Monday, 26 October 2015

No apology, just an explanation



My Forbes post on the threat to democracy in the EU touched a nerve. Well, several nerves, actually. Some people regarded my invocation of the Prague Spring as insulting to the people who suffered under Soviet oppression: others objected to my comparison of the benevolent EU with the evil USSR: and a few complained that I had presented the Syriza government as "martyrs", when they are nothing of the kind. And lots of Portuguese called me out for misrepresenting how their parliamentary democracy works.

First, let me deal with the Portuguese. I'm not going to discuss the Portuguese semi-presidential political system, here or anywhere else. I don't claim to be an expert on the political system of my own country, let alone someone else's. In the Forbes post, I was careful not to suggest that the Portuguese President had exceeded his constitutional authority. I criticised his words, not his actions.

Unfortunately it appears that my post, like others on similar lines, was used in support of the "Portugal Coup" protests. I wasn't immediately aware of this. But when I found out, I put a comment on the post making it clear that I do not think describing the President's actions as in any sense a "coup" is remotely accurate or helpful.

Nor does my post support the "Portugal Coup" idea. I interpreted the President's remarks as intended to ward off a possible "coup" from Brussels/Frankfurt along the lines of that experienced by Greece. That was the WHOLE POINT of the post.

Now for the rest. Some people were clearly upset by my comparison of the EU and the USSR. I am genuinely sorry if what I wrote caused offence. But we cannot have taboos in history, if we are to learn from it.

On the BBC's Sunday Politics programme yesterday, Ken Livingstone pointed out that the USSR under Stalin grew faster than any country in history. Andrew Neil riposted with "But what about the 25m people who died?" That is not a counter-argument. It is possible both to pursue policies that create fast growth and full employment, and to commit genocide. Both Hitler and Stalin did this. It is incumbent upon us to learn from what they did RIGHT, as well as the terrible wrongs they committed. We are the poorer if we refuse to look, unflinchingly, at the whole picture.

I visited the Soviet Union towards the end of Brezhnev's reign, when the USSR was beginning to open up to outsiders much as China has done recently. This was the early 1980s, when UK adult unemployment was over 3m and unemployment among young people (including graduates like me) considerably higher. At that time, visiting the USSR still had significant restrictions: you had to travel with Intourist, fly with Aeroflot (which was scary), and be escorted by an Intourist guide. But my Intourist guide encouraged us to go off on our own, explore and meet people. So I did. I spent quite a lot of time talking to people of about my age. It's disturbing to discover how people from a very different culture, view yours....

"Why is unemployment so high in your country?" my young Soviet friends asked. To them, unemployment was a terrible evil. But to me, child of the West, who hadn't yet realised what such high unemployment would come to mean for me, the restrictions on free movement of people, the shortages of goods in Soviet shops, and the very existence of "beriozka shops" that only those with access to Western currency could use, were the real evil.

In the years after my visit to the USSR, I learned - the hard way - that my Soviet friends were right. Widespread involuntary unemployment, particularly among the young, IS a terrible evil. It is an evil every bit as great as the inflation that we in the West have learned to fear. Young people never recover from unemployment at the very start of their working lives. It wrecks their careers, and destroys their hope and their self-esteem.

But the EU does not seem to know this. Despite unemployment across the EU averaging over 10%, and youth unemployment double that (and far higher in some countries), it remains fixated on the goal of "fiscal responsibility", believing that if governments balance their budgets and get out of the way of capitalist enterprise, employment will magically return. In time, it probably will.....but by then an entire generation will have been scarred for life.

So, what of the crushing of the Prague Spring? It was brutal, yes. As was Tiananmen Square in China. For sure, the EU has not descended to those depths. Indeed it cannot. It does not have an army, and neither does its largest and most dominant member state. Nor would there be support from other member states for use of military force against a member state. Memories of events like the Prague Spring, the Hungarian uprising and similar episodes involving countries that have since become EU member states, help to make it very unlikely that military force would be used to coerce a government into toeing the EU party line. We do not wish to be seen to behave like those we regard as unremittingly evil.

But we do not see our own evils. Nor do we see the good in those we regard as wholly evil. Our view is polarised: "we" are all good, "they" are all evil. Yet both "we" and "they"are human, and humans are capable of both good and evil. Indeed, what one human regards as "evil", another may regard as "good". We may regard the rape of Yazidi girls by ISIS soldiers as evil: we may be horrified by reports of ISIS fighters praying before committing rape: but in the ISIS ideology, raping an infidel girl is a good action. Brutality is not necessarily regarded as evil.

Unemployment is brutal, and youth unemployment particularly so. But in the EU, even very high unemployment - while perhaps not seen as a good thing - is regarded as preferable to inflation and debt default. There is no objective justification for such a view. It is entirely ideological.

All humans have the propensity to be dazzled by ideology and unable to see the evil that it brings. All of us are capable of mistreating other humans in pursuit of ideological goals. When the preservation of an ideal, or adherence to a set of rules, becomes more important than the welfare of people, brutality towards those who challenge the ideal or break the rules - or simply are not "one of us" - becomes inevitable. It matters not whether the goal is a socialist one-party state, a capitalist free market economy or an Islamic Caliphate: if the price for achieving it is the lives, hopes and wellbeing of others, it is a price too high to pay.

So although I regret that some people were upset by it, I will not apologise for comparing the breaking of Greece to the Prague Spring. For me, the similarities are significant. There is more than one way of forcing people to toe the party line. Brutality takes many forms.

The Syriza government made many mistakes, but then so did the government of Alexander Dubcek: it is a measure of how polarised our view has become that we see Dubcek as some kind of saint, martyred by the evil Warsaw Pact for daring to step out of line. This is entirely wrong: Dubcek was no saint, and he remained in power for some time after the Prague Spring. Similarly, it is wrong to regard Alexis Tsipras as an innocent victim. But that does not excuse the behaviour of the EU.

I would not want to see anyone choose a path that leads to debt default and economic collapse. But I defend absolutely the democratic right of the people of a country to make that disastrous choice. Today, that right is being systematically denied in the Eurozone, through the enforcement of tight fiscal rules backed up by threat of sanctions and fines. In some countries, governments now have little freedom to determine even fine details of tax and spending plans: everything is "overseen" by unelected bureaucrats in Brussels. This is not democracy.

The EU claims to be "democratic", but claiming democracy does not make it reality. After all, every Marxist-Leninist totalitarian state in history has claimed to be democratic. When the democratic right of people to choose their own path is denied through fear of retribution if they make the "wrong" choice, we are on the road to totalitarianism. That is the road down which the EU is now travelling.

Related reading:

The fallout from the Greek crisis threatens European democracy - Forbes
The dangers of historical taboos
Structural destruction
A worse crime?
The truth about evil - John Gray

Image: Red Square, Moscow, in 1982 - the year I went there. 



Wednesday, 21 October 2015

All Your Cars Are Belong Us



Did you know that most cars do nothing for 23 hours a day? Yes, they are totally idle. Sleeping safely in their owner's garage, or on his drive, or at her place of work, or in the station car park. Shocking, isn't it? What a terrible waste of assets. We should ensure that all these cars are DRIVEN. All the time.

But there is a reason why all these cars are idle. Their owners are busy doing something else. Many people who drive to work, or to the station, do jobs that they love, that they have the skills to do, and that earn them a good living. Should these people give up their jobs and embark on new careers ferrying people around for money, just so their cars don't stay idle for large parts of the day? Really?

No-one in their right mind would give up a job that was sufficiently well-paid for a quality car to be affordable, in order to drive for Uber (or any other "car sharing" business, for that matter). The remuneration just isn't that good. So presumably we are talking about people car sharing for money in addition to their day jobs. But this is not a free lunch. If the car owner's productivity in his day job falls because he is tired from moonlighting as an Uber driver, then making more productive use of his car comes at a cost - a cost that may lead to him losing his better-paid job. This is not clever. Better that the car remains idle for 23 hours a day, surely? 

