Wednesday, 24 August 2016

Maslow's hierarchy of money

A new study shows that the form of shadow "money" used in US prisons is changing. For many years it has been cigarettes (tobacco), and to a lesser extent stamps and envelopes. But now it seems the popularity of these in the prison black economy is declining - in favour of food. Specifically, Ramen noodles, a high-calorie, substantial foodstuff.

Without examining the reasons for this change, it would be easy to assume that this is a matter of relative scarcity. Perhaps Ramen noodles are cheaper and more widely available than cigarettes, so inmates are turning to them because they are easier to obtain. If so, then Gresham's Law tells us that Ramen noodles would eventually become the principal medium of exchange. Cigarettes would gradually disappear from circulation, becoming an increasingly expensive store of value.

Of course, rich prisoners might worry that lack of demand for cigarettes would reduce their value - after all, if you can't sell your ciggies, you might as well smoke them. So they might hoard Ramen noodles in order to restrict the amount in circulation, or they might try to force up the value of Ramen noodles by artificially pinning their price to cigarettes. We might end up with something akin to a bimetallic standard, with Ramen noodles being the "silver" used by the poor and cigarettes becoming rich prisoners' "gold".

This would create hardship for poorer prisoners, some of whom would be unable to obtain the noodles needed to buy other near-essential goods such as hygiene products. Perhaps there might be some enlightened prison officer who would deliver an inflammatory speech demanding the free circulation of Ramen noodles. "You shall not crucify prisoners on a cross of cigarettes"......

Alternatively, prisoners could be taking to Ramen noodles because they are all giving up smoking and want a new, healthier type of money. "Maybe Ramen noodles are the prison equivalent of Bitcoin", said one bright spark on Twitter.

Umm, no. The change is being driven by a fall in supply, not demand. And it is not the supply of cigarettes that is falling. According to Michael Gibson-Light, the author of the new study, the change is caused by deterioration in the supply of food:
"Prisoners are so unhappy with the quality and quantity of prison food that they receive that they have begun relying on ramen noodles -- a cheap, durable food product -- as a form of money in the underground economy," he said. "Because it is cheap, tasty, and rich in calories, ramen has become so valuable that it is used to exchange for other goods."
The US's prisons are overflowing with people, as politicians insist on more and longer prison sentences. But the funds to run the prisons are not keeping pace with the increase in inmates. Consequently, prisons are being forced to cut back on basic provisions, such as prisoners' food.

So the change in prisons' "shadow money" is being driven not by Gresham's Law, but by Maslow's hierarchy of needs. The lowest level on Maslow's hierarchy (see the image at the head of the post) is physiological needs - air, food, water, shelter, warmth, excretion.* Inadequate food within US prisons has financialised prisoners' physiological needs. It has turned food into money.

Tobacco addicts may claim that they have a physiological need for a smoke, but the widespread substitution of Ramen noodles for cigarettes suggests that for most prisoners, the need for tobacco is higher order. It is easy to see that stamps and envelopes belong in the "love and esteem" section, since they enable prisoners to communicate with family & friends. But where does tobacco fit in? Perhaps there is a hierarchy within a hierarchy, a relative ranking of physiological needs. Tobacco is only a driving physiological need until a greater need shows up.

There is of course a positive effect from this change. If cigarettes will no longer be so freely available, fewer prisoners will smoke them. But against that we must put the health effects of restricting food. What kind of society is it that will provide so little food to prisoners that a black market food supplement becomes money?

Food, of course, does not only feature at the physiological level. Few would argue that caviar and truffles are a physiological need: they belong in the "esteem" section, three levels higher. And in some forms of "self-actualisation", food intake can be severely restricted - ideological veganism, for example. Food features at every level of the hierarchy. And so does money, in one form or another. Money is the facilitator, the means by which people are able to meet their needs, including many of their higher-order needs: after all, self-actualisation is a bit irrelevant when you don't have food or shelter, and relationships can be broken beyond repair by failures at the physiological or safety level.

But Maslow's hierarchy applies to the individual, whereas what constitutes "money" is a collective decision. As Hyman Minsky said, anyone can create money, the problem is getting others to accept it. Money is a social construct. And yet - just as in Maslow's hierarchy, lower-order needs drive out higher-order ones, so when a whole community is distressed, lower forms of money drive out higher ones. Silver replaces gold, paper replaces silver....but when people are starving, gold, silver and paper become worthless, and food becomes money. We can, in a way, regard Gresham's Law as the social equivalent of Maslow's hierarchy.

This touches on fundamental questions about the nature of money. Food-as-money works for those who need food: inflation is benign, since it ensures that all those who want food can have it. Grain standard currencies are very good for agricultural communities, since they ensure that the price of food naturally adjusts to production and wide fluctuations in food prices are avoided. But for those who want to save for the future, food-as-money has serious downsides, including the fact that it can be eaten. When times are hard, the temptation to eat the money and leave nothing for the future can be very high. You can't eat metal or paper.

There is a vast ideological gulf between those who regard money as primarily a store of value, and wish to fix its supply to prevent the value falling, and those who regard money as primarily a medium of exchange, and wish its supply to respond flexibly to demand. In choosing Ramen noodles over cigarettes, it seems that prisoners prefer to regard shadow "money" as a medium of exchange.

