Friday, 27 May 2016

The Eurogroup statement on Greece, annotated

The Eurogroup (part of which is pictured above) has produced a statement on the outcome of the latest debt talks with Greece. As ever with Eurogroup statements, it confuses more than it enlightens. So here is my attempt at translating Eurogroup-speak into plain English.
The Eurogroup welcomes that a full staff-level agreement has been reached between Greece and the institutions. 
Phew. We got that through before the Brexit referendum.
Also, the Eurogroup notes with satisfaction that the Greek authorities and the European institutions have reached an agreement on the contingency fiscal mechanism, which is in line with the Eurogroup statement adopted on 9 May in particular as regard the possible adoption of permanent structural measures, including revenue measures, to be agreed with the institutions. It therefore provides further reassurances that Greece will meet the primary surplus targets of the ESM programme (3.5% of GDP in the medium-term), without prejudice to the obligations of Greece under the SGP and the Fiscal Compact.
Up yours, IMF. Greece has agreed to do "whatever it takes" to achieve that 3.5% primary surplus target that you say is unrealistic. Though there is a bit of a problem....
The Eurogroup also welcomes the adoption by the Greek parliament of most of the agreed prior actions for the first review, notably the adoption of legislation to deliver fiscal parametric measures amounting to 3% of GDP that should allow to meet the fiscal targets in 2018, to open up the market for the sale of loans and to establish the agreed Greek Privatisation and Investment Fund that should operate in full independence.
Greece didn't do everything it agreed to do last year. So it might not do what it has now agreed to do, either. But we know how to deal with this....
The Eurogroup mandates the EWG to verify in the next few days the full implementation of the outstanding prior actions on the basis of an assessment by the institutions, in particular the corrections to the legislation on the opening up of the market for the sale of loans, and on the pension reform, as well as the completion of all prior actions related to the government pending actions in the field of privatization.
Yup, we are sending in the bailout monitors again. They'll soon whip Greece into line.
Following the full implementation of all prior actions and subject to the completion of national procedures, the ESM governing bodies are expected to endorse the supplemental MoU and approve the disbursement of the second tranche of the ESM programme.
The second tranche under the ESM programme amounting to EUR 10.3 bn will be disbursed to Greece in several disbursements, starting with a first disbursement in June (EUR 7.5 bn) to cover debt servicing needs and to allow a clearance of an initial part of arrears as a means to support the real economy. The subsequent disbursements to be used for arrears clearance and further debt servicing needs will be made after the summer.
We might lend Greece some money to tide it over.....
The disbursements for arrears clearance will be subject to a positive reporting by the European Institutions on the clearance of net arrears. The additional disbursement for debt servicing needs will be subject to milestones related to privatization, including the new Privatization and Investment Fund, bank governance, revenue agency and energy sector to be assessed by the European institutions and verified by the EWG and the ESM Board of Directors.
....but only when we know for certain it has done all that we have agreed.
In line with the 9 May Eurogroup statement, and in view of the forthcoming full implementation of all the prior actions by Greece and completion of the first review, the Eurogroup considered today the sustainability of Greek public debt.
The Eurogroup agrees to assess debt sustainability with reference to the following benchmark for gross financing needs (GFN): under the baseline scenario, GFN should remain below 15% of GDP during the post programme period for the medium term, and below 20% of GDP thereafter. 
We will discuss debt relief with a view to doing as little as possible. Preferably, nothing.
The Eurogroup recalls the medium-term primary surplus target of 3.5% of GDP as of 2018 and underlines the importance of a fiscal trajectory consistent with the fiscal commitments under the EU framework.
Of course, if Greece does "whatever it takes" to achieve that 3.5% primary surplus target, we won't have to offer debt relief. And if it doesn't achieve that target, we can refuse to offer it on the grounds that Greece hasn't done what was agreed. This is looking good.
The Eurogroup recalls the following general guiding principles agreed on 9 May for possible additional debt measures: (i) facilitating market access in order to replace over time public financed debt with privately financed debt; (ii) smoothening the repayment profile; (iii) incentivising the country's adjustment process even after the programme ends; and (iv) flexibility to accommodate uncertain GDP growth and interest rate developments in the future.
Oh, if only there were more private sector debt. Then we wouldn't have to worry about whether Greece can actually afford the repayments. We could simply impose losses on the private sector like we did in 2012.
On 9 May the Eurogroup also reconfirmed that nominal haircuts are excluded, and that all measures taken will be in line with existing EU law and the ESM and EFSF legal frameworks.
We want our money back. All of it.
Guided by these principles and on the basis of technical work carried out by the EWG, the Eurogroup agreed today on a package of debt measures which will be phased in progressively, as necessary to meet the agreed benchmark on gross financing needs and will be subject to the pre-defined conditionality of the ESM programme.
Poul doesn't want to play "let's all agree to an impossible target". But Mutti says we all have to play together nicely. It's not fair.
For the short-term, the Eurogroup agrees on a first set of measures which will be implemented after the closure of the first review up to the end of the programme and which includes:
  • Smoothing the EFSF repayment profile under the current weighted average maturity

  • Use EFSF/ESM diversified funding strategy to reduce interest rate risk without incurring any additional costs for former programme countries

