History’s Biggest “Butterfly Effect” Occurred On This Day

Originally Posted on by macromon

The butterfly effect is the concept that small causes can have large effects. Initially, it was used with weather prediction but later the term became a metaphor used in and out of science.

In chaos theory, the butterfly effect is the sensitive dependence on initial conditions in which a small change in one state of a deterministic nonlinear system can result in large differences in a later state. The name, coined by Edward Lorenz for the effect which had been known long before, is derived from the metaphorical example of the details of a tornado (exact time of formation, exact path taken) being influenced by minor perturbations such as the flapping of the wings of a distant butterfly several weeks earlier. Lorenz discovered the effect when he observed that runs of his weather model with initial condition data that was rounded in a seemingly inconsequential manner would fail to reproduce the results of runs with the unrounded initial condition data. A very small change in initial conditions had created a significantly different outcome.  — Wikipedia

On this day in history, June 28, 1914, the driver for Archduke Franz Ferdinand,  nephew of Emperor Franz Josef and heir to the Austro-Hungarian Empire,  made a wrong turn onto Franz Josefstrasse in Sarajevo.

Just hours earlier, Franz Ferdinand narrowly escaped assassination as a bomb bounced off  his car as he and his wife,  Sophie,  traveled from the local train station to the city’s civic city.   Rather than making the wrong turn onto Franz Josef  Street, the car was supposed to travel on the river expressway allowing for a higher speed ensuring the Archduke’s safety.

Yet, somehow, the driver made a fatal mistake and tuned onto Franz Josef Street.

The 19-year-old anarchist and Serbian nationalist, Gavrilo Princip, who was part of a small group who had traveled to Sarajevo to kill the Archduke,  and a cohort of the earlier bomb thrower, was on his way home thinking the plot had failed.   He stopped for a sandwich on Franz Josef Street.

Seeing the driver of the Archduke’s car trying to back up onto the river expressway, Princi seized the opportunity and fired into the car, shooting Franz Ferdinand and Sophie at point-blank range,  killing both.

That small wrong turn,  a minor perturbation to the initial conditions, or deviation from the original plan,  set off the chain events that led to World War I.

Archduke_Jan27

Stumbling Into The Great War
Fearing Russian support of Serbia, Franz Josef would not retaliate by invading Serbia unless he was assured he had the backing of Germany.   It is uncertain as to whether the Kaiser gave Franz Josef Germany’s unequivocal support.   Russia, fearing Germany would intervene, mobilized its troops forcing Germany’s hand.

The great European powers thus stumbled into a war they didn’t want through complicated entanglements and alliances, and miscalculation.  Russia backing Serbia;  France aligned with Russia,  Germany backing the Austro-Hungarian Empire;  and Britian, who really didn’t have a dog in the fight except her economic interests, aligned with France and Russia.

Later the U.S. would enter the war due to Germany’s unrestricted submarine warfare threatening American merchant ships and the Kaiser floating the idea of an alliance with Mexico in the famous Zimmerman Telegram, which was intercepted by the British.

Of course, some will argue that Great War in Europe was inevitable

The great Prussian statesman Otto von Bismarck, the man most responsible for the unification of Germany in 1871, was quoted as saying at the end of his life that “One day the great European War will come out of some damned foolish thing in the Balkans.” It went as he predicted.  – History.com

Nevertheless,  maybe the course of history would have been different if not for that wrong turn on June 28, 1914, which created the humongous butterfly effect, which we still experience the consequences this very day.

The botched Treaty of Versailles  sowed the seeds the for World II.  The War contributed to the Russian revolution and Cold War.  The redrawing of borders in the Middle East after the War created the conditions for the instability and breakdown to tribalism the region experiences today.

A map marked with crude chinagraph-pencil in the second decade of the 20th Century shows the ambition – and folly – of the 100-year old British-French plan that helped create the modern-day Middle East.

Straight lines make uncomplicated borders. Most probably that was the reason why most of the lines that Mark Sykes, representing the British government, and Francois Georges-Picot, from the French government, agreed upon in 1916 were straight ones.  — BBC News

If Franz Ferdinand had not been murdered on this day in history,  that conflict between the Serbs and the Austro-Hungarian Empire may have been contained to just the Balkans.   Maybe.