But it is early days yet. There may still be a backlash from those rich in cigarettes. And you never know, they might even start using Bitcoin.

Related reading:

The nature of money
The golden calf
Ultra-liquidity - Pieria

Image from Wikipedia.

* The image at the head of the post shows sex as a physiological need, but this is disputed.

Sunday, 21 August 2016

The art of economics

Collected here are my posts about the changing nature of economics. Olivier Blanchard says "there is room for art as well as science". In these posts, I develop the concept of economics as art: vague, conceptual, imaginative, complex, and subjective. In other words - human.

I should make it clear that I am mainly talking about macroeconomics, although microeconomics is also changing for other reasons.

The problem of mathematics
When the Nile floods fail
The failure of macroeconomics
The necessary arrogance of elites
Spurious precision
No, please don't show me your model

Friday, 19 August 2016

No, please don't show me your model

Unsurprisingly, on my post "The Art of Economics", which attempted to put the mathematical models beloved of mainstream economics firmly in their place, is a comment defending mainstream mathematical models. Here it is, in part:
Secondly, you definitely don't need obscure heterodox models to predict a financial crisis. I've cited it before, but for instance Kiyotaki-Moore basically sketches out how a crisis like this can occur. There are actually plenty of examples of perfectly fine mainstream papers on this topic. And it wasn't just heterodox economists that predicted it. People like Dean Baker, Roubini or even Krugman didn't exactly rely on post-Keynesian or Minskyian economics, their logic was fairly straight forward. Stiglitz has some great models on bank failure, which are essentially mainstream info-asymmetry economics. I also think Minsky is useful but not that useful, and it's not especially scientific. He doesn't really have any kind of model, he just essentially asserts that banks will turn to speculators (and also made a lot of mistakes with regards to importance of credit cards, diminishing importance of large infrastructure loans etc..) The mechanisms aren't adequately explained. At least the Austrians, who I definitely oppose, have a mechanism for how banks turn to unstable speculators - aggressive monetary policy. 
This is bad science of the "show me your model" variety. A mathematical model may give apparently accurate results, but that does not mean it has the right theoretical foundations. Valuing the model over the theory was lampooned by the great physicist Richard Feynman, in this lovely metaphor:
[Feynman] imagines a Mayan astronomer who had a mathematical model that perfectly predicted full moons and eclipses, but with no concept of space, spheres or orbits. Feynman then supposes that a young man says to the astronomer, “I have an idea – maybe those things are going around and they’re balls of rock out there, and we can calculate how they move.” The astronomer asks the young man how accurately can his theory predict eclipses. The young man said his theory wasn’t developed sufficiently to predict that yet. The astronomer boasts, “we can calculate eclipses more accurately than you can with your model, so you must not pay any attention to your idea because obviously the mathematical scheme is better.”
In dismissing Hyman Minsky's hypothesis because the model was incomplete, my commenter has behaved like Feynman's Mayan astronomer. Never mind the theory, show me your model....

So, let's look at the mainstream model recommended by my commenter. Like all (yes, I mean all) pre-crisis economic models, Kiyotaki-Moore does not model the financial sector accurately - in fact it does not model it at all. And because of this, it models a financial crisis as starting with some kind of exogenous shock coming out of the blue, in this case a temporary shock to productivity. The model is a farming model, so a productivity shock of this kind might be an adverse weather event, perhaps.

Now, there may indeed be a shock that triggers a financial collapse, but it is not necessarily exogenous. In 2008, it was the fall of Lehman Brothers, which was by any reasonable standards an endogenous shock: similarly in 2007, BNP Paribas's announcement that it could not value subprime MBS, was an endogenous shock. Do endogenous shocks have different effects from exogenous ones? We do not know, and the model does not tell us.

But in the absence of any model explaining how debtors become fragile, we can have no reason to assume that ANY shock, exogenous or endogenous, would have destructive effects. Indeed Kiyotaki-Moore themselves say this is a weakness in their model:
A weakness of our model is that it provides no analysis of who becomes credit constrained, and when. We merely rely on the assumption that different agents have different technologies. 
"Different technologies". What a get-out line. But if you exclude the financial sector from your model, that's the kind of blanket excuse you end up with.

If your model cannot explain how people and corporations become over-leveraged and therefore fragile, it can have no predictive power whatsoever. All it can do is say "IF people/businesses are over-leveraged when a shock hits, THEN this is likely to be the effect". So Kiyotaki-Moore can neither explain nor predict a financial crisis. It merely describes how an (unexplained) shock propagates itself through an (unexplained) over-leveraged population, with long-lasting negative effects. That is useful, of course - in fact I think this model does a pretty good job of explaining the amplifying effect of collateral price falls in debt deflationary collapses. But that isn't what my commenter claimed it did.

Let me be clear. I don't have a problem with mathematical models, as long as they use appropriate mathematics and have a sound theoretical basis. But we have to respect their limitations. They don't necessarily adequately explain economic events, let alone reliably predict them. And they are never a substitute for logical thought. .