  • Waiver of the step-up interest rate margin related to the debt buy-back tranche of the 2nd Greek programme for the year 2017
The Eurogroup asks the EFSF and ESM management to take these measures forward within their mandate, on the basis of preparatory work by the EWG, and where needed to prepare formal decision making by the relevant EFSF and ESM decision-making bodies. The decision on the smoothening of the EFSF repayment profile and the reduction of interest rate risks should be taken as a matter of priority.
Klaus is our friend. He will make sure that these measures don't amount to debt relief
For the medium term, the Eurogroup expects to implement a possible second set of measures following the successful implementation of the ESM programme. These measures will be implemented if an update of the debt sustainability analysis produced by the institutions at the end of the programme shows they are needed to meet the agreed GFN benchmark, subject to a positive assessment from the institutions and the Eurogroup on programme implementatiom.
  • Abolish the step-up interest rate margin related to the debt buy-back tranche of the 2nd Greek programme as of 2018

  • Use of 2014 SMP profits from the ESM segregated account and the restoration of the transfer of ANFA and SMP profits to Greece (as of budget year 2017) to the ESM segregated account as an ESM internal buffer to reduce future gross financing needs.

  • Liability management - early partial repayment of existing official loans to Greece by utilizing unused resources within the ESM programme to reduce interest rate costs and to extend maturities. Due account will be taken of exceptionally high burden of some Member States.
  • If necessary, some targeted EFSF reprofiling (e.g. extension of the weighted average maturities, re-profiling of the EFSF amortization as well as capping and deferral of interest payments) to the extent needed to keep GFN under the agreed benchmark in order to give comfort to the IMF and without incurring any additional costs for former programme countries or to the EFSF.
Poul says he means it about debt relief. So to keep him happy, we will talk about debt relief. It's a racing certainty we won't ever have to deliver it.
For the long-term, the Eurogroup is confident that the implementation of this agreement on the main features for debt measures, together with a successful implementation of the Greek ESM programme and the fulfilment of the primary surplus targets as mentioned above, will bring Greece's public debt back on a sustainable path over the medium to long run and will facilitate a gradual return to market financing.
Debt relief won't be needed. Ever.
At the same time, the Eurogroup agrees on a contingency mechanism on debt which would be activated after the ESM programme to ensure debt sustainability in the long run in case a more adverse scenario were to materialize. The Eurogroup would consider the activation of the mechanism provided additional debt measures are needed to meet the GFN benchmark defined above and would be subject to a decision by the Eurogroup confirming that Greece complies with the requirements under the SGP. Such mechanism could entail measures such as a further EFSF reprofiling and capping and deferral of interest payments. Also, the Eurogroup commits to long-term technical assistance to boost Greek growth. 
We are going to make damned sure that debt relief won't be needed.
The Eurogroup recognises that over the exceptionally long time horizon of assessing debt sustainability there can be no forecasts, only assumptions, given the sizable degree of uncertainty over macroeconomic developments.
Anyway, the IMF's forecasting record is abysmal. No-one takes their prognosis seriously.
Against the background of the forthcoming successful completion of the first review and the agreement on debt relief, the Eurogroup welcomes the intention of the IMF management to recommend to the Fund's Executive Board to approve a financial arrangement before the end of 2016 that will support the implementation of the agreed fiscal and structural reforms.
 Poul will play by our rules. Herr Doktor Schaueble has told us so.
It is recognised that, consistent with IMF policies, approval of this arrangement will also be based on a new DSA and the assessment of possible debt relief measures mentioned above. 
The IMF will change its silly estimates to be consistent with our view that Greece can maintain a fiscal surplus of at least 3.5% forever.
The possible debt relief will be delivered at the end of the programme in mid-2018 and the scope will be determined by the Eurogroup on the basis of a revised DSA in cooperation with the European Institutions for purposes of taking into account the European policy framework, subject to full implementation of the programme.
The Germans want us to delay any further discussion of debt relief until after their elections. By that time Greece will have delivered the 3.5% primary surplus anyway, so we won't need to discuss it. And if it hasn't, we still won't need to discuss it.
The Eurogroup stands ready, in line with usual practice, to support the completion of future reviews provided that the policy package considered today, including the contingency mechanism, is implemented as planned.  The Eurogroup confirms that programme implementation, as well as policy conditionality and targets, will be reviewed regularly based on input from the institutions.
Did we mention that Greece must deliver that 3.5% primary surplus?


Image courtesy of the EU press office. 

Have we done enough to prevent another financial crisis?

Notes from a talk given at Trinity Business School, Dublin, on 26th May 20164

Well, it depends what sort of crisis you mean. Have we done enough to prevent a crisis like the last one?

Yes. We have scared ourselves so much about the dangers of disorderly bank failure that no way are we going to allow that to happen again – at least, not until we who lived through the crisis, and our children and grandchildren whom we tell about the crisis, are long gone and our legacy forgotten. No-one now would allow a bank like Lehman to fail. We might close it down, but we wouldn’t simply allow it to go bankrupt overnight.

We learned from the 2008 crisis that systemically-important banks must not be allowed to fail. And since we do not really know which banks are systemically important and which are not, that means that anything large enough to save, must be saved. Only very tiny banks can fail. The rest will be rescued, one way or another.

Most often, banks are rescued by merging them with other banks. But we have paid a price for this. Banking systems are now much more concentrated than they were. The UK has lost its entire middle tier of banks, not because of the high profile failures of RBS and HBOS, but because of the fallout in the mutual sector. In Ireland, there are now only two major banks. Greece has only four. Cyprus is down to two. Such concentration is bad for customers, since it reduces the competitive pressures that give customers choice and encourage banks to provide good service and value for money. And even more worryingly, such concentration increases the chance of bank failure leading to systemic meltdown.