Even if all these car owners took up new careers driving for Uber, or did a few hours in addition to their day jobs, their cars still would not be used 24/7. They would still be parked up the majority of the time. After all, people work maybe 8 or so hours in every 24, less at weekends. The rest of the time is spent sleeping, eating, helping the kids with their homework, visiting relatives, entertaining friends, fending off nuisance phone calls, setting the world to rights in the pub and doing a range of voluntary activities. And of course most people expect to have holidays (though some people actually drive their cars more when they go on holiday than they do the rest of the time). Do we really regard all these activities as unproductive? Must we replace them with driving, simply to ensure that cars are "used"? What is the cost to society of doing so? 

For example, suppose our car owner gives up running the local scout troop in order to drive for Uber in the evenings. Is he adding value to the economy? Economically, perhaps yes, though as I've already pointed out that there are limits to the amount of work that people can do before productivity suffers. Socially, I'd suggest, the answer is clear. No way is driving for Uber of equal social value to running the local scout troop. We have replaced a socially useful activity with an economic activity of at best marginal benefit. 

The underlying assumption is that economic value is the only "value" that matters. This is poisonous. Our society is founded on the things that people do in their spare time. When people are forced to work longer hours because their incomes aren't high enough, social and philanthropic activities decline. The argument that "idle" cars should be brought into use therefore ignores both economic and social opportunity costs. 

Of course, there are always the retirees who buy expensive cars with their pension lump sums. They aren't working, so there is no economic opportunity cost involved. And they probably spend their time playing golf, which is not a particularly socially useful activity. So clearly they should drive for Uber. And some do. 

But there is a cost, actually. They are retired for a reason, namely that they are getting old and may have medical problems. If they drive for Uber, they risk running down their own physical resources. 

And there is a second issue. They have spent their savings on a depreciating asset. Driving that car for money means that the asset depreciates even faster, not just because a car that is driven a lot wears out more quickly but also because a high-mileage car simply is not as valuable as a low-mileage one, however good its condition. "One careful lady owner" is a thing, in second-hand car markets. So it may not be in the financial interests of our retiree who has blown part of his pension on a top-of-the-range Mercedes to drive for Uber. The remuneration he will receive is unlikely to compensate him for both his time spent driving (and therefore not on the golf course) and the depreciation of his asset. When he replaces the Mercedes in five years' time, he may find that he ends up materially poorer than he would have been had he spent the time on the golf course instead of driving for Uber. 

Faster depreciation of assets is dis-saving. Unless it is compensated by high enough remuneration to support regular replacement of those assets while still generating a profit, it is NOT PRODUCTIVE. It does not create wealth. 

Commercial businesses take opportunity costs, profit margins and depreciation into account when making buying decisions. But ordinary people generally do not. How many people driving for Uber have taken into account not only the value of their time (including the loss of alternative activities) but the faster depreciation of their cars? I would venture to suggest that the number is vanishingly small. 

The fact is that commercial car sharing schemes are able to undercut existing taxi services because their drivers bear the cost of asset maintenance and depreciation. They exploit the fact that people do not value either their time or their assets properly. They are therefore founded on an information and power asymmetry. When banks do this, we call it mis-selling. But when it is hyped up as "sharing" and supported by "new technology", it will spread peace, love and happiness everywhere while building better communities and saving the planet, apparently. Eh??

But there is a second issue here. If people use their cars so little, why do they have them? Why don't they just use taxis or public transport? Well, there are good reasons for this. And they aren't, by and large, financial ones. 

The vast majority of people who drive, do so only as a means to an end. They want to get from A to B at a time of their choosing, without having to stop off at G, wait half an hour in the rain for a connection to X then change again at X to get to B. They like to travel in an environment where they can play loud rock music and smoke like chimneys if they want to. Using their own car means they can carry with them all the things they need (and probably quite a lot of things that they don't need, but that's human nature for you). They can ferry their own kids to school, removing the worry that parents feel when kids use public transport, supposedly "safe" taxis, bikes or their own feet. They can take Grandma to the day centre, the cat to the vet and the dog somewhere interesting for a walk. 

And for many (I am one), even when they aren't using the car they leave stuff in it. The boot of a parked car is an extra storage space. So although my car may be parked, it is not idle. It is being used.

People drive because it is easy, convenient and gives them control, not because it is cheap. Only when the cost of owning a car exceeds the cumulative costs of taxis AND taxis can adequately substitute for the convenience of a car, are they are likely to ditch their cars in favour of taxis. Similarly, when public transport is comprehensive and parking charges high, car ownership tends to decline. 

So if disruption and technological change in public transport and taxi services mean they improve, that is all to the good. Bring on driverless cars controlled by smartphones as a replacement for inefficient, crowded and dirty buses and expensive taxis. I, for one, would happily relinquish my car if there were a public transport service, or a private taxi service, that was equally convenient (including the extra storage space, please). It doesn't have to be cheap - after all, driving a car is dead time. If I can use that time more productively, I might be prepared to pay more, rather than less.  

But disruptive technology bringing real convenience improvement is not fundamentally what Uber and its relatives offer. They are offering me cheap rides in other people's cars. I don't have a problem with Uber disrupting taxi services and public transport, if that forces them to up their game, but I do have a problem with the idea that bringing idle cars into use is "productive". At Uber rates, I can't see how it is. 

But there is something else underlying this idea that "idle assets" should be brought into use. At the "Battle of Ideas" event that I attended last weekend, someone in the audience complained about yachts that he had seen moored at St. Katherine's Dock in London. "It was a fine sunny evening, and yet they weren't being used", he said. "Why don't the rich people let us use them?"

Indeed, why DON'T car owners, yacht owners and the owners of large houses rent out their assets to total strangers?

I'm sure you can work out why. If they are rich enough to afford them, they probably don't need the money. And if they don't need the money, why would they expose their assets to theft, vandalism, faster depreciation and general wear and tear? They leave their assets idle because they can

Leaving assets idle is the privilege of those rich enough to own them. It is the principle underlying property rights, that I can use my assets when I choose and lay them aside when I choose. I don't have to share them with others if I don't want to. You may regard it as wasteful for my car to be left parked while I am at work. but frankly that's none of your business. It is my car, and you have no right to tell me what to do with it. I've paid for exclusive use of that car. 

So, those too poor to afford those assets look enviously at them and say, "You aren't using that, so I should be allowed to". And those with green principles (and exploitative business models) latch on to this in the name of "sharing". In the latest version of Brave New World, everyone must "share" their assets for money. It's wasteful of them not to.

I'm astounded that people of libertarian persuasion can't see that this is creeping communism. All your cars are belong us. And your yachts, and your houses. In fact anything that you have and we want. It's immoral not to share them. Innit.

Related reading:






Tuesday, 20 October 2015

Generosity

In Dickens' "A Christmas Carol", the miser par excellence, Ebenezer Scrooge, is frightened by the Christmas ghosts into uncharacteristic acts of generosity. But I have always wondered how long his change of heart lasted. After all, Christmas lasts less than 2 weeks....then the decorations come down, the lights go out and we all start our post-Christmas diets. The abundance of Christmas is followed by the scarcity of Lent. I fear that Scrooge's habitual miserliness would have made a swift return once the visions faded and the grim reality of a diminishing hoard started to bite. As Fagin says, "In this world one thing counts,/ In the bank, large amounts".....even if the price of your wealth is the poverty or the loss of others. Scrooge and Fagin are brothers under the skin.