So I don't want you to show me your model. I want you to explain your thinking. What is your theory, and how have you defined it? What thought processes brought you to this point? What are your assumptions, and how have you justified them? If you cannot explain these in words, then however clever your mathematics, your model is devoid of substance. Throw away your Greek dictionary, and write me an essay in plain English.

Related reading

Photo of Richard Feynman from

Thursday, 18 August 2016

Spurious precision

Over at Bloomberg View, Noah Smith has a pop at what he calls “heterodox economics”. By this he means the new ideas in economic thinking that have sprung up since the 2008 financial crisis but so far haven’t made it into mainstream economic journals.

Noah starts by admitting that mainstream economics abjectly failed to predict the crisis and gave little or no guidance on how to deal with it. Because of this, according to Noah, “many people have looked around for an alternative paradigm -- a new way of thinking about macroeconomics that would have allowed us to avoid the pitfalls of the Great Recession.”

Indeed they have.  Though some of the ideas are not so new – Hyman Minsky’s “Financial Instability Hypothesis”, for example, dates back to 1992.

According to Noah, the search for alternative thinking inevitably attracted people who – for whatever reason – “felt shut out” of the mainstream. And as an example of one of these so-called “heterodox” economists, he cites me. Here’s Noah's quotation from my post “The necessary arrogance of elites”, together with his introduction to it:
Many among the heterodox would have us believe that their paradigm worked perfectly well in 2008 and after. As an example, take a recent blog post by British economics writer Frances Coppola. Coppola likens mainstream macro to classical music, which walled itself off from the innovations of rock and jazz. Like the musical innovators of the 20th century, she claims, the heterodox have found something that works better than the ossified old ways of the elite:
Heterodox economists working in the real economy –- many of them untrained in formal economics –- not only predicted it but correctly identified the causes …
The redefinition of the foundations of economics that is currently being done by heterodox economists will inevitably result in many of the models beloved of academic economists becoming obsolete.
(The post from which these quotations are taken was actually written in 2012. It was reprinted recently by Evonomics under the title “What UnpopularMusic Can Teach Us About The Future of Economics”.)

The paragraphs from which Noah has taken these quotations actually say the exact opposite of what he claims. Here they are, in full:
And as with “serious” music, when economics becomes so divorced from reality that it fails adequately to explain the real world in which people live, people reject it. People rightly ask why academic economists failed either to predict or adequately explain the financial crisis, whereas heterodox economists working in the real economy – many of them untrained in formal economics – not only predicted it but correctly identified the causes. There is a real danger that the anger people feel over what they see as the failure of mainstream economics leads to rejection of mainstream economics in its entirety and, importantly, withdrawal of funding for academic economic research. This, I feel, would be a mistake.
We may not see the relevance of dynamic stochastic general equilibrium models in a world which manifestly is not in equilibrium. But that doesn’t mean that these, and other mathematical models, have nothing to contribute. The redefinition of the foundations of economics that is currently being done by heterodox economists will inevitably result in many of the models beloved of academic economists becoming obsolete: as with much of the experimental serious” music of the 20th century, they will not survive the test of time. But there will be models that remain relevant, and there will be others that appear obsolete but that will in due course be redeveloped and find new life in the new economic paradigm. If we allow them to disappear, our economic understanding in the future will be the poorer.
Contrary to the impression Noah gave, I was defending mainstream economics and its beloved mathematical models. But not because they have done a good job – they have not. And not because economics does not need a different paradigm. It does, desperately. Noah’s arrogant defence of mainstream economics shows this more clearly than anything the heterodox community could say.

We who live through this paradigm shift have a blinkered and biased view, rendering us unable to see the true value of either the old or the new. We either defend the old and reject the new, because the old is all we know and the new has yet to prove itself; or we reject the old and defend the new, because the old has failed and we need something to believe. These are, of course, extremes. The eventual synthesis will include elements of both old and new. In what proportions, history will decide.

And this brings me to my fundamental objection to Noah's post.

Noah's core proposition is that economics has no validity unless it is expressed in mathematical terms. He says that economics without mathematics doesn’t add up. But economics consisting entirely of mathematics doesn’t add up either. Exclusive reliance on mathematics as language is highly problematic, and not just because it inevitably creates a protected elite. It is because of the impossibility of precision. To explain this, here is another musical analogy.

Anyone who has ever attempted to write down, in conventional musical notation, exactly what a jazz singer does knows how imprecise and inadequate musical notation is. Yet when it is removed from the source and viewed academically, it creates a kind of spurious precision. The original intention is demeaned and deformed to fit into the straitjacket of the notation, and the notation then “becomes” the music. Gifted performers, of course, interpret the music from the notation – but in bringing it to life, they re-create imprecision.

So too, relying on mathematical models to explain how our complex, ever-changing world works demeans and deforms it. The more precise a model is, the more unrealistic assumptions have to be made to make it work, and the less likely it is to be an adequate representation of reality. Reality is imprecise and transient.

The great economists of the past knew this - which is why we do not find pages of Greek symbols even in the writings of those who, like John Maynard Keynes, were fine mathematicians. And some members of the mainstream are beginning to realise that economics is much bigger than their beloved DSGE models. Olivier Blanchard, for example, recently called for a more diverse range of models, including "ad hoc" schematics that have little precision and much imagination. "There is room for both science and art", he said. Though he can't quite let go of the DSGE dream, not yet......