But we also learned from the last crisis that we cannot risk meltdown of the financial system. So we put our faith in centralised institutions – not only central banks, but also things like CCPs. We transferred increasing amounts of responsibility to regulators, because we don’t trust the managers of financial institutions. We substituted public sector safe assets for the private sector assets that failed us. And we demanded that political institutions ensure that there can never be another failure like the last one.

Political institutions have done a huge amount. Higher capital requirements for banks, solvency requirements for insurance companies, liquidity buffers, new measures of solvency and liquidity, macroprudential and microprudential regulation, conduct regulation, stress tests. Never have we had such intrusive regulation and control. 

But political institutions themselves are fallible. After all, regulators failed to address the excessive leverage and risky behaviour of financial institutions prior to the financial crisis. And the regulatory focus can be far too narrow. The spotlight is on banks and insurance companies: but intense regulation tends to drive dangerous activities into the shadows. The shadow banking sector is bigger than ever. And new providers in retail banking and payments are disrupting traditional banking models. If history is any guide, the next crisis is more likely to arise from these exciting new ventures than from our sclerotic banks.

Regulators and central banks are not the only institutions that failed to prevent a crisis. Two years after Lehman fell, it became apparent that Eurozone institutions had failed to address the excessive leverage and risky behaviour of Greece. 

Greece’s crisis could also have been blamed on banks. But the world chose to believe, with some justification, that the fundamental problem was corrupt and dishonest government. Suddenly, populations around the world decided that the large deficits that were the legacy of the financial crisis had to cut back, and voted in governments that would do the necessary fiscal butchery. No-one wanted to risk being another Greece.

Loss of faith in government was even more damaging than loss of trust in banks. The austerity measures voluntarily and involuntarily inflicted by governments squashed the green shoots of recovery. The result was years of stagnation and lost output. Arguably – in Europe, at least – the Eurozone crisis has had more lasting effects than the fall of Lehman.

All crises are political. They just manifest themselves in different ways. So the 2008 financial crisis was political, both the decision to allow Lehman to fail and the preceding decisions to bail out Fannie & Freddie, Bear Sterns and – in Europe – Northern Rock and BayernLB, decisions which raised expectation of bailout.

And the sovereign debt crisis was also political. It was not really about Greece, Portugal, Ireland, Spain….it was all about the Euro project. The European elites will do “whatever it takes” to preserve their dream of one currency for one continent, even if that means decades of depression for some countries and the destruction of the hopes and dreams of an entire generation.

So have we done enough to prevent another crisis?

No. We have not changed the core beliefs that generate crisis. Indeed, they are hard for us to recognise, let alone change. They are deeply rooted in our history and even our biology. Belief that there can be returns without risk, and gains without losses: that safety is cost-free; that following the herd is wise, and being contrarian is dangerous; that saving is good and borrowing, bad; that surpluses are a sign of strength, and deficits, weakness; that good luck is due to talent, and wealth the result of hard work. These are the beliefs that lead to crisis. These are still our beliefs.

The story of the post-crisis years is one of asset owners desperately trying to hold on to wealth, wealth that they accumulated in the boom years and are now reluctant to relinquish. The losses that they should have taken in 2008 were pushed on to governments: then when governments failed, the losses were pushed on to the silent majority. They have now endured years of unemployment, falling real wages and cuts to pensions and benefits. And for some, there is no end in sight. Politically this is unsustainable.

We cannot see where the next crisis will come from. But of one thing I am sure. It will not be like the last crisis: but in our inadequate response to the last crisis, and our failure to recognise the source of all crises in our own irrational beliefs, we are already sowing the seeds of the next.

Tuesday, 24 May 2016

Where on earth is growth in Greece going to come from?

It's not going to come from people working more. Excerpt from the IMF's latest Debt Sustainability Analysis for Greece, just released:

Oh dear. Quite apart from the negative contribution to growth, the prospect of unemployment taking 44 years to return to something approaching normality is simply appalling for Greece's population. I've looked in more detail at this here (Forbes).

Well, if labour isn't going to drive growth, there's always investment, yes?

Er, not really. The outlook for capital investment doesn't look too good either:

Yeah, about that financial sector.....Greek banks are still in crisis, it seems. The IMF thinks they will need another 10bn Euros on top of the 43bn they have already received, and even with this, they aren't going to lend. And they aren't worth anything, so can't even be sold to raise money. Greek banks are zombies, and like all zombies, they drain the lifeblood of their victims. They are a serious obstacle to Greek economic recovery.

So if people aren't going to work more, banks aren't going to lend, and there isn't going to be much in the way of investment, where is the growth going to come from?

Aha. Structural reforms, of course!

So the IMF doesn't believe Greece can deliver the pace of structural reforms that would be needed to deliver TFP growth much above 1 percent. No-one should be surprised by this. The remarkable thing is that anyone ever thought it could.

And that means that the outlook is poor - for the foreseeable future. A long-run growth rate of 1.25 percent - or more likely less - in an economy that has shrunk by 27 percent in the last seven years, means that Greece effectively faces decades of depression.

Whatever fiscal sins successive Greek governments may have committed, I find it hard to believe that the Greek people deserve such hardship.

Related reading:

Debt Sustainability Analysis, Greece, May 2016 - IMF
IMF predicts unemployment in Greece will fall to 12 2040 - Forbes
The Economic Consequences of the Eurozone - Forbes
Morality in the Greek crisis

Thursday, 19 May 2016

Keynes and the Quantity Theory of Money

"Best diss of the Quantity Theory of Money comes from Keynes", commented Toby Nangle on Twitter, referring to this paragraph from Keynes's Open Letter to Roosevelt (Toby's emphasis):
The other set of fallacies, of which I fear the influence, arises out of a crude economic doctrine commonly known as the Quantity Theory of Money. Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor.
But is Keynes really dissing the Quantity Theory of Money (QTM)? He is objecting to the way in which it is used, and the policies that are derived from it.