Yet our economy runs on generosity. Everything we have, we have because of the generosity of others - the people who produce what we invent, buy what we produce, give us their time, their effort, their talents and - one way or another - their money. I call it generosity, though it goes by other names too - "spending", "producing", "consuming", "donating", "helping". Wealth is created by doing things for others. Doing things primarily for yourself may also benefit others - this is what my parents call "enlightened self-interest", though we also know it as "trickle-down economics". But too often doing things primarily for yourself impoverishes both you and others: you, because self-centredness cuts you off from the richness of human interaction, and wealth is no substitute for love: and others, because your greed deprives them of wealth and your selfishness deprives them of your company. Selfishness and greed don't cause poverty, they ARE poverty.

Humans are, as a species, innately wealthy. We are intelligent, resourceful and creative. And when times are good, we are generous. But when times are hard, our concern for others is diminished due to our fear for our own future, and we withhold from others all that we have to offer. This is natural and perhaps understandable, but it is neither morally right nor economically sensible. When we withhold our natural wealth from others, we do not keep it safe - we destroy it. Ideas that never become reality are worthless. Money that is not invested productively generates no economic growth. When we fear scarcity, we create poverty.

The hoarders of wealth depend on the generosity of others to create the future prosperity upon which the value of their hoard depends. John Galt rejected the people who demanded that he share his wealth: but in rejecting them, he brought about the very thing he feared. A small enclave of like-minded people could not possibly have consumed enough of his ideas to give him the material wealth he craved. For that, he needed the purchasing power of those he rejected. Without it, he was condemned to a life of poverty without reprieve.  "Galt's Gulch" would perhaps be better named "Galt's Ghetto".

And "Atlas Shrugged" should be subtitled "the Folly of Selfishness". For folly it is. Scrooge's story shows that greedy and selfish people are eventually rejected by the people whose generosity they depend upon. "Hating on bankers" is society's rejection of people in the financial sector whose greed and selfishness caused economic disaster in 2008. "Hating on the rich" is society's rejection of people whose wealth has been maintained through extraordinary economic measures while everyone else has been feeling the pinch. What is seen as "unfair" - rightly or wrongly - ultimately is rejected, sometimes painfully. Fagin was hung...... and in the vision of the Ghost of Christmas Future, Scrooge's tombstone lies forgotten and neglected, for he died unloved.

We can have prosperity. We really can, and for everyone, not just a fortunate few. But it depends on whether we are willing to let generosity become something we practise all year round, not just at Christmas. And that can only be achieved if we vanquish the real foe - our fear of scarcity. The terrible children of the Ghost of Christmas Present, Want and Ignorance, are spawned by that fear. When we vanquish our fear, they too will vanish.

Our wish that  it could be Christmas every day could come true. It is up to us to make it happen.

Related reading:

The death of John Galt - Pieria
Does charity end after Christmas? - A dragon's best friend

Sunday, 18 October 2015

The shabby economy



Yesterday, I attended a panel discussion on the "Sharing Economy" at the Battle of Ideas. Benita Matovska, who describes herself as "chief sharer" of the comparison website Compare & Share, enthused about how the Sharing Economy would build communities, transform capitalism and restore the planet. "It's all about trust," she said.

No it isn't. It's all about money.

Here's what Matovska herself says on the Compare & Share website.
I was trying to book a family holiday in Morocco - when we travel as a family we're quite adventurous, we like to share, meet real people and have those amazing money can't buy experiences....
I'm sure everybody would like to have experiences money can't buy. But actually she wasn't after a "money can't buy" experience. She was after an expensive experience at a cheap price:
I spent hours searching through site after site and not finding the unique holiday experience I wanted at a price I could afford. I wanted to go to one single site. And that was my light bulb moment - a comparison site for the Sharing Economy. I wanted to be able to car share at my destination, find sites where I could experience the holiday through the eyes of a local, to contribute to the local economy (I care) and of course to discover hidden vintage markets and cool collectibles.
And she got it, too.
Last summer - once Compare & Share had launched accommodation - my dream holiday in Morocco became a reality. We stayed in a gorgeous beach house near Essaouira. The highlight was being invited to a rural beach wedding and my daughter and I dancing barefoot at 2 am on floor drums with a room full of Berber women and girls celebrating - a priceless experience!
I could say a lot of unpleasant things about this. Her "priceless experience" amounted to cheap voyeurism by a rich snob who wants to "share" other people's cars and houses so she can have a cheap holiday. There's a disturbing colonial attitude underlying this quote too: she and her daughter surrounded by a bevy of adoring native women....it's straight out of the Jewel In The Crown. She'll be "sharing" big game hunting next.

But didn't it ever occur to her that the "rural beach wedding" she attended was probably created as a tourist attraction to fool people like her into believing they are "experiencing the holiday through the eyes of a local", because, you know, "genuine" local events sell holidays? The natives aren't stupid. They know how to milk tourists for money.

Anyway, more power to Matovska for disrupting the holidays industry, just as AirBNB is disrupting the hotel trade and Uber the entrenched self-interests of regulated taxi services. Travel agencies and car hire firms are badly in need of a shakeup. And if as a result of cutting out the middlemen the "local economies" in tourist spots get more money, that's all to the good. But please don't call this "sharing". It's trading.

Letting your spare room out through AirBNB is not "sharing your house". It's letting a room for money. Working part-time for Uber is not "sharing your car". It's driving a car for money.

Ah, but we all know that AirBNB and Uber are wicked capitalists ripping off the genuine sharers, don't we? They aren't part of the real "sharing economy", which is all about people doing things for each other and sharing unused assets. Apparently no-one does this any more, so we need websites to help us do this.

This would be fine if "sharing" websites actually encouraged sharing. Buying things collectively so everyone can use them. Lending your lawnmower to someone who needs to cut their lawn. Or better, cutting their lawn for them. For free, because they are your friend or your neighbour, or simply because you want to help them.

But by and large, that's not what these "sharing" websites do. They are trading platforms. Marketplaces, where people can sell services and rent out or exchange assets.

Selling seats in your car is not "sharing car rides", it's transporting people around for money. People "sharing" their house with you are letting out their house for money. People inviting you to share their meal are not doing so because they like your company, they are making money from cooking and entertaining. Locals offering you "experiences unlike any other" are not doing that because they love you, they are doing it because you will pay them.

Websites like these are simply Ebay for services. Street traders, online. My friend Mervyn Dinnen calls it the "Who will buy?" economy, 21st century version. Instead of looking out of the window at the street traders, Oliver checks his iPad.

These websites have 21st century marketing, too. People who wouldn't like to see themselves as doing anything as wickedly capitalist as selling describe themselves as "sharers", even though their form of sharing involves charging people. And their customers are also "sharers", even though they have to pay. How to hook the gullible, 2015 edition.

To assist with hooking the gullible, the mix is lightly spiced with genuine sharing opportunities. Matovska's website, in the same paragraph, brings together Tabl and Grub Club, both of which are distributed marketing platforms, with Casserole Club, which encourages people to support needy neighbours by providing food for free. Altruism and trade become indistinguishable. Both are "sharing".

There are also "sharing" sites whose real purpose is to make money by providing intermediary services. BorrowMyDoggy, for example, hooks up dog owners with people who would like a dog but can't have one themselves. But both sides have to pay a subscription. So it's a commercial dating agency. For dog lovers.

Of course, some forms of trade in the "sharing economy" don't involve money. They are barter. You could see Casserole Club as bartering food for friendship, for example. But defining an altruistic enterprise in such terms is a very slippery slope. Any charity could be seen as bartering services for self-esteem or status. I'm not sure this is particularly helpful.

Definitely barter, however, is this.  "Did you know that there is £3.5 trillion of stuff going unused globally?" trills Matovska's website. "Why not start sharing some?" Yes, it's a jumble sale. Or a charity shop. Beloved of churches and the Women's Institute for generations, the "sharing economy" has discovered them. But there's a twist. Let's not sell old stuff for money. Let's just put up a sign saying "Share" and let people take what they want in exchange for dumping their own old stuff.