Noah's post unfortunately seems to have elicited some rather defensive responses from the heterodox community, along the lines of “But we DO like mathematics!” or even, “Actually our mathematics is better than yours”. But this is to buy into Noah's core proposition. The heterodox economics community should - and, to be fair, in most cases does - reject it outright. Economics is not, and cannot be, exclusively mathematical. This is the terrible mistake that the mainstream economists of our time have made.

The spurious precision of mathematics led "serious" music down the blind alley of serialism. And it has led mainstream economics down the blind alley of general equilibrium. I defend DSGE models, yes, but for their future possibilities, not for their current application.

There is no need for the heterodox economic community to be defensive about vagueness. Vagueness is creative, and imprecision and ad-hocery are the future. The art of economics is being reborn.

UPDATE: I have removed from this post five bullet points which were intended as a very brief summary of Noah's post, and reorganised the post to compensate. Noah says that they are not what he meant, and I respect that. And anyway, they are a distraction from the core argument of this post.

Related reading:

Where danger lurks - Olivier Blanchard
Colds, strokes and Brad Delong
The Slowly Changing Resistance of Economists To Change - Steve Keen (Forbes)

Image from Sibelius.

Tuesday, 9 August 2016

Birth of a bank

I have been following with some amusement the death and resurrection of the Bitfinex exchange. Bitfinex was forced to suspend trading after losing nearly 120,000 BTC in a hacking on 2nd August. But instead of going into liquidation, as we might expect, it reinvented itself - as a bank.

Bitfinex had been doing bank-like things ever since its creation in 2012. It accepted deposits from some of its customers, and lent out those deposits to other customers - with the depositors' permission, of course. However, as long as customers controlled their own wallets, and default by a borrower rebounded directly back to the lender, Bitfinex could simply call itself an exchange, or a peer-to-peer lending platform.

Bitfinex kept customer money in individual wallets under lock and key - three keys, to be precise. Two of the three keys were needed for funds to be moved from the account (or two of three digital signatures, if you prefer).

One key was held by Bitfinex, and a second was held by a trusted custodian and signatory, Bitgo. For wallets containing borrowed funds and belonging to a US resident, the third key was held by the customer. For all other wallets the third key was held in cold storage under Bitfinex's control.

Clearly, since they did not control the keys, the customers did not have control of their funds. They could only move them by giving instructions to Bitfinex or Bitgo. But Bitgo would only operate its key on the instruction of Bitfinex: it would not accept separate instruction from the customer. So in practice, customers could only move their funds if they instructed Bitfinex to do so. This is already looking much more bank-like, isn't it?

But wait. Bank deposits are loans to banks, and depositors are senior creditors. In the event of insolvency, senior creditors are only entitled to a share of the assets - they don't have an automatic right to recovery at par. This applies even for insured deposits, since insurance is separate from the liability itself. In insolvency, all depositors may take a haircut - but insured depositors are then made good by their insurance. In conventional banking systems, deposit insurance is a public good, though it may be limited to smaller deposits. It exists primarily to prevent bank runs, and secondarily to mitigate the damaging effects of bank failures on more vulnerable people.

In contrast, in a custodian system, customers have not lent their money - they have placed it in a safe deposit box. They have every right to expect that even in the event of insolvency, their money is safe. This is why regulators like the CFTC insist that client money must be segregated from the broker's or exchange's own money. Losses must be born by shareholders and creditors, not by customers.

Bitfinex's system was supposedly custodian. But the fact that customers did not have control of their own funds suggests that it was not. After all, who ever heard of a safe deposit box to which the customer can only gain access with custodian permission, but custodian staff can raid at will?

And raid it they did. No, I don't mean the hacker - though that was a raid on certain customer accounts. I mean Bitfinex management.

Following the theft, Bitfinex management decided unilaterally to "socialise losses". It imposed a 36.067% haircut on all customer balances. It also turned out that Bitgo, the custodian, had no insurance against customer losses. So all customers suffered a loss. In effect, Bitfinex management raided customer deposit boxes to cover the exchange's losses. Importantly, they did so WITHOUT customer agreement. They treated depositors as if they were lenders to the exchange itself, not lenders to other customers.

On the borrowing side, Bitfinex does not allow customers to withdraw funds from their wallets until all borrowings have been cleared. It does not allow them to borrow more than 70% of the value of a short sale. And it will forcibly liquidate balances in order to settle loan obligations.Yet even with such coercive provisions, it seems that Bitfinex was in the habit of absorbing loan defaults rather than passing them on to the lending customers. So it also treated borrowers as if they were borrowers from the exchange itself, not from other customers.

It's all looking highly bank-like, isn't it? But wait. We have credit intermediation and maturity transformation, true. But for Bitfinex to be a bank, not just a peer-to-peer lender, we need a third element. Fractional reserve lending - or as it should be called, money creation.

As long as Bitfinex was only trading existing currencies, there was no fractional reserve element. Deposits were lent out to borrowers, and no money was created. But that has all changed now. As part of the bail-in of depositors, Bitfinex created its own currency.