The QTM itself is an identity:


where M is the quantity of money in circulation, V is its velocity, P is the general price level and Y is output.

As this is an identity, it tells us nothing at all about the direction of causation. Indeed, in this form, MV is the dependent variable and should be regarded as responding to changes in PY, not vice versa.

But the identity can equally be written PY = MV.  And in this quotation, Keynes himself uses it in this way:
Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. 
We can use the QTM to explain this. If M is fixed, then when Y is rising either V must rise (money must circulate faster, which implies people spending more frequently) or P must fall. But when P is falling, people tend to delay purchases, which slows the velocity of money. So falling P tends to be associated with falling, not rising, V. Thus, if M is fixed, Y will eventually stagnate or even fall.  M should be allowed to rise as Y rises, keeping the price level stable.

So, far from dissing it, Keynes in effect used the QTM himself.

And yet he is definitely critical of it. So what is he really complaining about?

His objection is to ACTIVE expansion of the money supply in order to stimulate output. This is apparent from the final sentence:
It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor.
Putting this differently, we can say that although holding M fixed eventually prevents Y from rising (limiting factor), increasing M when Y is stagnant does not necessarily kick it into rising. Whether it does, depends on people's willingness to increase spending.

Apologists for the QTM tend to insist that increasing the money supply must stimulate spending: if people have more money they will spend it, duh. But this depends on other things. Really rather fundamental things, in fact.

The first concerns what we mean by "money". In its pure monetarist form - and I confess I have used it in this way myself - M is defined as the monetary base, M0. Arch-monetarists will tell you that increasing the monetary base increases economic activity, so all that is needed to get economies moving after a slump is lots and lots of QE. I'm afraid on this I am in agreement with Keynes. It is bunk. Increasing the monetary base alone is incapable of getting economies moving. A brief glance at Japan is more than enough to tell us this.

The problem is that in the modern monetary system, only a small proportion of money in circulation is monetary base. The rest is what we call "broad money", which is created by banks in the course of lending. And when banks are damaged, they don't lend. No, let me widen that. When private sector balance sheets are damaged - people are over-indebted, their credit ratings are shot to pieces and they are struggling to service their existing debts - banks don't lend and people don't borrow.

It's self-reinforcing: banks tighten credit standards to shore up their highly risky balance sheets just when the balance sheets of households and businesses are at their most fragile. We blame banks for not lending, while simultaneously demanding that they make themselves less risky: we blame businesses for not borrowing to invest in new capacity, while simultaneously encouraging households to cut back spending in order to pay down debt and save for the future. And into the middle of this steaming pile of double standards and conflicting messages, we pour enormous amounts of monetary base, in the mistaken belief that it will encourage banks to lend and people to spend. The truth is that it has very little effect on either.

Banks do not use monetary base for lending. Adding huge quantities of monetary base to the system does not make them lend. Again, a brief glance at anywhere that has been doing QE in any quantity is easily enough to tell us this. Broad money creation does not depend on the amount of M0 in the system. It depends on the willingness of banks to lend, and the willingness of households and businesses to borrow. And that depends on the health of private sector balance sheets. When private sector balance sheets are badly damaged, broad money stagnates, and no amount of monetary base will make any difference.

Keynes did not explain exactly why adding monetary base to the system makes no difference when private sector balance sheets are damaged. For that insight, we need to look to Richard Koo. But Keynes understood the effect. Adding monetary base to the system when banks do not want to lend and people do not want to spend is like "pushing on a piece of string". Or perhaps like leading a horse to water. If the horse does not want to drink, it will not, even if it is presented with the River Nile.

But central banks can also add broad money to the system, if they buy securities directly from businesses and households rather than from banks. Does this work any better?

Not much, frankly. And this brings me to my second fundamental point. If what you want is to encourage people to spend, you must increase the money available to those most likely to spend it.

Simply buying the assets of the rich is not going to make much difference to economic activity. They will spend the money, yes - on other assets. But down at the grass roots level, businesses will still be struggling to find anyone to buy their goods and services, because the people who buy these things are not the rich - they are ordinary people who are underpaid, over-indebted and struggling to make ends meet. The people most likely to spend, given more money, are the poor, not the rich. So I might take a more nuanced view than Keynes. Loosening the belt can make the belly fatter, if the way in which the belt is loosened means the people with more money to spend are those most likely to spend it.

This may or may not mean an increase in broad money. It could simply mean redistribution of existing broad money. Soak the rich, in short. Or tax their unproductive investments (yes, I know, this is heresy).

Insufficient attention is paid in QTM-land to distributional niceties. And yet the distribution of money is as important as its quantity. If the majority of the money in the economy is held by a few, who circulate it among themselves to buy investment assets, then adding more money inflates the prices of those assets while output stagnates and the prices of goods and services used by ordinary people fall.

So helicopter money would be far better than QE as a monetary stimulus. But as John Kay points out, helicopter money is deficit spending, really. And this brings me to my third fundamental point.