But charity shops and jumble sales make money for local communities and good causes. How is undercutting them "building communities"? How is dumping your stuff on a table for it to be taken by a total stranger "making connections"? Pardon me, but this is just getting something for nothing, isn't it? It contributes absolutely nothing to the economy, local or otherwise.

Indeed the whole idea of the "sharing economy" seems to be based not on the idea of working together to produce something for mutual benefit (the cooperative principle) but on millions of people scraping a living by selling services and renting assets to each other. How does this add value to the economy over the longer term? There is no production. It is entirely consumption. Recycling is all very well - and we do need secondary markets - but we cannot build an economy solely on sweating existing assets. An economy that exists solely on consumption has no long-term future.

The sharing economy is the shabby economy, the frugal "make do and mend" society where no-one will buy anything unless they absolutely have to and everyone is running down their existing assets. The Victorian novelist Elizabeth Gaskell wrote about this in her novel "Cranford": genteel elderly ladies making a virtue of thrift because they were actually dirt poor but too proud to admit it. It's the hallmark of a society in decline, a society that has nothing innovative to offer, a society so fearful of change that it dare not create anything new. The sharing technology may be innovative, but the economic vision underlying it is stagnation, not prosperity.

And it's an unpleasant vision, too. Sharing is a fundamentally generous act: it is giving goods, services, time, for nothing. But people who are always looking to make money aren't being generous. If everyone is constantly looking for ways to make money from "sharing", we will be not only economically but morally poorer.

Sharing is also an act of faith. You lend someone your car if you trust them not to steal it and not to crash it. If you don't trust them, you either don't lend your car or you charge them to borrow it - in which case you are in a trading relationship with the borrower, not a sharing relationship. Money is an expression of LACK of trust. So the "sharing" economy, in seeking to monetise the generosity that people show towards others, is not "building trust". It is destroying it.

So the "sharing economy" is shabby, unproductive, stagnant, mean and distrustful. I don't want to live in such an economy. I would much rather have Mike Wright's vision of an economy founded on advanced manufacturing and high-tech services, in which skilled people earn high salaries. Mike is an executive director of Jaguar Landrover. He's a filthy capitalist. So am I.

And so, actually, are Benita Matovska and her kind. After all, they don't do this sharing stuff for free, despite their altruistic spin. They make money from it. That's old-fashioned capitalism. Not "transformed" in any way.

Related reading:

The something for nothing society
GDP transactions in secondary markets
Generosity




Saturday, 17 October 2015

The UK Government is spinning a yarn


At Prime Minister's Questions the other day, Jeremy Corbyn produced a case study of a working single mother who would suffer a substantial real fall in income due to tax credit cuts despite the NLW and tax threshold rise. In response, David Cameron claimed the new National Living Wage and tax threshold rises would mean that working people on low incomes would be better off by 2020. Who is right?

The National Living Wage will improve earned income for a high proportion of families. The Resolution Foundation estimated that:
  • 4.5 million employees will see their hourly wage rise as a result of introduction of the NLW in 2016. Of those, 1.9 million earning less than the NLW are set to be brought up to at least that level, with a further 2.6 million gaining from spillovers. 
  • By 2020, a total of 6 million employees – 23 per cent of all employees in Britain – are likely to have received some increase in their pay as a result, with 3.2 million being brought up to at least the NLW and another 2.8 million moved onto higher wages through spillovers.
  • By 2020, the average gross gain to employees directly benefiting is expected be £1,210 while for those who only benefit from spillovers, it is estimated to be £240 (in 2016 prices). Clearly however, the precise size of the pay rises experienced by individuals will vary depending on their previous pay levels and the hours they work.
The NLW is expected particularly to benefit women (many of them part-timers), young people aged 25-30, and over-65s who are still working.

The distribution of the NLW looks pretty good, too, with over 50% going to workers in the bottom half of the income distribution.

But for a significant proportion of people, particularly those with children, earned income is topped up with benefits. So what is the effect of the NLW on total income?

Here's the Resolution Foundation's chart showing the effect of the NLW on net household incomes across the income distribution:



Clearly, the NLW most benefits those around the lower middle of the earnings distribution.  The greatest improvement in net income is experienced by those in the 4th decile. But the improvement is tiny, only half a percentage point. And for other deciles the improvement is much less. The effect of the NLW on household net income is distinctly underwhelming.

Although those in the 3rd and 4th deciles benefit most from the NLW, there is a substantial wedge between the earned income gain from the NLW and the effect on net income. As the Resolution Foundation explains, this is because for these households, what they gain from the NLW is to a considerable extent wiped out by taxation (my emphasis):
The requirement to pay tax and National Insurance (NI) on these additional earnings explains part of this shift. In addition, members of this middle group of households are more likely than others to be eligible for Universal Credit (UC). Crucially, entitlement to UC reduces as earnings increase – for each pound earned above around £5,000 a year by a household, 65 pence of UC entitlement is deducted. This means a worker gaining the full £1.10 hourly boost implied by a NLW of £9.35 in 2020 (using the OBR projection) would only be 39p an hour better off, falling to 26p if they also pay tax and NI. 
Overall, only 60 per cent of the gross wage gains are translated into net income gains with the situation more acute for those in the lower-middle part of the distribution; only around half (53 per cent) of the £220 gross gain in decile 4 finds its way through to household incomes.[22] As such, the share of the total gain flowing to the bottom half of households falls from 52 per cent when calculated on a gross basis to 45 per cent on a net basis. 
So workers in the 3rd and 4th deciles - hardly the richest people in society - may experience marginal tax rates as high as 76.4% as a direct consequence of the NLW. Lovely.

But even though that is a shockingly high marginal tax rate, it isn't a fall in income. It's an increase, though a small one. Single parents will keep less of the NLW gains than any other group, because they are more likely to be on Universal Credit. But even single parents won't suffer marginal tax rates of over 100%. So why is Jeremy Corbyn's single mother apparently facing a fall in income?

The problem is not the NLW itself, it is the government's measures to reduce working-age benefits by a total of £13bn by 2020. The most significant of these measures are:
  • Freezing working age benefits for four years from April 2016; 
  • Reducing the point at which tax credits or UC entitlements start to be reduced as earnings rise (the "taper");
  • Removing entitlement to the family element for new claims or new families entitled to UC or tax credits from April 2017;
  • Limiting support from Child Tax Credit or the child element of UC to two children for new claims or births from April 2017, meaning that families with three or more children only receive support for two.
The message is clear. If you are poor, don't have children.

In his Budget speech, the Chancellor claimed that “taken together with all the welfare savings and the tax cuts in this Budget, it means that a typical family where someone is working full time on the minimum wage will be better off.” But the Resolution Foundation disputes this:
However, with the NLW expected to increase the nationwide wage bill by £4.5 billion in 2020, and only around 60 per cent of this gain expected to translate to gains in income, the policy clearly cannot fully offset the losses to income from the £13 billion cuts to welfare.  
In short, the Chancellor's figures do not add up. Again.

The extent of the shortfall for the poorest in society is graphically illustrated by this chart:



There are two things that stand out from this chart. The first is how regressive the Budget changes are. The welfare cuts fall disproportionately on the poorest in society, and the NLW does not offset them. Wages make up very little of the income of those in the 1st decile, so increasing the NLW has little or no effect on them, as the chart shows. These people therefore face real income cuts without the prospect of compensatory wage rises.

But Jeremy Corbyn's single mother is working, apparently. We don't know what her circumstances are, but it seems unlikely that she is in the very poorest group. However, the chart shows that there is a net income loss from the Budget changes for families in the bottom half of the income distribution, while those in the top half - except for the very rich - experience a net gain because they benefit from the NLW. So Jeremy's single mother could be in the 2nd or 3rd decile and still face a significant cut in her net income.