The haircut of customer balances exchanged existing currencies (which Bitfinex can't create, but needs in order to settle its debts) for newly created "tokens" called BFX. These bear no interest, are pegged at par to the US dollar, and will (hopefully) be tradable. They have no maturity date, but they can be redeemed by their originator. So they are zero-coupon, perpetual, callable debt securities. Possibly, in the future, they could be shares.

Now, let's remind ourselves of the characteristics of a fiat currency. Fiat currency consists of "tokens", which usually bear no interest* but are tradable. The tokens have no maturity date, but can be called in by the issuer at any time. So fiat currencies are zero-coupon, perpetual, callable - well, are they debt securities, or are they equity shares?

But, I hear you say, fiat currencies are produced by central banks out of thin air, aren't they?

No. They are created by banks. Any fractional reserve bank can create fiat currency. The vast majority of fiat currency in circulation is created by commercial banks in the course of lending. Most countries choose to restrict the issuance of notes and coins to central banks or government. But in Scotland and Northern Ireland, banks issue their own banknotes, which are pegged at par to sterling.

Bitfinex has been lending on its own account. I'm sorry, but it has. And now it is creating its own IOUs to cover the fact that it doesn't have enough reserves to meet its obligations. These IOUs are currently worthless, of course, since Bitfinex has currently no intention whatsoever of honouring the notional convertibility to US$. But the customers either have to accept them or force Bitfinex into liquidation - which would potentially leave them worse off. The best the customers can hope to do is create some value by sticking with Bitfinex and trying to create a market in BFX.

And of course, if they succeed, there will be absolutely nothing to prevent Bitfinex doing more own-account lending and issuing more BFX to fund it.

Bitfinex has become a bank.

Related reading:

You've been buttfinessed - BitMex Blog
I am a bank
The IMF proposes the death of banking
Of course Scotland can use the (Scottish) pound - Forbes

Image from Positive Money.  

* In fact many forms of fiat currency do bear interest. But of course Bitfinex could pay interest on its tokens. That wouldn't really make any difference to what is going on here.

Sunday, 31 July 2016

The WASPI campaign's unreasonable demand

As my readers will know, I have been watching the WASPI campaign with a growing sense of despair. Every attempt to find a realistic solution to their issue fails because it does not meet their demand for "fair transitional arrangements". But they have steadfastly refused to say what "fair transitional arrangements" are - at least publicly.

The 1995 Pensions Act included transitional arrangements. The rises in women's state pension age (SPA) did not start for 15 years after the Act was passed, so did not affect women born prior to April 1950. And women's SPA was to rise gradually from 60 to 65 over the course of 10 years, from 2010 to 2020. The 2011 Pensions Act accelerated the transition and added an extra year to the SPA for men and women born from 1955 onwards.

Like many, I think the 2011 Pensions Act was unfair, increasing the SPA for some women by up to 18 months ON TOP OF the 1995 Pensions Act rise, with very little notice. I support a campaign to have the 2011 acceleration relaxed or - ideally - overturned. Some might ask, therefore, why I oppose WASPI.

My opposition to WASPI stems from the fact that the co-founders are not fundamentally interested in the 2011 acceleration. Their target is the 1995 Act.

This was clear from their original "ask". And it is now abundantly clear that they have not deviated from that position. They have simply concealed it.

The WASPI "ask" originally posted on their FB page was this:

This was reiterated by Anne Keen, one of the five WASPI co-founders, in her verbal evidence to the WPSC in December 2015, a written transcript of which is in the public domain:
Basically, what we are asking—and we feel this is a very fair ask—is for the Government to put all women in their 50s, born on or after 6 April 1951 and affected by the state pension age in exactly the same position they would have been in had they been born on or before 5 April 1950. As Lin has touched upon, we have worked since we were 15 and we have built up over 40 years’ worth of National Insurance contributions now. All of our working lives we expected to receive our pension when we were 60. Nobody told us any different. Although there was not a written contract as such, there was a psychological contract. All of our working lives we were told, “You will get your pension when you are 60”.
But when Richard Graham MP and Baroness Altmann, among others, pointed out that this amounted to rolling back the 1995 Pensions Act, WASPI fiercely denied it, claiming that they were in favour of equalisation and did not want the 1995 Act overturned. All they wanted was "fair transitional arrangements" - whatever those are.

And we now know what those are. Yesterday, this was posted on the WASPI Facebook group:
Can we remind everyone of the specifics and objectives of our campaign which are clearly communicated on our web site (and in the wording of the petition):

"The Government must make fair transitional arrangements for all women (born in the 1950s) on or after 6th April 1951 who have unfairly borne the burden of the increase to the State Pension Age (SPA)". 

This is what the campaign is fighting for and will continue to fight for. However, other options are being suggested by supporters and MP's which are not in line with the aims of the WASPI campaign or the APPG. We can no longer tolerate individuals sending out mixed messages and compromises. Such a disunited approach is damaging and gives the government an opportunity to attack and oppose our campaign.