Expanding the monetary base with QE while simultaneously reducing government spending and raising taxes to "fix the fiscal finances" is a wash. No, it's worse than that. It transfers money from households who would actually spend that money on goods and services, and businesses who would invest it for future growth, to banks and the rich, who only spend it on assets. The wealth effects from inflated asset prices may at the margin encourage more spending among those foolish enough to borrow (or dis-save) on the strength of unrealised capital gains, while the depressed interest rates that are the inevitable consequence of inflated asset prices may also encourage borrowing by those who would struggle to service debts if interest rates were higher. I am constantly amazed that any policymaker thinks that such unwise behaviour is to be encouraged.

 Deficit spending would be both safer and more effective than flooding banks with reserves and blowing up asset price bubbles. But we have tied ourselves into a ridiculous straitjacket because of wholly unjustified fear of government debt. So now we propose helicopter money and "people's QE" as a way of doing deficit spending while pretending we are not. Is anyone really fooled?

I leave the last word to Keynes, from the same letter to Roosevelt.
In the field of domestic policy, I put in the forefront, for the reasons given above, a large volume of Loan-expenditures under Government auspices. It is beyond my province to choose particular objects of expenditure. But preference should be given to those which can be made to mature quickly on a large scale, as for example the rehabilitation of the physical condition of the railroads. The object is to start the ball rolling. The United States is ready to roll towards prosperity, if a good hard shove can be given in the next six months. Could not the energy and enthusiasm, which launched the N.I.R.A. in its early days, be put behind a campaign for accelerating capital expenditures, as wisely chosen as the pressure of circumstances permits? You can at least feel sure that the country will be better enriched by such projects than by the involuntary idleness of millions.
Deficit spending - even dressed up as helicopter money - is a whole lot less scary than stagnation and lost output. Get on with it.

Related reading

When Wonks Get Things Wrong - Pieria

Sunday, 8 May 2016

The safe asset scarcity problem, 2050 edition

S&P forecasts a serious shortage of safe assets by 2050 if the developed nations, in particular, do nothing to adjust their fiscal finances in the light of ageing populations. This has serious implications for government and investor behaviour - and the future of the ratings agency that issued it.

Here is S&P's hypothetical sovereign ratings chart out to 2050. Yes, ratings - although as we shall see, ratings will become largely irrelevant in the weird world of the future.

Clearly the price of sovereign bonds will rise significantly, particularly for those in the three "A" categories. S&P doesn't indicate which nations would be the issuers of these rare breeds, but it is a fair bet that their sovereign bonds are already trading at negative rates for some distance along the yield curve. So we are looking at fully negative yields for certain countries in the not too distant future.

The "A" team

These countries will be paid to borrow. Of course, no-one will really want to buy interest-bearing bonds: zero-coupon bonds would trade at a premium. But the extreme scarcity of safe assets would mean these countries can issue whatever they like. So these countries will refinance existing debt and lock in negative rates for as long as they possibly can, And from their issued debt, they will earn enough to fund a large part of their state pension liabilities. For these countries - the primary producers of an extremely scarce and very valuable commodity - their own sovereign debt will become an asset, not a liability.

Of course, they will have to ensure they keep their "rare breed" status. So along with negative rates would go fiscal policies to maintain a primary surplus and encourage saving and investment. The capital share of income would have to be rather high. For an elderly society, this should be ok. Capital tends to be owned by the old, and although pensioners don't generally save, they do live on the returns from capital.

However, nominal returns on investment in these countries will be very low, and nominal interest non-existent. Pensioners would have to dis-save rather than live on interest income, and rely on negative rates and deflation to maintain the real value of their capital even though the nominal amount is reducing. This is pretty scary for your average golden ager suffering from money illusion. We would therefore expect severe demand deficiency as ageing populations adopt frugal lifestyles due to inadequate interest income and worry that their savings will run out before they die. Deflation would be deeply entrenched and unresponsive to central bank policy. 

And this creates something of a problem. Negative yields along the entire sovereign yield curve imply either deeply negative policy rates or an inverted curve. Which of these applies depends on the central bank's response to entrenched deflation. Does it accept that an elderly society is naturally deflationary, and simply maintain policy rates sufficiently low to ensure that government can afford its pension liabilities (it's a wonderful thing, having complete control over the supply of a very scarce and very valuable commodity)? Or does it try to curb deflation?

If the central bank decided to try to curb deflation, it would have to raise (not lower) short interest rates and sell (not buy) its own sovereign debt - hence the curve would be inverted. This should be obvious if you consider that in a fully negative carry environment, debt is the issuer's asset and savings are a liability. If balance sheets are reversed, so must be policies aimed at influencing portfolio decisions.

But using monetary policy alone to push back on the economic effects of a demographic shift is like trying to hold back the tide. It won't work, and you risk being washed away. In my view, monetary policy in these countries would be far better used to support a fiscal policy that guarantees reasonable income to the old and thus puts a floor under demand. Both must be credible over the longer-term, otherwise the old will save the money in case the income is withdrawn by a future government. There could be an argument for insulating this form of fiscal/monetary cooperation from the political cycle, perhaps by using some form of Fiscal Council.

So the A-team should embrace negative yields, negative rates and deflation. For them, these are benign.

The B-team

A large number of sovereigns will fall into this category. Many, though not all, will also have ageing populations.

The problem that S&P highlights is the fact that elderly entitlement programmes in these countries assume a much larger working population earning far more money than is likely to be the case. These governments would struggle to raise the money from taxing younger people to pay generous pensions to the old, and unlike the A-team would not be able to cover pension obligations from earnings on negative-rate debt.

