📈 S3T May 17, 2024 - Market ATHs don't match reality, GenAI prompting goes next level, 25M Eth hack, Pricing Power, Perennial Inflation

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In this edition of S3T:

• 📈 Markets Surge on Inflation News: A 0.1% drop in inflation sparks a bull run, with traders optimistic about potential interest rate cuts.
• 📉 Contrasting Realities: Concerns remain with predictions of more inflation, declining office space, and financial struggles for Amazon workers.
• 🏠 Real Estate Woes: Issues of affordability and racial bias persist, while real estate TV glamorizes the market.
• 🧠 AI Innovations: OpenAI's GPT-4o and Google's Project Astra introduce advanced multimodal AI capabilities, changing how we interact with technology.
• 🌍 Climate Change and AI: Researchers explore AI to combat drug-resistant pathogens accelerated by climate change.
• 📊 Corporate Pricing Power and Inflation: Understanding how companies' ability to raise prices without losing customers contributes to perennial inflation and challenges affordability, highlighting the need for leaders to align their actions with their commitments to financial equality.

Opinions expressed are those of the individuals and do not reflect the official positions of companies or organizations those individuals may be affiliated with. Not financial, investment or legal advice. Authors or guests may hold assets discussed.

0.1% Drop in Inflation Sparks ATHs

Markets hit new all time highs this week as the headline inflation rate fell to 3.4% in April (from 3.5% in March - doesn't take much to get this market excited). Traders assume this means interest rates will come down and everything will be fine. Meanwhile, back in reality:

• JPMorgan chief Jamie Dimon worries there's more inflation on the way.
• Manulife sees a 40% decline in US office space, and Starwood's REIT heads for insolvency as investors continue to pull their funds out. Just more signs the return to office campaign isn't saving commercial real estate - in spite of local governments offering incentives to corporations.
• Amazon warehouse workers still struggle to afford the basics, 5 years after Amazon raised wages to $15hr, per this new study by the University of Illinois CEUD.
• Debra Kamin who uncovered widespread racial bias in the real estate appraisals, notes in her latest piece Real Estate Fantasies that just at a time when housing affordability is at its worst, people are being lured into the dream world of real estate TV.

To understand the paradox of euphoria and gloom, see the special Change Leadership feature below explaining headline vs perennial inflation, and how pricing power contributes to perennial inflation.

GPT-4o will change the nature of prompting

On May 13, OpenAI rolled out GPT-4o (the letter "o" for "omni"). The new model can converse using speech, emotional cues and visual inputs - processing real time audio, vision and text via one neural network, for example:

• use a phone's camera to read a math problem on a piece of paper, then tutor a person through the steps to solve the problem.
• read code and then talk a person through what it does.

To see examples, go to the OpenAI Spring Update video on this page...the math problem starts about 13:30, the code review starts around 18:00.

A Macbook desktop version is promised, as of May 16 it was not yet on the Apple Store - but a lot of copycats were. But you can start using GPT-4o in ChatGPT now.

Google Project Astra

Google also announced a multimodal AI assistant - something it calls Project Astra. See videos with examples of Astra on the announcement page. Google says "some of these capabilities are coming to Google products, like the Gemini app and web experience, later this year."

☣️ Climate change is accelerating the spread of drug-resistant pathogens - can AI help?

🌡️ Climate change with its increasing rates of flooding and warmer temperatures will encourage the spread of drug resistant infections even further. This has prompted researchers to look for ways to apply AI to this problem space. Governments and global policy makers should get ready for drug resistance outbreaks as global temperatures rise. Recognize the connection, invest in research that proves out feasible options for prevention and management.

🔦 The $25M Ethereum Hack puts MEV in the spotlight

In 2022, two brothers took advantage of a flaw in open source trading bots and tricked them (and traders) into actions that netted the brothers $25M in less than 15 seconds. This week the Justice Dept. announced charges against the brothers and released a statement along with the formal indictment (PDF) which provided technical details on the exploit.

Coindesk reached out to the Ethereum community and got these insights on what exactly this means for Ethereum and crypto security.

Takeaways for security and compliance leaders

• Don't interpret this as an issue with Ethereum's security - this is more about an arcane aspect of blockchain settlement: the Maximum Extractable Value (MEV) that miners/validators use to maximize their profits. The practice has been controversial but tolerated since the amounts extracted are usually small. Explainer here.
• This exploit was possible because of a flaw in an open source bot. Open source is awesome, but if you're running it as part of a platform that handles money or impactful decisions, assume it has flaws that will be eventually exploited unless you take steps such as: limiting access, monitoring, and reviewing/certifying with extreme suspicion.