The butterfly effect.  Think how many small events, decisions, mistakes, one small turn, or “minor perturbations” in plans have had enormous consequences in your own personal life.

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Presidential Economic Scorecard

As we prepare for tonight’s debate, let’s take a closer look at the economic scorecard. President Biden has overseen a stronger economy compared to former President Trump, but his tenure has also been marked by significantly higher inflation. Biden inherited a budget deficit of approximately 15% of GDP and increased stimulus spending, which was supported by the Federal Reserve’s monetary policies. This combination has contributed to the current inflation, for which Biden is accountable.

In contrast, Trump’s presidency was significantly impacted by the COVID-19 pandemic and the resulting economic shutdowns, leading to the largest quarterly GDP drop on record. Additionally, for the first time in history, core CPI inflation saw three consecutive months of negative readings.

While the data is skewed by the pandemic, the sitting president, for good or for bad owns the economic conditions during their tenure. Think Jimmy Carter, who was faced with the OPEC II oil crisis and the Iran hostage situation, both largely outside his administration’s control yet it cost him his reelection.

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King Dollar Drives Yen to 38-year Low

The Japanese yen’s dramatic decline underscores the powerful influence of the Federal Reserve on global markets. Japanese authorities find their intervention efforts ineffective as the yen touched a 38-year low against the dollar. The persistent strength of the US dollar, driven by the Fed’s “higher for longer” interest rate policy, highlights the relevance of the Interest Rate Parity (IRP) model in current FX market dynamics. This model, which ties exchange rate movements to interest rate differentials, is particularly pertinent as high US borrowing costs draw money into the dollar, strengthening it further.

Despite Tokyo’s interventions, the yen’s decline illustrates Japan’s limited control over its currency amid US monetary dominance. Investors and analysts point to the need for the Fed to ease its policies to alleviate the yen’s slide. The current scenario exemplifies how global financial markets are deeply interconnected, with US policy decisions exerting widespread influence.  More than $7 trillion in foreign currency trades occur daily, dwarfing the $140 billion average daily trade in global goods and services.  

The yen’s depreciation also illustrates the challenges central banks face in stabilizing their currencies against a backdrop of divergent monetary policies and robust economic conditions in the US.

Key Points

  • The Japanese yen has reached a 38-year low against the dollar, showcasing the impact of US monetary policy.
  • Japanese authorities’ intervention efforts to stabilize the yen are proving ineffective.
  • The Federal Reserve’s ‘higher for longer’ interest rate policy keeps US rates high, drawing money into the dollar and strengthening it.
  • Global investors recognize the Fed’s dominant role, with high US borrowing costs impacting global currencies.
  • A key gauge of the dollar hit a year-to-date high, further pressuring other world currencies.
  • Despite Tokyo’s record intervention, the yen continued to weaken, indicating limited success of these measures.
  • Analysts believe effective intervention will only occur if the Fed eases its policies.
  • Asset managers have increased their bets against the yen, reflecting bearish sentiment.
  • Contrary to earlier expectations, the robust US economy and persistent inflation have kept the Fed from cutting rates.
  • Upcoming US inflation data may influence future Fed decisions and subsequently affect the yen.

Exchange Rate Determination Models

Exchange rates are a crucial component that facilitates the over $30 trillion in annual trade of global goods and services.  On any given day, FX traders utilize various models of exchange rate determination, either explicitly or act as if they do, in their trading strategies.  The following are a concise overview exchange rate modes:

  1. Purchasing Power Parity (PPP):
    • Prices of identical goods should be the same across countries (Absolute PPP).
    • Exchange rates adjust based on inflation differences (Relative PPP).
  2. Interest Rate Parity (IRP):
    • Covered IRP: Forward rates reflect interest rate differentials.
    • Uncovered IRP: Expected currency depreciation offsets interest rate differences.
  3. Monetary Models:
    • Flexible-Price Model: Prices adjust quickly, linking money supply to exchange rates.
    • Sticky-Price Model: Short-term price rigidity influences exchange rates.
  4. Portfolio Balance Approach:
    • Exchange rates are influenced by supply and demand for financial assets.
  5. Balance of Payments Approach:
    • Focuses on current and capital account balances affecting currency value.
  6. Asset Market Approach:
    • Investor expectations and financial asset demand impact exchange rates.