Nonetheless, these governments will be able to borrow more cheaply than they can at present. After all, there will be a severe shortage of safe assets. And when there is a severe shortage of anything, people look for cheaper substitutes as prices rise. B-team bonds are still investment grade, and far more plentiful than the gold-plated A-team bonds. Investors prepared to accept some risk in return for a lower price would be likely to opt for these. So bonds with a "bbb" rating in 2045 would be significantly more expensive than bonds with a "bbb" rating now, and yields correspondingly lower - with spillovers to corporate bonds too. There wouldn't be much in the way of interest income for investors in these countries, though capital would appreciate nicely.

So pensioners would have a double income problem: interest on savings would deliver little, and government would be under pressure to cut entitlements. Shifting the balance of pension provision more towards the private sector would not solve this problem. In the end, all pensions must be paid from the earnings of younger people, either through taxation and redistribution or through higher saving to increase the capital share of income. (If this isn't clear, I recommend reading John Eatwell's paper.)

We would expect these economies, like the A-team, to suffer severe demand deficiency as both the old AND the young adopt frugal lifestyles, the old because they are income deficient and the young because of high - probably compulsory - saving and/or high taxes. Deflation would be widespread, and central banks would be under pressure to counter it. If present practice is anything to go by, very low or negative policy rates and persistent QE would be the order of the day. S&P's chart tells us that today's "exceptional" monetary policy is in fact the new normal.

So what is the solution? Well, first we need to understand what the problem really is. S&P would like us to believe that these governments must "do something" to fix the damage to their fiscal finances caused by rising unfunded pension commitments. But I think this entirely misses the point. It is not governments that need to change their behaviour, but investors who need to change their attitude.

In a demand-deficient economy, squeezing household incomes with higher taxes, entitlement cuts and compulsory saving does not "fix the fiscal finances". It makes them worse, as falling output destroys the tax base. And this makes government debt less safe, not more. Tolerating higher debt/gdp may actually be in investors' own interests.

Indeed, if the world is to raise output sufficiently to support all these pensioners - including those in the A-team countries - B-team governments will probably have to spend a lot more. When the private sector is determined to save instead of spending, governments need to spend, even if this means much higher government debt/gdp. Public investment, demand support (such as a basic income) and targeted welfare all help to revitalise economies.

In the world of the future, interest rates will be persistently very low. B-team sovereigns will be able to borrow cheaply, and those that have their own central banks (which ideally would be all of them) can support the price of their sovereign debt. Innovative products such as GDP-linked bonds could be used to relax the government borrowing constraint. And risk-averse investors faced with severe safe asset shortages will have little alternative but to fund them.

I wonder whether, in the safety-scarce world of the future, we might see a power reversal. Rather than governments fearing a buyer's strike, perhaps investors will fear a government strike. A government that refused to sell its bonds to investors who demanded policies it considered harmful would be quite something.

The junk team

According to S&P the junk team could be as large as 25% of all countries by 2050. This is laughable. The world is getting richer, not poorer - yet sovereigns are becoming riskier? Really?

Even in the junk team, the safe asset squeeze is likely to depress interest rates. And these countries compete with other risky asset providers such as startups. So interest rates for even quite risky prospects could be significantly lower than they are now.

But risky though they are, these countries are likely to be those with the best growth prospects. In a world of deflation and stagnation, is it really sensible to regard the only bright spots as "speculative"? They will be the principal sources of global growth, and as such far more promising - and arguably safer over the longer-term - as investments than the moribund bonds of declining civilizations.

So investors need to change their attitude to these, too. Unless there is stable long-term investment in the junk team, neither the B-team nor the A-team can be regarded as "safe". The fortunes of the junk team are crucial for the survival of the rest.

And finally....

The future of ratings agencies

It's a great chart. But what it is really telling us is that S&P's way of assessing the creditworthiness of sovereigns belongs to a bygone age. In the new world, junk is safe, debt is an asset and investors fear governments. So ratings will be meaningless in future, and ratings agencies, redundant.

So long, S&P. It's been nice knowing you.

Related reading:

In the countries of the old
Rethinking government debt
Bond yields and helicopters
The liquidity trap heralds fundamental change
When governments become banks
The land of the setting sun - Pieria
The foolishness of the old - Pieria

Saturday, 7 May 2016

Pilate's game

After the Welsh Assembly elections - in which UKIP did rather well - I had a Twitter exchange with an angry Welshman. He said:

I challenged this, of course. But in the ensuing heated discussion, I misquoted him:

As far as I am concerned, I misquoted him because I had not remembered his tweet accurately. Memory is fallible. But as far as he is concerned, I misquoted him because I am a liar. We do not disagree on the facts, but on their interpretation. Who is right?  What is the truth?

In Greece, the Debt Truth Committee has drawn together facts about the origins of Greece's debt. And from this, it has deduced what it believes to be the truth. Greece's debt is odious and should be rejected. But others, even if they agree with the facts, disagree with the conclusions drawn from them. For them, Greece owes this money and should pay it in full. Who is right? What is the truth?

Legal systems exist to establish the truth. Facts (evidence) are important, but they are insufficient to establish truth: there must be a plausible psychological case (motivation) too. And establishing truth is only possible when everyone tells the truth as they see it. Many legal systems require participants to swear a solemn oath promising to tell "the truth, the whole truth and nothing but the truth". Most enact severe penalties for lying to the court (perjury). The reason is evident: the court has no means other than the testimony of witnesses of establishing the truth, so if witnesses lie, miscarriage of justice is inevitable.

Miscarriages of justice are not only lethal for those wrongly convicted, they are socially destabilising: a legal system seen as arbitrary and discriminatory does not long survive. It is no accident that "Thou shalt not bear false witness" is one of the Ten Commandments. Life and death decisions depend upon establishing the truth, not simply the facts.