Understanding the Challenges to Affordability: Headline vs perennial Inflation

Most companies have a mission statement or policy stating their commitment to affordability and financial equality for their customers and for society as a whole. Yet few leaders have a clear understanding of how their decisions may be working in opposition to their stated aims.

Corporate pricing power is a key contributor to perennial inflation

Pricing power refers to a company's ability to raise prices without losing customers. While this can drive profitability, it often contributes to inflation and affordability issues. Understanding the different types of pricing power and their impact is crucial for leaders, especially in regulated industries.

In recent years, at long last, there has been a growing realization that corporate profits are a primary driver of inflation today. So why have establishment economists had a long history of scapegoating wage earners rather than corporations? Because in the words of this economist: “we don’t have as much and as good data on profit as we do on wages.”

Types of Pricing Power

1. Industry Monopolies: These are the traditional monopolies we usually think about - railroads, energy companies, or other conglomerates that control or gatekeep large portions of the market, limiting competition and enabling price control.
2. Branding Monopolies: Companies like Apple and Microsoft may leverage strong brands to command higher prices. Customers perceive their products as superior, allowing these companies to maintain higher price points without significant loss in sales.
3. Platform Monopolies: Technology giants such as Amazon and Google create ecosystems that lock users into their platforms. This integrated environment makes it difficult for customers to switch to competitors, thus allowing these companies to increase prices with less concern about losing customers to lower priced competitors.
4. Regulatory Monopolies: This is the one that is too often overlooked. Regulatory monopolies occur when regulators and regulated companies over time evolve a complex set of regulations that make it difficult for more efficient innovators to enter the market, and that enable encumbents to justify bloated org and cost structures.

Regulatory Monopolies and Their Impact

Regulated industries, such as banking, healthcare, and utilities, often see regulatory bodies enforcing complex rules. This complexity acts as a barrier to entry for newer, potentially more efficient competitors. When regulators and regulated entities develop a symbiotic relationship, it enables a regulatory monopoly that sustains high prices and inefficiencies.

For instance, the interaction between the SEC and the cryptocurrency industry illustrates how regulators can hinder innovation. The SEC's stringent and often unclear regulations has created obstacles for new entrants, preserving the market dominance of traditional financial institutions.

The Consequences of Regulatory Monopolies

1. Increased Costs: Regulatory compliance often requires significant resources, including extensive documentation and audits. These costs are passed on to consumers, contributing to higher prices.
2. Barrier to Innovation: New, efficient technologies and business models struggle to enter the market, stifling innovation and keeping prices high.
3. Bureaucratic Growth: Organizations in regulated industries tend to become bloated, as they absorb resources to comply with regulations. This leads to inefficiencies and higher operational costs.

To be clear: the answer here is not to do away with regulations and accountability. The answer is to find more efficient ways to be accountable and comply with the rules in a way that meaningfully benefits the customers and communities the regulations are suppose to protect, rather than simply benefitting process owners and their vendors.

Call to Action for Leaders

To address these issues, leaders in regulated industries must recognize their role in maintaining high prices and consider steps to mitigate this:

1. Streamline Compliance: Work with regulators with a mindset that seeks ways to fulfill regulatory requirements more efficiently. This could involve leveraging technology to reduce paperwork and improve processes. It could also involve talking through the specific outcomes that regulations are supposed to achieve, then looking at the most cost effective ways to ensure those outcomes.
2. Encourage Innovation: Work with regulators to create environments that support new entrants and innovative solutions. This could involve pilot programs or phased compliance introductions.
3. Foster Competition: Embrace competition as a means to drive efficiency and lower prices. This benefits consumers and enhances the overall market.
4. Engage with Regulators: Advocate for smarter regulations that achieve their goals without imposing unnecessary burdens. Collaboration can lead to more effective and efficient regulatory frameworks.

Summary

Most of us work with organizations who have mission statements that talk about benefits to customers, affordability, and equality. By recognizing the pricing power we have - especially if we are in a regulated industry - we can be on the lookout for cases where we are making decisions that oppose our stated mission.

Understanding and addressing the different types of pricing power, especially regulatory monopolies, is essential for tackling inflation and affordability issues. Leaders in regulated industries have a significant role in shaping a more competitive and efficient market. By streamlining compliance, encouraging innovation, fostering competition, and engaging with regulators, they can enhance customer loyalty, competitiveness, and their positive impact on communities.

Further reading

• Seller's Inflation University of Massachusetts Amherst study on what allows some firms to raise prices even in a time of crisis.
• McKinsey's playbook on leveraging Pricing Power to increase margins

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