Current FX Market Trends:

  • Interest Rate Parity Focus:
    • Interest rate differentials heavily influence today’s FX markets, particularly the Fed’s policies.
    • The Federal Reserve’s “higher for longer” policy keeps US interest rates high, boosting the dollar and pressuring other currencies like the yen.
  • Speculative and News-Driven Movements:
    • Exchange rates are volatile due to speculation and economic news, with traders betting heavily against the yen.
  • Global Economic Sentiment:
    • Broader economic conditions and risk appetite influence FX market behavior, with the yen’s weakness reflecting the US’s dominant financial position.
  • Technical Analysis *

These models are a sample of several that provide a comprehensive framework for understanding the complex factors that influence exchange rates in the global economy. Each model highlights different aspects of the economic environment, including price levels, interest rates, financial markets, and international trade flows.

* Although not a traditional economic model, traders widely use technical analysis to predict short-term exchange rate movements. This approach relies on historical price data, chart patterns, and statistical indicators to forecast future price movements.

The above was based on and motivated by a recent  Bloomberg article

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How America Spends vs. How American Spent

Over the past fifty years, American household spending has significantly changed due to technological advancements, globalization, and evolving socio-economic factors. Housing costs have dramatically increased, consuming 27% of household budgets today compared to 19% in 1984, fueled by the chronic housing shortage and escalating construction costs. Conversely, food expenditures have decreased from 20% to 14% of household budgets, thanks to efficiency gains in agriculture that have halved food costs since 1972. Healthcare spending has surged, driven by industry consolidation and increased demand for medical services, despite technological advances that have generally curbed costs in other sectors. Healthcare spending per capita in the U.S. is nearly double that of other wealthy nations.

Clothing expenses have plummeted due to globalization and the outsourcing of production, which has reduced prices but drastically lowered the proportion of garments made in the U.S. In 1972, most, if not all, clothing was made in the United States. Today, the share is around 3 percent

Meanwhile, spending on entertainment and dining out has remained stable, reflecting enduring consumer value in these categories. The shift towards mobile communications from landlines illustrates the impact of technology on consumer habits. Healthcare is expected to claim an increasing share of consumer budgets, particularly as the population ages, signaling continuous growth in healthcare demand. These shifts offer a clear view into the evolving priorities and economic pressures shaping American life.

  • Housing Expenditure Rise: Housing expenses have increased from 19% of a household’s budget in 1984 to 27% today.
  • Decrease in Food Spending: The proportion of income spent on food has declined from 20% in 1972 to 14% due to increased agricultural efficiency. Farms are more than twice as productive as they were in the 1970s.
  • Healthcare Costs Surge: Healthcare spending has grown significantly, fueled by industry consolidation and increased demand for medical services.
  • Globalization Impact on Clothing: The share of clothing made in the U.S. dropped from nearly 100% in 1972 to 3% today, with consumers buying more but spending less due to overseas manufacturing.
  • Stable Entertainment and Dining Costs: Spending on restaurants and entertainment has remained relatively constant, indicating sustained consumer interest.
  • Technological Transformation: Shifts from landlines to cellphones and data plans have kept communication spending stable despite technological changes.
  • Education Spending Increase: More Americans are pursuing higher education, leading to increased spending in this sector.
  • Efficiency in Vehicle Expenses: Households own more cars yet spend a smaller portion of their budget on them, thanks to manufacturing efficiencies.
  • Rising Miscellaneous Expenses: A notable increase in spending on prepared foods and snacks reflects a shift towards convenience.
  • Future Healthcare Spending: Experts anticipate healthcare will continue to consume a larger portion of household budgets, particularly as the population ages.

The above analysis summarizes a recent article in the Washington Post. The data are from the Bureau of Labor Statistics’ Consumer Expenditure Survey

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Do These Trendy Baby Names Ring A Bell?