It should be noted that WASPI is the only campaign group for 1950s women to have achieved any level of success over the past year, with 4 debates in Parliament, 120+ supportive MPs, numerous votes of support from local councils, an ongoing petition, the APPG and the start of a mass complaint to the Parliamentary Ombudsman.

Anyone not agreeing with these objectives or wishing to pursue other goals or agenda will be invited to leave the WASPI Campaign.

Celia & Anne
 And this:
Some clarity from Anne Keen as to what transitional arrangements are being asked for;

Transitional Arrangements
There is still some confusion regarding our ask - "The Government must make fair transitional arrangements for all women born on or after 6th April 1951 who have unfairly borne the burden of the increase to the State Pension Age (SPA)"

So what do we mean by transitional arrangements?

Transitional, as the word implies, is an arrangement to move women from one stage to the next. In relation to our campaign we mean a financial arrangement to move them from the date when they expected to receive their State Pension (60 years) to their new State Pension age (for example, 66 years).

In this example, the woman concerned would need an income for 6 years from age 60 to 66 years to replace the expected State Pension income that has been lost. On reaching State Pension age, the transitional arrangement would cease and the woman would receive her State Pension in full. WASPI is also seeking financial recompense for “lost” state pension.  
Several options that reflect our aim and that of APPG have already been suggested:- Barbara Keeley’s bridge pension and Owen Smith 70% / 30% option (made to his constituents after the last debate) and the **JSA option encompass transitional arrangements i.e. to summarise, a reduced pension/payment made at aged 60 until the new SPA is reached, whereupon a full state pension will be made. WASPI are also seeking financial recompense, for 'lost" pension.  
Options mentioned by Owen Smith at the last debate were not transitional. Neither is the one suggested by Frank Field/Work and Pensions Select Committee.  
Many non-supportive MP's deliberately misconstrue our ask by saying we want the law reversing. We don't. We are campaigning for transitional arrangements as specified above that are not means tested. 
Unfortunately, the government have yet to acknowledge that we have been treated unfairly despite the fact that we are not asking for anything that we do not have a fundamental right to.  
* The APPG party has been formed to:- “To provide a cross-party forum in which to hold the government to account on the issue of transitional arrangements to compensate 1950s-born women who are affected by changes to the State Pension Age and to campaign on issues around the State Pension Age". 
**JSA rates from aged 60 until new SPA. Not means-tested and not subject to any JSA “conditions”.
I want to draw your attention to the following two clauses in the second post above, which I have highlighted: 

"...the woman concerned would need an income for 6 years from age 60 to 66 years to replace the expected State Pension income that has been lost."

 "WASPI is also seeking financial recompense for “lost” state pension."

These two together amount to a demand for the financial equivalent of full state pension from age 60 for all women born in the 1950s. The "income" may be less, but the "financial recompense" would top it up to the full amount. In other words, they add up to the original "ask" as explained by Anne Keen in her evidence to the WPSC, quoted above.

So this group of women is demanding special treatment. Effectively, they want the 1995 Pensions Act to apply to everyone except them.They are even happy for it to apply to some older women, since they specifically exclude those born April 1950-March 1951 from their campaign.

The essence of the WASPI campaign's case is that the DWP failed to inform 1950s women individually about the SPA rises in the 1995 Pension Act. This is true. But bad communication does not justify excluding 1950s women from the provisions of the 1995 Act. The most it might create is some moral obligation to provide targeted relief to women who face genuine hardship because they had expected to receive state pension at 60 and have no other possible source of income. Anything more would disadvantage younger women, who also suffer the effects of the 1995 Act and who also did not receive (and in most cases still have not received) individual communications about SPA rises. And it would add to the burden of unaffordable payments to older people that younger generations must support. It would be wholly unfair and highly regressive.

When I pointed out that their demand would impoverish younger women who are at least as badly affected by the 1995 Act as they are, WASPI laughed it off, suggesting that those women should "start their own campaign". And when I suggested that uprating working-age benefits such as JSA and ESA would support those women who are genuinely facing hardship, they dismissed this as unacceptable because many of them would not qualify for assistance. They reject out of hand realistic proposals that would genuinely help women in difficulty, because that would mean no money for the rest of them. They are staggeringly selfish and greedy. They would be better named GRASPI than WASPI.
Now we know what the WASPI campaign's demand really is, we can reject it with a clear conscience. So let's focus on overturning the unfair 2011 Pensions Act, shall we? And ending the brutal sanctions regime for JSA and ESA? And stopping the cuts to working tax credits?
Good, that's settled then.
Related reading:

What WASPI really want - the WASPI ask in full - Cash Questions
The angry WASPIs
Here I stand, I can do no other
What they really want
Kafka at the DWP

Image from

Friday, 29 July 2016

Bitcoin's security pricing problem

I can't resist this.

Blithely ignoring the utter mess he and his developers have managed to make of the cryptocurrency Ethereum, Vitalik Buterin has written a post on inflation and monetary policy. Wow. Is there no end to his talents?

In this case, there is most definitely an end. Economics 101 is the end, pretty much. I don't claim to be the world's greatest economic expert - not by a LONG way - but the errors in this piece leapt out at me. 