And this brings me to the BBC Question Time audience member who challenged Amber Rudd over cuts to tax credits. BBC News reported that Michelle Dorrell is a self-employed beautician running a nail bar from her home. Clearly she's no slacker. She's a hard-working woman trying to do her best to keep her family through her own efforts. The sort of person, in fact, whom the Conservatives said they wanted to help.

It's worth noting that as Ms. Dorrell is self-employed, the NLW will not apply to her, and it is unlikely that she would be able to increase prices to NLW level. She is therefore among those facing real cuts in income, due to tax credit changes, with little prospect of earnings increase to compensate. , No doubt there will be those who say that running a nail bar isn't really work and she should get a proper job mopping floors.

Self-employment incomes have fallen by 22% since 2008-9: median incomes for the self-employed are now half those of the employed, and their take-up of tax credits is much higher. One in seven people is self employed: their exclusion from national statistics is thus a serious distortion. The invisibility of the self employed in policy making is a national disgrace.

The response of David Cameron's adviser to Ms. Dorrell is frankly incredible:
The point the prime minister and government is trying to get across is that it’s important you see the changes we are making in tax credits are part of an overall package of changes, designed to ensure we push wages up.”
She's being fobbed off. Raising tax credits might push wages down, but there is absolutely no reason to assume the effect is symmetrical. Employers like wages to fall. They aren't nearly so keen on increasing them. The NLW will increase them, a bit, but that has absolutely nothing to do with tax credit cuts.

In fact this is entirely political spin. The changes are about reducing the welfare bill, not raising wages.

There was always a very large hole in the Conservatives' spending plans, which would inevitably have to be filled with cuts to in-work benefits. But despite this, the Conservatives somehow managed to persuade the working poor that in-work benefits were not at risk.

Like Chris Dillow, I suspect this was primarily managed through subtle redefinition of "welfare" to mean out-of-work benefits. Working people on low incomes don't see tax credits as "welfare". Welfare is what scroungers get, not hard-working people. So the Conservatives could trumpet "welfare" cuts while still promising to support "hard-working families".

The strategy worked. People like Michelle Dorrell believed them. It never occurred to her that in voting Conservative, she was voting for a party that would slash her own income. Turkeys do vote for Christmas, if they are led to believe that people eat goose for Christmas dinner. 

So Jeremy Corbyn was right. The single mother in his case study does indeed face real cuts to her income. As does Ms. Dorrell. She will pay a high price for her gullibility.

Wednesday, 14 October 2015

The Slough of Despond

I'm bored.

Bored with this crisis. Bored with endless calls for bank reforms. Bored with never-ending stories of inadequate bank resolution and legal battles which benefit no-one but lawyers. Bored with ineffectual monetary policy and fiscal gridlock. Bored with seeing the same things proposed over and over again, even things we know don't work and will never happen.

Today, Mike Konczal wrote a piece on why restoring Glass-Steagall wouldn't solve anything. He's right, of course. But it is now seven years since the crisis, and we have known for most of that time that restoring Glass-Steagall wasn't going to happen and wouldn't solve anything anyway.Why are we still discussing it now? Why can't we just accept that Glass-Steagall is dead, and move on?

Today, I had to explain YET again that although banks create money when they lend, that does not mean lending doesn't need funding. Payments are deposit outflows. That applies whether the deposits concerned are created by the bank through lending or placed in the bank by customers. So no, banks can't "just lend" without any form of funding. Banks have to fund deposit outflows. If they don't, they can't allow money to be removed from deposit accounts. Look what happened in Greece when the ECB limited the funds available to Greek banks.

Today, I read yet another piece proposing that the UK should have a system of small savings banks "just like Germany's". Because, you know, banks aren't lending to SMEs. Laudable, but creating a UK Sparkassen network isn't by itself going to solve the problem. There are very significant differences between Germany and the UK. In the UK, most lending goes towards house purchase. In Germany, much less of it does, because fewer people own their own homes. Because of this, German households hold far more of their savings in the form of bank deposits than UK households do. UK households' savings are mostly in the form of property and pensions. So where are the deposits going to come from to fund a new network of Sparkassen focused on SME lending? And what would the consequences be for the funding of existing banks and building societies? It's blindingly obvious that 250 new deposit-funded banks are simply going to take deposits from mortgage lenders, forcing them to make greater use of bond issuance and wholesale funding. Like that worked so well for Northern Rock. Why don't researchers think things through?

Today, I was sent a copy of a proposal to the Dutch parliament to "replace bank-created money with Government-created". That old chestnut, again. Yet another version of the Chicago plan. I've lost count now of the number of full reserve banking proposals I've seen. I've yet to see one that actually succeeded in eliminating bank money. And I've also yet to meet an advocate of full reserve banking who understood that it is to all intents and purposes a strict gold standard, with alchemists replacing miners. I keep saying it is a really bad idea because central banks get their forecasts wrong ALL the time and anyway economies work better if demand for money leads supply. But the idea keeps coming back to haunt me. I worry that some lunatic government will actually try out one of these idiot schemes one of these days.

Today, I heard that Barclays is to appoint an investment banker as CEO. Thank goodness. The vilification of investment banking and reification of retail banking in recent years has been poisonous. It has caused the near-destruction of an industry that is vital for business investment. No wonder business investment has been so poor.

In September, the Bank of England's Andy Haldane discussed negative rates and the end of cash as if these ideas are new. As if they have never been discussed before. But we've been discussing negative rates and their effects for years, and we've been discussing eliminating physical cash, or at least finding ways of discouraging people from hoarding it, for even longer. Has no-one heard of Silvio Gesell?

We now have empirical evidence that banks may raise interest rates to borrowers when they are charged for depositing money at the central bank. The G30 report released last week observed that Credit Suisse raised mortgage rates in January 2015 because of the ECB's slightly negative interest rate on reserves. If interest rates were significantly more negative, what do you suppose banks would do? Yet we are still talking about negative interest rates as if they are expansionary monetary policy. They aren't. They are direct taxation of bank deposits, which is financial repression. And financial repression is contractionary, especially in the absence of a trade surplus. We KNOW this. It is not rocket science. Why are we still considering negative rates?

We seem to be completely stuck. Unable to escape from the Slough of Despond, we flail around in circles.


But why are we stuck? Why have we been unable to find our way out of the mire? John Bunyan has the answer:
Wherefore CHRISTIAN was left to tumble in the Slough of Despond alone; but still he endeavoured to struggle to that side of the slough that was farthest from his own house, and next to the wicket gate: which he did, but could not get out, because of the burden that was upon his back. But I beheld, in my dream, that a man came to him whose name was HELP, and asked him what he did there?
Chr. "Sir," said CHRISTIAN, "I was bidden to go this way by a man called EVANGELIST, who directed me also to yonder gate, that I might escape the wrath to come; and as I was going thither, I fell in here." 
Help. But why did you not look for the steps? 
Chr. Fear followed me so hard, that I fled the next way and fell in.
Fear. Yes. All-pervasive, paralysing fear holds us in a depression from which we cannot escape.

Central banks are terrified of raising interest rates, because it might cause bankruptcies on Main Street and crashes on Wall Street. They look at below-target inflation, flat wage growth and awful productivity, and think "there is no reason whatsoever for raising interest rates". I never thought I would find myself writing this, but - yes, there is. Purchasing power in today's fiat money economies is created by bank lending, and very low interest rates are deadly for banks. They can't make money when yield curves are flat and the slightly-below-zero bound is binding. The longer very low interest rates remain, the more difficult it is for banks to survive. They could improve their profitability by doing riskier things, but we don't like that either: prudential regulation is making it ever more expensive to take risk. Then we wonder why M4 lending growth is persistently negative (see table A2.2.3). Meh.