Great piece in the Washington Post today about trendy baby names. 

Wattenberg has a theory…she calls her “grand theory” of baby names… In the olden days, Americans shared a monoculture dominated by three broadcast TV networks, no internet and no annual SSA name rankings. Hence the frequent reliance on family tradition when a bouncing baby arrived.

Nowadays, she said, people not only have access to unlimited cable channels and the internet, but those innovations have helped usher in a “username creation” mentality — meaning that if someone else has the same name, it’s viewed as taken. So parents tend to tweak their baby’s name just a bit — keeping the “-son,” for example, while swapping the “Ja-” for “Car-.”

Wattenberg finds “an incredible irony” in this. People think they’re choosing something totally unique, but they do it in a way that winds up moving with the zeitgeist. As a result, names have a , with nearly half of all baby names now following identifiable suffix trends — a phenomenon Wattenberg calls “lockstep individualism.”  – Washington Post

Baby names often encapsulate the trends and cultural shifts of their times, with different spellings and endings marking distinct generational identities. A detailed analysis of American baby names from 1945 to 2023 highlights these shifts, showcasing how names evolve from traditional to unique and trendy variations.

Key Points:

  • Generational Markers: Names ending in ‘-ly’, ‘-ley’, and ‘-leigh’ indicate generational trends, with ‘ly’ popular among Gen X and ‘leigh’ rising in the 2010s.
  • Peak Popularity: ‘Ly’ endings peaked in 1970, ‘ley’ in 1987, and ‘leigh’ in 2019.
  • Cultural Shifts: Traditional family names have been largely replaced by more unique names that still conform to unspoken social norms.
  • The Role of Sounds: As naming traditions faded, the sounds and aesthetics of names took precedence, influencing name choices.
  • Data Analysis: The Social Security Administration’s data reveals broad trends in name endings, despite challenges in categorization.
  • Changing Trends: The popularity of names like ‘Jason’ in the 1970s has given way to a variety of names sharing similar suffixes like ‘son’ (Mason, Jackson, Carson).
  • Lockstep Individualism: Despite striving for uniqueness, many modern names conform to popular endings, demonstrating a blend of individuality and conformity.
  • Influence of Media: The rise of internet and media has shifted naming conventions, moving away from family traditions to more unique and personalized choices.
  • Impact of Trends: The data reveals that modern names increasingly share common endings, reflecting broader societal trends.
  • Personal Story: The article also narrates a personal journey of choosing a name for a newborn, reflecting the delicate balance between uniqueness and fitting in.

This analysis not only shows how names can reflect broader cultural trends but also illustrates the personal and societal factors that influence these choices over decades.

 

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BFTP: Greatest Arbitrage Ever

In the spirit of yesterday’s post, AI’s Impact On Energy Demand, a whimsy repost.

Upshot?   One gallon of gasoline = the energy equivalent of 54.7K Big Macs.

IBFTP = Blast From The Past

Greatest Arb Ever: Cracking Gas into Big Macs

OK, time for a little fun.  You can try this and let us know if it works.

Almost everything today comes down to energy, right?

The rise in food prices is really nothing more than an energy problem.   After all, food consumption is about the digestion of calories — one metric of energy measurement – to fuel the human machine.

Scientists have learned to “crack” the energy of foodstuffs,  mainly corn and sugar, and convert these into transportation fuel.   It gives new meaning to “cracking corn.”

If we could do the reverse and crack highly efficient refined fuels into foodstuffs,  for example, we believe we have found the greatest arbitrage of all time.

The Energy Conversion Table below shows that one British Thermal Unit (BTU) is equivalent to 252 calories and one gallon of gasoline is equivalent to 125K BTUs.   Therefore, one gallon of gasoline is the energy equivalent of 31.5M calories.

The energy component of a Big Mac without cheese, for example, is 576 calories, so one gallon of gasoline is the energy equivalent of 54,688 Big Macs.  Still with us?

We’ve included the following table/matrix to show that if you drove 50 miles today in a car that gets 20 miles per gallon, you consumed the energy equivalent of 137K Big Macs.  Yuck!