But what exactly do we mean by "truth"?

The question "what do we mean by truth" reverberates down the centuries. The trial of Jesus* includes an extraordinary round of verbal sparring in which - unusually - Jesus does not have the last word. "The reason I was born and came into the world is to testify to the truth", says Jesus. "Everyone on the side of truth listens to my voice".

Pilate's riposte is one of the most famous lines in the Bible: "What is truth?"

Thinking he has proved that Jesus is just a harmless nutter, Pilate goes out to the crowd and says "I find no basis for a charge against him". He wants to let Jesus go. But the crowd - whipped up by powerful individuals - insists that Jesus must die.

Are they right? Is the majority view the truth? An entire religion has been built on trying to explain and justify Pilate's decision to give in to the crowd. And thousands - nay, millions - have died over the centuries because of that decision. With hindsight, the decision of the crowd has been seen by many to be a terrible mistake. But we still do not "objectively" know whether Jesus deserved execution under Roman law. And we never will. We can never objectively know what motivates an individual to do as they do. They may not even know themselves.

Truth is subjective. My "truth" (that I unintentionally misquoted) is different from my antagonist's "truth" (that I lied). And the onlookers are no more objective. All they have is the fact that I misquoted, my antagonist's assertion that I lied, and my claim that I misquoted because my memory was faulty. And they are swayed by their own knowledge of previous behaviour by both sides, and perhaps also by other influential voices. Those who know me are likely to believe that I made an innocent mistake, unless their previous experience of me is that my word is untrustworthy. Those who know my antagonist are more likely to believe that I am a liar. So if "who is right" is determined by the crowd, whether or not I am a liar depends entirely on whether I have more supporters than my antagonist. There is no "objective truth".

 It is therefore disturbing that, in a piece by Ethereum's creator Vitalik Buterin about "subjectivocracy", he implicitly assumes that there must always be an objective truth. This, for example:
Objectivity has often been hailed as one of the primary features of Bitcoin, and indeed it has many benefits. However, at the same time it is also a curse. The fundamental problem is this: as soon as you try to introduce something extra-cryptoeconomic, whether real-world currency prices, temperatures, events, reputation, or even time, from the outside world into the cryptoeconomic world, you are trying to create a link where before there was absolutely none. To see how this is an issue, consider the following two scenarios:
  • The truth is B, and most participants are honestly following the standard protocol through which the contract discovers that the truth is B, but 20% are attackers or accepted a bribe.
  • The truth is A, but 80% of participants are attackers or accepted a bribe to pretend that the truth is B.
From the point of view of the protocol, the two are completely indistinguishable; between truth and lies, the protocol is precisely symmetrical.
There is, of course, a third possibility: the participants do not know the truth but are expressing their own validly-held opinions. They do not have to be liars or attackers to get it wrong. They just need to be ignorant or biased.

So, let's re-run Jesus's trial using Buterin's subjectivity criteria, as laid out here:
The power behind subjectivity lies in the fact that concepts like manipulation, takeovers and deceit, not detectable or in some cases even definable in pure cryptography, can be understood by the human community surrounding the protocol just fine. To see how subjectivity may work in action, let us jump straight to an example. The example supplied here will define a new, third, hypothetical form of blockchain or DAO governance, which can be used to complement futarchy and democracy: subjectivocracy. Pure subjectivocracy is defined quite simply:
  • If everyone agrees, go with the unanimous decision 
  • If there is a disagreement, say between decision A and decision B, split the blockchain/DAO into two forks, where one fork implements decision A and the other implements decision B.
All forks are allowed to exist; it’s left up to the surrounding community to decide which forks they care about. Subjectivocracy is in some sense the ultimate non-coercive form of governance; no one is ever forced to accept a situation where they don’t get their own way, the only catch being that if you have policy preferences that are unpopular then you will end up on a fork where few others are left to interact with you.
Clearly, there isn't a unanimous decision. Having met Jesus, Pilate disagrees with the crowd. He has information that the crowd doesn't have. But the crowd isn't prepared to back down. So in Buterin's cryptographic world, the blockchain would be split. Decision A would be to let Jesus go: decision B would be to execute him. The community decides Jesus's fate.

Pilate is now "on a fork where few others are left to interact with him". Decision A is not possible, because the community decision is B, and the choice is binary (Jesus either lives or dies). Pilate has lost. It is simply untrue to say that "no-one is ever forced to accept a situation where they don't get their own way". When the choice is binary, anyone on an isolated fork must either accept the majority decision or leave the game. Pilate cannot get his own way, because if he overrides the community decision the crowd will riot and he will lose at least his job and possibly his life.  His solution - publicly washing his hands of the whole thing - amounts to leaving the game.

So the community decides to execute Jesus, and the only dissenter is forced to leave the game. Whether or not "Jesus deserves to die" is objectively true is irrelevant. Using Buterin's logic, the community decision IS the truth. Jesus deserves to die. Sorry, Christians.

To reach the position "Jesus deserves to die", it is not necessary to assume that anyone is lying or malicious. It is only necessary to assume that people have conflicting beliefs. The majority believes that Jesus is dangerous and should be put to death. Pilate's different view is insufficient to change their minds, even though it is based on better information. People are only too ready to discard or ignore information that contradicts strongly-held beliefs, especially when that information comes from a less than trusted source. Confirmation bias doesn't disappear in a cryptographic environment.