But even worse is the fiscal terror that prevents governments acting to restore their economies,  or even forces them to do lasting damage in the name of "setting fiscal finances on a sustainable path". We know that trying to eliminate a fiscal deficit when the private sector is highly indebted and the external sector is in deficit depresses growth. We know that fiscal surpluses are contractionary. We know that spending cuts hurt the poorest most, and tax cuts all too often benefit the well-off most. We know that high unemployment among the young scars them for life. We know that high adult unemployment is associated with increased suicide risk, particularly among men.

We know that programmes of public works restore depressed economies, fast and effectively. Dammit, even Hitler knew this. Why don't we do them? Because we are scared.

We won't let our governments borrow for long-term public investment because "OMG Greece!", even though interest rates are on the floor and investors are crying out for safe long-duration assets. We won't let our governments print money for long-term public investment either, because "OMG Weimar!", even though public investment would raise production whereas Weimar's problem was that production had been trashed. We talk about the "burden of debt service for the next generation", while refusing to invest in the tangible and intangible assets that would help ensure the next generation actually has a future.

I fear for my children. But not because of public debt. No, I fear for them because of unemployment, underemployment, low wages, debt, poverty. And war. OMG, war. Can't we see that the path we are on now has in the past always led to war?

There is no justification for this. The obstacles are entirely political. We need Help.

So, here are my Helpful suggestions:
  • Stop proposing new bank reforms. We've heard it all before. Get capital buffers up to 20%, then leave banks alone. Particularly, stop attacking investment banks. They have a job to do.
  • Stop trying to restrict what central banks can do. Liquidity is lifeblood to the financial system. Trying to restrict it causes gangrene. Let central banks provide it freely. 
  • Stop expecting central banks to restore growth. They can't. 
  • Stop worrying about public debt. Borrow to invest for the future. Then central banks will be able to raise interest rates, since increased borrowing would tend to push them upwards anyway. 
  • Stop trying to balance budgets. They will balance themselves in due course. 
  • Stop worrying about inflation. There isn't any. If it appears, cheer.
And on a personal level - stop worrying and enjoy life. Even if you are flat broke and out of a job. Like me.

UPDATE: I have reluctantly decided to close comments on this post. As Niels said, "which bit of ' bored with seeing the same proposals over and over again' gave you the impression that it was time to offer the same proposals again?" It's been an interesting discussion, but it's time to move on. I want to enjoy life. I hope you do too. 

Related reading:

Pilgrim's Progress - John Bunyan

Sunday, 11 October 2015

The dangers of historical taboos

The Group of 30 central bankers and economists has produced a new report, "Fundamentals of central banking: lessons from the crisis". It traces the history of central banking theory and practice, including the economic thought that underlies it. And it draws from it some important lessons about the causes of the 2008 crisis and the reasons for the very long, slow recovery. I've discussed the main themes of the report here (Forbes).

But in this post, I want to focus on a particular piece of economic history. This chart leapt out at me from the report:


Note that this chart starts only two years after the Weimar hyperinflation, hence Germany's elevated inflation rate at the start. This is important, as we shall see.

What struck me is how similar the profiles of the two countries are during the Depression. Both experienced Fisherian debt deflation - annualised CPI fall at peak was 10% for both countries. And both had very high levels of unemployment. German unemployment was actually higher than American, peaking at 30%.

But the recovery was very different. German unemployment fell rapidly during Hitler's tenure, while US unemployment remained elevated until after World War II. Looking at this chart, an alien from Mars who knew nothing of the history of the 20th century might think that the German government did a far better job of restoring its economy than the American government. After all, full employment is always a good thing, isn't it?

Hitler achieved that remarkable fall in unemployment through debt default, autarky and a massive programme of public works. Clearly, this works. So why do we avoid his approach like the plague?

The simple answer is that autarkic governments are usually brutal ones. They don't necessarily start that way, but that is what they become, as people fight against the closed economy and the ever-increasing levels of central control needed to keep it that way. Further, because autarky deprives countries of resources they can't produce themselves, autarkic governments often have expansionary ambitions; instead of trading for goods and services, they seize the means of producing them.

Hitler presided over one of the most murderous governments in history, directly responsible for the deaths of an estimated 13 million people. His attempt to create a European empire ended in defeat and destruction after the most expensive war in history. Looked at from this perspective, that remarkable fall in unemployment doesn't look so good, does it?

The US remains deeply scarred by the memory of unemployment. Google "Great Depression", and you are presented with pictures of soup kitchens, migrating farm workers and queues of out-of-work men, all of them from the United States: it is difficult to find pictures from other countries. We still read the novels of Steinbeck and the speeches of Franklin D. Roosevelt, both icons of this time. Many of the structures and policies put in place at that time to end unemployment remain today: for example, the Federal Reserve's mandate is as much to keep unemployment low as to maintain price stability, and both mainstream and heterodox economists wax lyrical about negative effects of tax and welfare changes on unemployment.

But even though the Great Depression in Germany was similar to that in the US, and German unemployment was actually higher, it does not seem to have left such lasting scars. It is the hyperinflation a decade earlier that is burned into German memory. Images of wheelbarrows full of cash, and walls papered with banknotes, are the iconic images of Germany's interwar disaster. And although this is often forgotten outside Germany, Germans still remember with horror the crippling public debt that blighted their economy and caused the Weimar and Danzig hyperinflations. The German obsession is thus with debt and inflation, rather than unemployment.

This might of course be due to the fact that German unemployment did not remain elevated for as long as unemployment in the US did. But I wonder if there is another reason.

Much of the "public works" was arms production, as Hitler prepared to take over the rest of Europe. You can end unemployment by starting wars. And we can't forget the work ethic of the concentration camps, either. "Arbeit Macht Frei", it says over the gate of Auschwitz - "Work Makes [You] Free". To start with, at least, people were sent to concentration camps to be worked to death, though later "work" was bypassed and the camps became merely killing grounds. You can end unemployment by making large numbers of people slaves, whom you can pretend are not "people" (this is of course also a very painful part of the US's history).

So I wonder if the means by which Hitler ended unemployment in the 1930s has actually left another scar, deeper and far more painful. Could it be that the reason why Germans remember hyperinflation and debt, rather than unemployment, is that the means by which the unemployment of the 1930s was brought to an end is too horrible to contemplate? Does this explain why successive German governments since World War II have resorted to mercantilism (export-led growth founded on repression of domestic demand), rather than public works, to keep unemployment low? And does this also explain the apparent callousness towards other EU countries that have both very high unemployment and very high debt?

I know that Germany wants to put the horror of its past behind it. But mercantilism and autarky are closely related, and the autarkic policies of previous German governments have twice resulted in world wars. Why is it taboo to suggest that mercantilist policies by the current German government might not end too well, and German hegemony in Europe might not turn out to be benign?

Nor do I wish to restrict my discussion of taboo subjects to Germany. We tamely accept and even encourage mercantilist policies in other countries. Yet history tells us that these lead to conflict at home and wars abroad. Why is it taboo to suggest that this time might not be different?

I am very uneasy about taboo subjects in historical analysis. If we are afraid to look at history, we cannot learn from it: and if we cannot learn from history, we are doomed to repeat it.

Related reading:

A poignant reminder
Morality in the Greek crisis
Fear the fear
Currency wars and the fall of empires - Pieria




Friday, 2 October 2015

Posts on Russia

I wrote a number of posts on Forbes about Russia at the back end of 2014. At the time, there was a lot going on with the currency, the central bank and the banks. So for ease of reference, I've collected them here, in chronological order.

Why the Russian Central Bank can't defend the ruble

Has the Russian Central Bank thrown in the towel?

The Russian Central Bank is regaining control, but for how long?

Oil, sanctions and Russian politics

How to destroy a currency, Russian style

Russia and the banks

How OPEC destroyed the Russian ruble

Russian ruble: Let it fall, let it fall, let it fall

The Great Russian Bank Bailout

Why does Venezuela think Russia is its friend?