The last table, The Greatest Arbitrage Ever, shows the dollar price of a Big Mac in various countries (no wonder the Brazilians are now aligning with U.S. against China ‘s FX policy)  and the Big Mac energy equivalent price of a gallon of gas.  That is, one gallon of gas is the energy equivalent to 54,688 Big Macs and with the price of a Big Mac in Brazil at $5.26, the Big Mac energy equivalent price of a gallon of gas in, say Sao Paulo, is $287,656.25.

What an arb, no?  Buying a gallon of wholesale gasoline in Rio for $2.45, “cracking” it into 54,688 Big Macs, and selling them at $5.26 for $287,656.25 sounds like a “splendid arbitrage” to us!

Fun exercise and we can’t wait for the e-mails from the economists on this one.  Before you waste your time,  remember, we’re not serious!

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Global Risk Monitor: Week In Review – June 21

The global markets experienced mixed results for the week. Equity markets mostly rose, led by a rebound in European shares and Brazil, while bond yields exhibited slight increases. Currencies saw the dollar index strengthening slightly, with mixed movements among major currencies. Commodities showed varied performance, with notable gains in crude oil and platinum and losses in metals like nickel and zinc. Lumber was down 8.68 percent.  Financial conditions continue to ease. 

  • Equities:
    • The S&P 500 rose by 0.61% to 5,464.62.
    • Brazil’s BOVESPA increased by 1.40% to 121,341.13.
    • The Nasdaq Composite saw a minimal change, rising by 0.03% to 19,704.86.
    • The French CAC was up 1.67%, and Italian shares rose almost 2.0%.
  • S&P Sector ETFs:
    • Financials (XLF) gained 1.67% to 41.33.
    • Energy (XLE) was up 1.94% to 89.75.
    • Technology (XLK) increased slightly by 0.33% to 228.41.
  • Magnificent Seven Stocks:
    • Google (GOOGL) rose by 1.57% to 179.57.
    • Apple (AAPL) fell by 2.35% to 207.49.
    • Nvidia (NVDA) took a hit, down 4.03% to 126.57.
  • AI ETFs:
    • AIQ increased by 0.45% to 35.53.
    • BOTZ slightly fell by 2.04% to 30.76.
  • Bond Yields:
    • US 10-year yield rose by 2.9 basis points to 4.26%.
    • Mexico 10-year yield fell by 19.5 basis points to 10.33%.
    • Australia 10-year yield increased 11 basis points to 4.25%
    • Japanese 10-year yield gained 3.9 basis points to 0.98%.
  • Other Interest Rates:
    • The 2-10 year Treasury differential slightly increased by 0.9 basis points to -48 basis points.
    • AAA US Corporate Spread widened 4 bps to 43 basis points.
    • Euro sovereign spreads were slightly tighter, led by Portugal coming in 5.8 bps.
  • Currencies:
    • The Dollar Index increased by 0.29% to 105.83, up 4.38% for the year.
    • USD/BRL (Brazil) saw a rise of 1.04% to 5.4326.
    • USD/CAD (Canada) fell by 0.32% to 1.3690.
    • USD/ZAR (South Africa) declined by 2.21% to 17.9665.
  • Commodities:
    • Crude oil prices rose by 2.68% to $80.59 per barrel.
    • Nickel dropped by 2.18% to $1,473.80 per ton.
    • Zinc saw a gain of 2.36% to $2,861.00 per ton.
    • Gold fell slightly by 0.44% to $2,321.96 per ounce.
  • Cryptocurrencies:
    • Bitcoin fell by 3.01% to $63,996.11.
    • Ethereum increased slightly by 0.94% to $3,506.53.
  • Other:
    • VIX remained stable at around 13.
    • Equal-weighted S&P (RSP) outperformed the S&P500 (SPY) by 85 bps
    • Financial conditions continue to ease Chicago Fed’s NFCI, falling to -0.5807

 

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AI’s Impact On Energy Demand

“Energy is the golden thread that connects economic growth, social equity, and environmental sustainability.” – Ban Ki-moon

The rise of artificial intelligence is now turbocharging demand for bigger data centers……The almost overnight surge in electricity demand from data centers is now outstripping the available power supply in many parts of the world, according to interviews with data center operators, energy providers and tech executives. That dynamic is leading to years-long waits for businesses to access the grid as well as growing concerns of outages and price increases for those living in the densest data center markets….By one official estimate, Sweden could see power demand from data centers roughly double over the course of this decade — and then double again by 2040. In the UK, AI is expected to suck up 500% more energy over the next decade. And in the US, data centers are projected to use 8% of total power by 2030, up from 3% in 2022, according to Goldman Sachs, which described it as “the kind of electricity growth that hasn’t been seen in a generation.”

