up was a little over two percent (2006, 2007, 2011, 2012, 2013).  On the other five Januaries, where it went down, it fell by over four percent (2005, 2008, 2009, 2010, 2014).  The January Effect seems about a legitimate as the Leading Lipstick Indicator: the intuition is there and “60% of the time it works every time”, as Brian Fantana says.  Yet we would be remiss to make buy and sell decisions citing it as a rationale. 

            As I write, the DJIA has fallen around five percent this year, the worst since 2009…when we (along with the rest of the world) were in a bona fide recession.  What could be the cause of this?  Ironically, though not surprisingly, one of the stabilizers that helped cancel the recession is contributing to the poor performance now.  This is, of course, quantitative easing which has been propping up the stock market as much as the economy.  Now that it is scaling back, down to 65 billion dollars this month, the chicanery of the animal spirits is a little more dramatic and a little more visible than usual.  People have been calling it a “taper tantrum”.  Let’s hope that when Janet Yellen takes the helm of the Federal Reserve on Monday she’ll have the volition to successfully wean capital markets off the easy money they have become accustomed to.

            The other major contributing factor to this month’s poor performance comes from the developing world.  According to Reuters investors have pulled nine billion dollars out of emerging market funds and bonds in the past week. Yikes.  It seems like a lot of the volatility in has been due to weakening exchange rates (Turkey and Argentina, notably), but from reading the news, I get the impression that it largely reactionary as investors see their peers selling off their assets.  Hat tip to the animal spirits.  

From Yahoo Fiance, cue sad music.

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Bitcoin Redux

I touched on bitcoins in the last post several months ago and had no idea even then that they would take the world by storm as much as they have now. Nearly all the blogs that I’ve read have posted about it multiple times, from tech sites like Wired and TechCrunch to economics ones like the Mises Institute’s blog. It has even come up in mainstream media sources like CNN. You’ve undoubtedly read about them either in my previous post or elsewhere so the exposé is not needed here.

Observe the bitcoin exchange rate in US dollars for the past six months and compare the scales to the chart in my previous post from only a few months ago, when the exchange rate sat around $100/BTC. As I write today, it is over $1050/BTC. It doesn’t take a genus to see that speculators have brought some serious skin to the game as an appreciation of over a thousand percent has taken place in such a short time. Once the playground of computer geeks and contraband smugglers, this digital currency has become the talk of everyone from Wall Street to Main Street. Even the second most powerful man in the world, Ben Bernanke, gave bitcoins a veiled compliment during one speech.

In the past couple months, speculation has become a dangerous game as the exchange rate fluctuates several percent every day, the most dramatic dates being an appreciation of what looks like around 69% on November 17th and a depreciation of 17% on November 30th. The preposterous volatility continues, trending perilously upward while the world sits and watches as the best laid schemes of mice and men succeed…or go awry.

It is important to note that the value of other currencies do not fluctuate this much. Nor it is an exaggeration to say that the world would simply self-destruct from instability if it did. For comparison, the US dollar has been able to purchase .83 euros at its absolute strongest and .67 euros at its absolute weakest, a band of about 24 percentage points, in the past five years.

It is surprising, then, that no one has tackled the issue of why the bitcoin’s exchange rate is so volatile but I will attempt a conjecture today. Take the world of foreign exchange, where currencies like the dollar, euro, yen, and all others are bought and sold for each other. Transactions happen continuously and at the speed of light as perfect information distribution and access to all markets simultaneously keep exchange rates in viciously tight equilibrium. The world’s markets spin on with astonishing stability considering that four trillion dollars worth of currency cross the planet every single day.

I believe that the reason bitcoin has not enjoyed similar stability is that none of the main exchanges offer built-in stability mechanisms. They are only spot markets. In a spot market, one may buy or sell bitcoins in whatever currency he pleases at the prevailing market price. In regular foreign exchange markets, there is not only a spot market, but also a forward market, which allows buyers and sellers to enter a contractual agreement to pay a certain exchange rate at some point in the future. There are also options, swaps, and currency pairs, which are entirely outside the scope of this essay and likely the topic of another. The point is, the existence of derivatives and the forward market self-enforces stability and that “viciously tight equilibrium” from above. Without those checks in the bitcoin market, mutability is the law of the land.

I daresay that the world is witnessing the growing pains of bitcoin, that it has become more popular than existing institutions can handle. Yet when someone has the volition to make a robust market with the same features other currencies enjoy, and if it becomes popular enough, the exchange rate instability will largely end. Bitcoins will be, from an investment standpoint, rather indistinguishable from their government-backed peers.

By the way, if you're a bitcoin user and would like to make a donation to my site, my wallet's address is  1GSCJTsYLEaBF2HX6WmnXDF9QuNezGo4v1 and it'd make my day to see something show up.

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What's the Big Deal with Bitcoins?

            Bitcoins…bitcoins...bitcoins!  It seems like the world has all of the sudden, or at least as of early this year, become entirely enamored with bitcoins as evidenced by the overwhelming press coverage they have been getting recently.  I don’t know how I managed to get this far in the year without writing about it because it has been a fascinating phenomenon to watch unfold.

            Recall from the end of my last post that bitcoins are an open-source fiat money that is backed by no government or bank, but rather the citizens of the internet.  It is the most fiat of money for that very reason.  Bitcoins have been around for several years, beginning in 2009 and growing slowly in popularity since then.  The exchange rate of dollars to bitcoins began 2013 at around $13 and rose to an all-time high of $230 by April and then dramatically crashed before leveling off around the hundred dollar mark where it sits now, several months later.  What happened in those months that caused the sudden bubble and bust?  I have a theory: an educated guess, if you will based on a little reading and some mental puzzle-solving.

            Bitcoins have been used primarily for ecommerce transactions of illegal goods because they are, by design, international and anonymous (or at least very difficult to track).  Drugs, firearms, fake IDs, and rather significantly more unsavory goods are dealt through illicit marketplaces with bitcoins being used as the medium of exchange, internationally and anonymously like the buyers and sellers themselves.  Hold that thought in the back of your mind.

            What was going on in the world in early 2013, culminating in March?  The European financial crisis had hit Cyprus pretty hard.  I even wrote a post about the whole incident when it was happening.  Cyprus is a tax haven for Russian business magnates and so one of the things that was suggested by the ECB/IMF/European Commission during the early weeks of March (March 16^th to be exact) was to confiscate 40% of the bank deposits of uninsured accounts with a value over 100,000 Euros: essentially targeting the Russian businessmen.  This idea was eventually dropped on March 25^th, but during the days between the 16^th and 25^th, the fate of those deposits were up in the air.  

            Before looking at the exchange rate graph below, take a wild guess as to when the bitcoin boom started, recalling that bitcoins are the de facto underground market currency and that a substantial portion of Russia’s economy is built on the dealings in such markets…and that Cyprus was a tax haven.

            If you guessed that the dramatic boom started in the third week of March, you’d be correct!  Bitcoins had been increasingly in the public eye since the beginning of the year but the major step up began when the deposits were threatened by seizure.  I suspect that the rest of the world noticed the inflation and speculators carried the bitcoin’s value to its highest point even after the deposits’ threat had gone away.  Examine the graph for a while and see if you can’t extract more insight from it.  The events of the past few months on the web and in the rest of the world are more interesting than ever and I suspect we can learn about how humans deal with booms and busts by seeing the bitcoin crisis as a microcosm of what has happened, and maybe will again, for other securities and currencies in the rest of the world.

By the way, the exchange rate chart can be made here where you can manipulate the time frame as well as several technical indicators.

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