No doubt there will be more in due course. Russia and its problems are not going away any time soon.

The "something for nothing" society



While visiting Germany in the summer, I was struck by the prevalence of adverts saying something on the lines of "Sie sparen können". I've never seen a society so obsessed with saving, not in the sense of putting money away (though they do that too) but in the sense of reducing costs. Never mind the quality, look  at the price. "You can save". Always.

Penny-pinching is by no means limited to German households. Ever since we collectively decided, on September 16th 2008, that the money had run out, we have all - households and businesses - been scrimping and saving like mad, reluctant to spend money in case we too run out. We look for bargains, delay purchases until end-of-season sales, and avoid paying for things unless we absolutely have to. We have become a "something for nothing" society.

At an individual level, this seems sensible. Most people have limited incomes, and wages have stagnated for a long time now. Businesses, too, have felt the pinch: sales have fallen, and they have been forced to reduce prices and cut costs to the bone. Money is scarce, so we must use it carefully. Thrift and prudence are the way to prosperity. Generosity is a luxury we can't afford.

But this is the madness of crowds. When everyone is cutting costs, hunting for bargains and trying to get something for nothing, no-one can make any money. And this bears down on incomes. If businesses are forced to cut prices, they won't increase wages and they may lay off staff or cut working hours. When the employed find their incomes squeezed, they stop using the services of small businesses and the self-employed. When small businesses and the self-employed can't find work, their incomes crash and many go out of business. Miserliness doesn't lead to prosperity, and deflation is not benign. It causes depression and poverty, particularly among those who lead precarious lives.

Nowhere is this more apparent than in today's internet-based small businesses. People have come to expect expect things they find on the internet to be free, or nearly so: music, writing, statistics, apps.... It has never been so easy to create and publish original material, and never so difficult to earn an income from doing so.

Journalists worry that their industry is dying, because of competition from millions of free blogposts and the growing tendency of internet surfers to dip into lots of publications rather than concentrating on a few. The days of being able to rely on subscriptions from devoted readers are over: if you put your publication behind a paywall, you lose readers. Most online journals have learned to allow access to at least some articles free. The biggest exception to this is the academic publishing world, which still manages to keep most of its publications gated. But there are moves to undermine this, as academics themselves publish ungated working papers and new sites spring up that help them to do so.

There is a real dilemma here. Information is a social good. Arguably, it should be free. After all, what is the point of academic research if the only people who can read it are those who can get past an academic paywall, which generally speaking means other academics? What is the point of data that is difficult and expensive to obtain? What is the point of articles that are only read by a few people? But if information is completely free, the labour of those who produce that information goes unrewarded. Intellectual property becomes worthless.

This has, of course, long been a problem in the entertainment world. People love to be entertained, but they really don't want to pay for it. They don't see entertaining people as "work". After all, performers love to perform, don't they? Why should we pay them for doing something that they love?

This creates a real dilemma for performers. Most do, indeed, love performing. If they refuse to perform unless they are paid, therefore, they risk not doing what they love. They also risk not eating. Whether a performer gets paid well for their work depends on two things: whether they are bloody-minded enough to refuse to perform if the pay isn't good enough, and whether they have another source of income that pays the bills, so they don't have to take badly-paid jobs. Performers who are either too devoted to their art or too poor to survive without it don't earn money.

Journalism and the performing arts are, of course, service industries. We still seem wedded to the idea that proper work is "making stuff", and working in a service industry isn't proper work so doesn't deserve proper pay. But as "making stuff" increasingly becomes the province of robots, service industries are the future of employment. And at present, we haven't got our heads round the idea that people in service industries should be well paid. It's not just in the entertainment world that making a decent income is next to impossible. The worst paid workers in society are those in the care sector and the hospitality sector. We really don't want to pay people to look after our children, our elderly parents and our sick and disabled relatives. Nor do we want to pay people to clean our houses and offices and serve us meals. Apparently we can't afford it.

But pushing down prices in service sectors has unfortunate consequences, not just for those working in that sector but for society as a whole. If everyone expects to pay rock-bottom prices, or preferably nothing at all, price is no longer an indicator of quality and Gresham's Law prevails. Why put in the time and effort to produce good writing or deliver good care? You won't be paid for it. There is no point in being more than perfunctory. If you love your work, and feel that you can make a difference by doing a good job, you will simply be exploited. Might as well sell lemons.

The tendency for poor work to drive out good when prices are very low degrades service industries. We decry the declining quality of online articles and long for something better written and researched, not seeing that this is the inevitable consequence of avoiding paying for good writing (I confess, I avoid paywalls too). This is bad enough. But in the care sector, reluctance to pay for quality is disastrous. When good quality care is driven out by bad, the result is abused children, neglected elders and suffering among the sick and disabled. And when benefits are cut because well-off people with good jobs object to those less fortunate than themselves apparently getting something for nothing, suffering is amplified. Miserliness creates misery.

Scrimping and saving in the private sector can be offset by generosity in the public sector. When people and businesses won't spend, government must. But we have now convinced ourselves that government has run out of money too, and so must scrimp and save like us. When government becomes as miserly as the private sector, the only source of income becomes external trade. This can work well if other countries are enjoying the good life, as Germany discovered in the mid-2000s. But when the whole world decides that there is no money left and everyone - government, business, households - must scrimp and save, the result is global misery.

When every country in the world is pursuing an export-led growth strategy, export-led growth becomes impossible. We simply end up with competitive monetary easing as countries try to steal demand from each other, falling global trade and declining global growth. That is where we are now. Historically, such a position has been followed by growing use of tariffs and barriers to trade and restrictions on the movement of goods and people. And since everyone likes to find someone else to blame for their own problems - and governments are particularly keen on this - global miserliness tends to lead to social and political unrest, cross-border skirmishes, local conflicts and outright war.

We desperately need a change of attitude. And I think that attitude change must come from the micro, not the macro, level. From individuals changing their behaviour. We need to stop scrimping and saving and learn to enjoy the good life again.

So if you are in the habit of bargain hunting and trying to get something for nothing, think again - especially if you are fortunate enough to be in a secure well-paid job. Look for quality, not price. Expect to pay for quality goods and services. And be generous. It is generosity, not miserliness, that creates prosperity.

Related reading:

Generosity
IMF World Economic Outlook - IMF

Image (unsurprisingly) from http://www.letssavemoney.com/news/article/1225/free-stuff-get-something-for-nothing/. Since they are advising people on how to get something for nothing, I didn't pay for my use of the image. I'm sure they won't mind, will they?

Thursday, 1 October 2015

Capital, liquidity and the countercyclical buffer, in plain English

The FT reports that due to “modest but rising credit growth”, the Bank of England’s Financial Policy Committee (FPC) considered raising banks’ countercyclical capital buffer. According to the FT's Caroline Bingham:
This measure requires lenders to build up capital in good times to draw down in more challenging times. 
And she goes on to say this:
The prospect of yet more capital that banks must set aside would come on top of capital rules on a European and global basis that lenders must implement. They complain that these ever-increasing buffers weigh on their profits and therefore lending ability.
No, Caroline, no. Banks do not "build up" or “set aside” capital. Capital is an integral part of the balance sheet structure. As the Bank of England explains, it is a form of funding:
It can be misleading to think of capital as ‘held’ or ‘set aside’ by banks; capital is not an asset. Rather, it is a form of funding — one that can absorb losses that could otherwise threaten a bank’s solvency.
 And you really shouldn't listen to the complaints of banks. They talk their books. 

Like any corporation, a bank’s balance sheet is made up of assets, which are principally but not exclusively loans, and liabilities (debt), which are principally but not exclusively deposits. The equity of the bank (shareholders’ capital) is the difference between assets and liabilities. The bank is solvent if total liabilities are less than total assets. It is insolvent if total liabilities exceed total assets. This can happen if asset values collapse rapidly, as they did in the 2008 financial crisis. Note that a bank run, in which deposits rapidly leave the bank, does not by itself cause insolvency. It is the associated asset value collapse as the bank is forced to sell assets at fire sale prices to raise cash to fund the run that causes insolvency. I’ve explained this previously – see links at the foot of the post.