…Globally, there are more than 7,000 data centers built or in various stages of development, up from 3,600 in 2015…These data centers have the capacity to consume a combined 508 terawatt hours (THh) of electricity per year if they were to run constantly. That’s greater than the total annual electricity production for Italy or Australia. – Bloomberg

The average American home uses 30 kilowatt-hours (kWh) of electricity per day, totaling about 900 kWh per month and approximately 10,800 kWh per year. However, the power demand can increase significantly when multiple appliances are used simultaneously.

One terawatt-hour (TWh) of electricity can fully power 70,000 homes for a year, light over one million homes, or cool 500,000 homes for a year. A TWh is a unit of energy equal to one trillion watt-hours, or one billion kilowatt-hours. It is often used to measure large amounts of electricity or heat.

  • Watt (W): A small unit of power. For instance, a small LED light bulb might use about 5 watts of power.

  • Kilowatt (kW): 1,000 watts. Household appliances are usually rated in kilowatts. For example, a typical microwave oven might use around 1 kW of power.

  • Megawatt (MW): 1,000 kilowatts or 1 million watts. Power plants are often rated in megawatts. A large wind turbine might have a capacity of around 2 to 3 MW.

  • Gigawatt (GW): 1,000 megawatts or 1 billion watts. Entire electrical grids or major power plants are sometimes rated in gigawatts. For example, the Hoover Dam has a capacity of about 2 GW.

  • Terawatt (TW): 1,000 gigawatts or 1 trillion watts. Terawatts are used to measure total energy consumption or production on a national or global scale. For instance, the total electricity consumption of the entire United States in 2021 was about 4 terawatt-hours (TWh) per day, which averages out to a continuous power consumption of about 167 TW.

  • Terawatt-hour (TWh): A unit of energy equal to one trillion watt-hours, or one billion kilowatt-hours. One TWh can power 70,000 homes fully for a year, light over one million homes, or cool 500,000 homes for a year.

A terawatt (TW) and a terawatt-hour (TWh) measure different aspects of energy. A terawatt is a unit of power, representing the rate at which energy is used or produced at a specific moment; for instance, a power plant operating at a capacity of 1 TW is producing one trillion watts of power continuously. On the other hand, a terawatt-hour is a unit of energy, representing the total amount of power consumed or produced over time; for example, if that power plant operates at 1 TW for one hour, it will generate 1 TWh of energy. In essence, terawatts measure power (instantaneous rate), while terawatt-hours measure energy (accumulated usage over time).

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R.I.P. #24

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Follow The Capital Flows

According to IMF data reported by Bloomberg News, despite global calls to diversify away from the dollar, the U.S. has attracted a significant share of international investment post-Covid. The U.S. share of global investment flows rose from 18% pre-pandemic to one-third recently, driven by high U.S. interest rates and incentives for renewable energy and semiconductor production under President Biden. In contrast, China’s share has significantly declined. However, potential changes in U.S. policy and interest rates could impact these trends.

Key Points:

  • U.S. investment share increased from 18% pre-Covid to about 33% recently.
  • High U.S. interest rates and Biden’s economic initiatives have attracted significant foreign direct investment.
  • China’s global investment share has halved since the pandemic.
  • Potential policy reversals in the U.S. and lower interest rates could change investment dynamics.
  • Emerging markets are struggling, receiving minimal capital inflows.
  • Significant investments in the U.S. include Samsung’s $6.4 billion grant for chip production in Texas.
  • Concerns about U.S. political stability and fiscal health could affect future investment attractiveness.

Source:  Bloomberg.

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