Firstly, inflation. Here is Buterin on inflation:
The primary expense that must be paid by a blockchain is that of security. The blockchain must pay miners or validators to economically participate in its consensus protocol, whether proof of work or proof of stake, and this inevitably incurs some cost. There are two ways to pay for this cost: inflation and transaction fees. Currently, Bitcoin and Ethereum, the two leading proof-of-work blockchains, both use high levels of inflation to pay for security; the Bitcoin community presently intends to decrease the inflation over time and eventually switch to a transaction-fee-only model.
Inflation? Really? The cryptocurrency whose adherents promote it as the world's greatest ANTI-inflationary currency is suffering from inflation? Surely not!

Definitely not. Let's remind ourselves of the economic definition of inflation. Since Buterin seems to like referencing Wikipedia, this is Wikipedia's definition:
In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money - a loss of real value in the medium of exchange and unit of account within the economy.....The opposite of inflation is deflation. 
So, if Bitcoin is inflating, it should be buying less of whatever is purchased with it. Bitcoin can be used to purchase some goods and services, but as it is not yet widely accepted as a medium of exchange (MOU), the best way of establishing its purchasing power is to look at its exchange rate to a widely accepted MOU, such as the US dollar. This is BTCUSD over the last year:

That is an appreciating currency. Each unit of BTC now buys more USD than it did a year ago - rather a lot more, actually. Which means that each unit of BTC buys more goods and services than it did a year ago. Were the prices of goods and services quoted in bitcoins, we would see price falls, not rises. This is deflation, not inflation.

So if Bitcoin is deflating, not inflating, what on earth does Buterin mean when he says that Bitcoin is paying for security through inflation?

He does not mean economic (price) inflation. He means MONETARY inflation - sustained expansion in the supply of money. Bitcoin has a hard limit on the number of bitcoins that can ever be mined, but it is nowhere near that limit. At the present time, the supply of bitcoins is expanding at the rate of 12.5 every 10 minutes.

What Buterin means by "inflation" paying for security is that Bitcoin miners are rewarded for their validation of transactions by being given additional bitcoins, created "ex nihilo" as a result of their work ("proof of work") - which in practice means their expenditure of energy in validating transactions back through the chain.

Now, we can argue about whether monetary inflation matters, and if so to what extent. In economic circles, the jury is out on this, but Bitcoin is ideologically driven by hard-money Austrian principles, so we might expect that its adherents are very concerned to limit the supply of money. But my objection here is to simple sloppiness in terminology. When people say "inflation", they generally mean price inflation. So if you mean monetary inflation, Vitalik, say so.

Ok, so we've cleared that up. Now on to my main objection to this piece.

Buterin is essentially discussing the relative merits of two different ways of paying miners for the validation of transactions: additional bitcoins, or transaction fees. There is a lot of geekery here, so I'm going to do my best to translate.

When Bitcoin reaches its hard limit on the supply of bitcoins, all future transaction validation will be rewarded with transaction fees, not additional bitcoins. Personally I am of the opinion that the switch to transaction fees might occur before then, since the cost of mining additional bitcoins will rise exponentially as the hard limit is approached, making it prohibitively expensive to mine them - this is a fine example of the law of "diminishing returns". But I could be wrong. Anyway, the point is that unless the Bitcoin community agree to raise the limit - which is the subject of fierce dispute at present - at some point Bitcoin will switch to a transaction-fees-only reward model.

Buterin's concern is that in a transaction-fees-only model, the fees need to be set high enough to discourage malicious operators from taking over the network by making miners offers they can't refuse. How much would it cost to take over the entire network? Buterin has some ideas:
Hence, we have $1.2-4m as an approximate estimate for a “Maginot line attack” against a fee-only network. Cheaper attacks (eg. “renting” hardware) may cost 10-100 times less. If the bitcoin ecosystem increases in size, then this value will of course increase, but then the size of transactions conducted over the network will also increase and so the incentive to attack will also increase. Is this level of security enough in order to secure the blockchain against attacks? It is hard to tell;it is my own opinion that the risk is very high that this is insufficient and so it is dangerous for a blockchain protocol to commit itself to this level of security with no way of increasing it.
Translation: in a proof-of-work system, imposing a hard limit on the number of coins in existence is a VERY silly idea. (Bitcoin enthusiasts will no doubt disagree.)

Of course, Ethereum's proof-of-stake (investment) is MUCH better, natch:
In a proof of stake context, security is likely to be substantially higher. To see why, note that the ratio between the computed cost of taking over the bitcoin network, and the annual mining revenue ($932 million at current BTC price levels), is extremely low: the capital costs are only worth about two months of revenue. In a proof of stake context, the cost of deposits should be equal to the infinite future discounted sum of the returns; that is, assuming a risk-adjusted discount rate of, say, 5%, the capital costs are worth 20 years of revenue. Note that if ASIC miners consumed no electricity and lasted forever, the equilibrium in proof of work would be the same (with the exception that proof of work would still be more “wasteful” than proof of stake in an economic sense, and recovery from successful attacks would be harder); however, because electricity and especially hardware depreciation do make up the great bulk of the costs of ASIC mining, the large discrepancy exists. Hence, with proof of stake, we may see an attack cost of $20-100 million for a network the size of Bitcoin; hence it is more likely that the level of security will be enough, but still not certain.
Well, OK, a perpetuity pricing model does make sense, though the 5% discount rate is huge for a system that supposedly disperses risk and is free from price inflation. But if the price of security in a transaction-fee system is that far below the price of security in a sensibly discounted return-on-investment model, the transaction fees aren't anywhere near high enough.