What we call “capital” for banks is actually various forms of equity and near-equity. It comes in two flavours: Tier1 capital, which is shareholders' funds, and Tier2 capital, which is debt that can be converted to equity (so-called “convergent contingent” bonds (Co-Cos) and other forms of subordinated debt) and various forms of capital reserve.

Tier1 capital is split into two parts. The largest portion is "Common Equity Tier1", which as the name suggests is entirely equity. The smaller portion, "Additional Tier1", may include perpetual preferred stock.

In the event of the bank suffering losses due to bad loans, it is Tier1 capital that is wiped out first. Shareholders of the bank always lose their money before anyone else. If the bank’s losses are so severe that Tier1 capital is entirely wiped, Tier2 capital is next in line.

Tier1 and Tier2 capital therefore protect creditors from losses. A bank’s creditors are unsecured bondholders, unsecured depositors, insured depositors, secured bondholders (including repo funding from other banks) and the central bank. In the event of a major bank failure, they are wiped in that order.

Clearly, the greater the proportion of capital to debt that a bank has – or, if you like, the greater the “gap” between assets and liabilities - the more losses it can absorb before creditors are affected. 

Capital and leverage ratios define the minimum size of the gap between assets and liabilities that is consistent with providing reasonable protection to creditors against losses. They do so in slightly different ways: the capital ratio (capital/risk weighted assets) uses a view of the asset side of the balance sheet that takes into account the risk of each asset, while the leverage ratio (capital/total assets) ignores risk.

But why not protect creditors completely? Why not force banks to keep the gap between assets and liabilities sufficiently wide to absorb all potential losses from risky lending?

Some people argue that banks should do exactly this. Advocates of “full reserve banking”, in its strictest form, want bank lending to be funded only from banks’ own capital, not from deposits. Their view is that deposits should not be placed at risk. So they want banks to match their stocks of deposits with equally large stocks of risk-free assets – cash “reserves” or government bonds.

Cash reserves are not capital. They are cash deposits at the central bank which are maintained by banks to enable depositors to withdraw funds. Since, generally speaking, depositors don’t all withdraw their funds at the same time, the amount of ready cash that banks keep on deposit at the central bank is usually well under 100% of customer deposit value. In the USA banks are required to keep reserves equivalent to 10% of eligible customer deposits - this is the "reserve requirement ratio" (RRR) . But in Canada and Denmark, the RRR is zero, and banks borrow reserves as needed to settle deposit withdrawal.  In the UK, prior to the advent of QE, the required reserve ratio (RRR) was tailored for each bank individually: however, since QE forces banks to maintain much larger cash deposits at the central bank than they need, the UK’s RRR is currently also zero.

Gold and government bonds are not capital either. They are safe liquid assets. They can be sold quickly and easily to meet depositor demands for withdrawals, reducing the likelihood of the bank needing to borrow emergency funds either from markets or from the central bank.

The “Liquidity Coverage Ratio” defines the proportion of safe liquid assets that banks must hold (in this case “hold” is the correct terminology, whereas it is incorrect for capital) to cover short-term outflows. This is how the Basel Committee explains it:
The objective of the LCR is to promote the short-term resilience of the liquidity risk profile of banks. It does this by ensuring that banks have an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted easily and immediately in private markets into cash to meet their liquidity needs for a 30 calendar day liquidity stress scenario. The LCR will improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy.
So, to summarise: capital requirements influence the overall structure of the balance sheet, and in particular the gap between assets and liabilities, while liquidity requirements influence the structure of the asset side only.

Now, about that countercyclical capital buffer (CCB). The CCB and the RRR serve similar purposes, but on opposite sides of the balance sheet: the RRR affects the asset side of the balance sheet, while the CCB affects the liability side.

Raising the RRR forces banks to hold more of their assets in the form of reserves, reducing their lending capacity. It does NOT mean they have less money to “lend out”. Banks create deposits when they lend: every time a bank lends, therefore, the RRR forces it to increase cash reserves at the central bank by a percentage of the value of the newly created deposit. Clearly, the higher the RRR, the greater the proportion of the balance sheet that is made up of reserves, and the less room there is for other loans. This is how raising reserve requirements discourages bank lending. China makes extensive use of the RRR to control bank lending. 

If the RRR were raised to 100%, banks would have to obtain new reserves from the central bank in advance of lending to ensure that the new deposit was immediately matched 100% by reserves: the new loan asset would be matched by capital or by forms of debt not subject to the RRR. This is “full reserve lending”. Strict "full reserve lending" or "narrow banking" should therefore perhaps be called "full capital lending". 

Historically, central banks have tended to use the RRR to lean against banks’ tendency to over-lend in good times. But since banks’ balance sheets are currently stuffed with excess reserves, the CCB is now a more effective measure.

The CCB is not a “reserve” built up in good times that can be “drawn down in more challenging times”. It is an additional capital requirement that regulators can add to or deduct from the basic Common Equity Tier1 capital requirement, depending on the state of the economy and the behaviour of banks. The European Commission explains it thus:
As the name indicates, the purpose of this buffer is to counteract the effects of the economic cycle on banks’ lending activity, thus making the supply of credit less volatile and possibly even reduce the probability of credit bubbles or crunches. It works as follows: in good times, i.e. where an economy is booming and credit growth is strong, it requires a bank to have an additional amount of CET1 capital. This prevents that credit becomes too cheap (there is a cost to the capital that a bank must have) and that banks lend too much.
When the economic cycle turns, and economic activity slows down or even contracts, this buffer can be “released” (i.e. the bank is no longer required to have the additional capital). This allows the bank to keep lending to the real economy or at least reduce its lending by less than would otherwise be the case.
So the purpose of the CCB is to dampen credit booms and busts.

Bank lending amplifies the natural business cycle, and as we have seen in recent years, can cause disastrous credit crunches and major crashes. Banks enthusiastically lend more and take more risk when times are good, then cut back hard when there is a downturn. As lending increases, the total size of the balance sheet increases but the proportion of equity to total assets (leverage) diminishes. And as banks “risk up”, the proportion of equity to risk-weighted assets (capital ratio) also diminishes. Conversely, when banks cut back, capital ratios rise precipitously. The CCB therefore “leans against” the tendency of capital and leverage ratios to reduce in good times and rise in bad times.

More importantly, the CCB influences lending activity. Banks profit from the spread between the return on their assets and their cost of funds. Equity funding is more expensive than debt, not least because of preferential tax treatment of debt. Increasing the CCB therefore raises banks’ funding cost, forcing them to raise rates to borrowers and/or tighten credit standards. Conversely, the CCB can be reduced in a downturn, lowering banks’ funding cost and therefore encouraging them to reduce interest rates and relax credit standards. 

This, of course, explains why banks complain about the CCB. After all, raising their cost of funding by forcing them to use equity instead of debt hurts their profits, poor darlings, and makes them less willing to lend. That, Caroline, is its purpose. 

Related reading:

The equivalence of debt and equity
Anatomy of a bank run
Cleaning up the mess
Liquidity matters
Bank capital and liquidity - Bank of England
CRD IV: Frequently asked questions - European Commission
The Bankers' New Clothes - Admati & Hellwig (book)

I've expanded the section on Tier1 and Tier2 capital slightly after complaints from some readers that it was over-simplified in the original version of this post. However, I've still kept it simple and have deliberately not gone into detail about the additional capital layers in CRD IV, of which the CCB is one. For a more detailed explanation of CRD IV regulatory capital structure, please read the European Commission's Q&A in the links above.