This is the uncomfortable truth that Buterin is trying to avoid. The security he thinks his system needs is expensive. Users might not be willing to pay for it.

In a transaction-fee-only system, fees that are high enough to discourage miners from selling out to a higher bidder may be too high to discourage users from transferring to another system. Losing your users is every bit as bad as losing your miners. So having discarded the hard cap on the coin supply, Buterin thinks he has a solution to the problem of expensive transaction fees (or poor security). He wants to identify the optimum mix of new coins and transaction fees in miners' rewards. And he tries to use Ramsey pricing to determine it.

In a typical Ramsey pricing model, two different products are transported on the same railway network. The railway network is a monopoly with high fixed costs: if the price charged to transport the products were set at the marginal cost of their production, the railway would lose money. So a percentage markup is added which is sufficient for the railway to break even. We assume this forces the producers of the products to raise their end prices. However, the two products have different price elasticities of demand: one has a much higher value than the other, and hence a higher price elasticity of demand (which means that people are more likely to refuse to buy it if the price goes up). Clearly, if the railway charges the same percentage markup on both products, sales of the higher-value product will slump relative to those of the lower-value. To prevent this - since it is discriminatory - Ramsey pricing puts a lower markup on the product with the higher price elasticity of demand, and a higher one on the product with the lower price elasticity of demand.

Sadly, Buterin's example misconstrues the context of Ramsey pricing. The differential markup is not because of social harm to purchasers of the products: there is no captive audience. No, the differential markup is to protect the producers of the higher-value good, since the higher price elasticity of demand for their product means that the railway's markup would cause them greater loss of sales than the equivalent markup on a product with lower price elasticity of demand. It's the equivalent of a variable sales tax - indeed Ramsey pricing is sometimes used in tax policy.

Clearly, we do not have a similar situation here. What we have is a single good (coins) which are transported at a fixed fee (transaction fee). The problem is simply one of supply and demand. If the price demanded by miners for supplying security is too high, users will vote with their feet. If the amount that users are prepared to pay for security is too low, miners will sell out to attackers. There should be some equilibrium point at which most users will pay an amount that most miners are happy with: there will remain a tail risk of takeover, just as there will remain a tail risk that the crypto equivalent of Uber entices away the users by massively undercutting the transaction fees. Equilibrium is NOT a risk-free position.

Buterin thinks that it is not possible to set transaction fees high enough to reduce the risk of attack to acceptable levels. I might say that in a decentralised democratic system, if users don't want to pay for security, they shouldn't have to. If the consensus is that a raised risk of attack is an acceptable price to pay for lower transaction fees, that is how it should be. Buterin has no right to start dictating to people what level of attack risk they should be allowed to take.

And he is quite wrong to suggest that mining rewards (new coins) can be used to subsidise transaction fees. Coin rewards for miners are in fact an additional cost for the users. This brings me back to where I started in this article. He misused the term, but he was right about inflation - though he didn't follow it through.

Classically, expanding the money supply is associated with price inflation. In a whole economy, the relationship is very complex. But in this case, it is much less so. BTCUSD has been rising constantly over the last year, which shows us that the rate of expansion is less than the rate of increase in demand for the coins. Nonetheless, the price would have risen more if no new coins were produced. Even though Bitcoin is deflating, the difference between the price (in USD) of 1 BTC when the money supply is expanding and the price (in USD) of 1 BTC when the money supply is fixed is a real cost to the users of the system, since it means their bitcoins don't buy so much. It is equivalent to a higher transaction fee.

So Ramsey pricing just doesn't apply. What we are really dealing with here is human preferences. Do miners prefer to receive transaction fees or new coins? Do users of the system suffer from money illusion - so prefer to have lower transaction fees and a higher rate of price inflation (or lower rate of deflation)? It should be possible to determine some mix of coin rewards and transaction fees that keeps most people happy. And it is entirely conceivable that Bitcoin might choose to operate with transparently higher transaction fees as the price of retaining its hard cap, while Ethereum chooses to run with lower fees and some price inflation. That is for the respective communities to decide.

In fact, what Buterin is trying to solve here is exactly the same conundrum as central banks face (and have never solved). What is the optimum balance of interest rates and inflation? Should we fix interest rates (transaction fee) at some level, and allow inflation (coin supply) to flex? Or should we fix inflation (coin supply) and allow interest rates (transaction fee) to flex? Or some combination of flexible coin supply AND transaction fee?

Whatever approach is adopted, in a simple niche system like Bitcoin or Ethereum the equilibrium would be pretty much the same. The system would have to be far more complex for the choice of target to make much difference. The mix of coin rewards and transaction fees is largely irrelevant: it is the total cost of security that matters, not how it is paid for. In his concern to protect his system from attack, Buterin is chasing a chimera.