Now, Buterin does recognise the possibility that the majority might make an objectively wrong decision out of ignorance. But his solution to this presupposes that there is some way of establishing objective truth using markets. (For goodness' sake, Vitalik, there is a man's life at stake here!)

Here is how Buterin explains it:
So, how does this secondary “public function” of markets apply here? In short, the answer is quite simple. Suppose that there exists a SchellingCoin mechanism, of the last type, and after one particular question two forks appear. One fork says that the temperature in San Francisco is 20’C; the other fork says that the temperature is 4000000000’C. As a VSU, what do you see? Well, let’s see what the market sees. On the one hand, you have a fork where the larger share of the internal currency is controlled by truth-tellers. On the other hand, you have a fork where the larger share is controlled by liars. Well, guess which of the two currencies has a higher price on the market… 
In cryptoeconomic terms, what happened here? Simply put, the market translated the human intelligence of the intelligent users in what is an ultimately subjective protocol into a pseudo-objective signal that allows the VSUs to join onto the correct fork as well. Note that the protocol itself is not objective; even if the attacker manages to successfully manipulate the market for a brief period of time and massively raise the price of token B, the users are still going to have a higher valuation for token A, and when the manipulator gives up token A will go right back to being the dominant one. 
Translation: someone runs a book on the outcome of Jesus's trial, and the bookies' odds are used to reinforce the voting, thus making it more likely that there will be the "right" outcome. **

But in this case, I suspect that the bookies would simply reinforce the crowd. After all, there is no objective measure. No compelling "fact" that can be used to establish whether or not Jesus is a dangerous subversive. There are only beliefs.
Now, what are the robustness properties of this market against attack? As was brought up in the Hanson/Moldbug debate on futarchy, in the ideal case a market will provide the correct price for a token for as long as the economic weight of the set of honestly participating users exceeds the economic weight of any particular colluding set of attackers. If some attackers bid the price up, an incentive arises for other participants to sell their tokens and for outsiders to come in and short it, in both cases earning an expected profit and at the same time helping to push the price right back down to the correct value. In practice, manipulation pressure does have some effect, but a complete takeover is only possible if the manipulator can outbid everyone else combined. And even if the attacker does succeed, they pay dearly for it, buying up tokens that end up being nearly valueless once the attack ends and the fork with the correct answer reasserts itself as the most valuable fork on the market.
Once again, Buterin assumes that there must be dishonesty involved. Of course, the Bible does say that there were two false witnesses, and that the crowd was "whipped up" by powerful individuals. But then it would, wouldn't it? After all, the Christian case is that Jesus's death was the worst miscarriage of justice in history.

But as I've already noted, it is not necessary for anyone to be lying. The witnesses may genuinely believe that Jesus is subversive. The "chief priests" may genuinely believe that Jesus is too dangerous to be allowed to live. Indeed, the lethal, socially divisive outcome of Jesus's trial rather suggests that no deliberate dishonesty was involved. When both sides believe they have the "truth", the game is to the death and all bets are off.

So Pilate's question goes to the heart of the matter. What is "truth"? Truth is whatever I believe it to be. In the absence of a "higher power" that can objectively state what "truth" is, I can only establish the truth of my "truth" by asserting power over those whose "truth" is different from mine. The more people I can persuade, bribe or coerce into agreeing with me, the more powerful I am and the more likely I am to win in any "battle of beliefs". In the end, truth is power.

It is thus unsurprising that there is discussion in the cryptographic world of "ultimate oracles" which can be trusted to arbitrate impartially in any dispute:
A solution for oracles will most likely be that an default (centralized) oracle can set an outcome first but there will be an objection period. If someone has an objection (and makes a deposit) another more reliable (and more costly) service should be triggered. If this option is given and the "last resort" oracle is widely believed to be 100% uncheatable than it might get never user. So to have such an oracle would be extremely valuable.
Note that even accessing the oracle requires payment in ever-increasing amounts. This is hardly a legal system that supports the claim of the poor and weak against the rich and powerful, is it? Only the rich have access to justice. The oracle does not eliminate power asymmetries, it reinforces them.

But what form would such an oracle take?
So let's think about the "ultimate oracle" - the most secure one that can be made. For the security it is important to see what people who determine the outcome have at stake. In the case of Augur it will be the REP tokens, in the case of a human Twitter oracle it will be its personal reputation (maybe there is an real world value bigger than what is measurable on the blockchain but if we would purely look at the blockchain it would be the future income from this reputation - or other benefits that comes along with good reputation).
Oracles must be incorruptible and omniscient: furthermore, the penalty for ignoring an oracle must be severe. In the old days, oracles were creatures of the gods, set apart from the world (thus incorruptible) and obtaining their information from supernatural sources (hence omniscient). And as the crowd was far more afraid of the wrath of the gods than of any human, oracles were rarely ignored.

But these modern-day oracles have no divine backing. So the best Koppelman can come up with is the idea that they can be trusted to give the right answer because if they don't. no-one will trust them any more. Forgive me, but this is circular logic. If an oracle must please the crowd with the "right" answer or be thrown down, it cannot be impartial. Indeed this was Pilate's problem. He wasn't a sufficiently trusted "oracle", so could not credibly deliver an impartial judgement.

(This is part of our problem with central banks, by the way: we expect them to be impartial and omniscient, but also to please us with the "right" decisions, on pain of losing their independence....)

However, this is all academic anyway. After all, this logic would only apply in a cryptographic environment. It would never be used in the real world when lives are at stake.

Or.....would it?
Perhaps, in some futuristic society where nearly all resources are digital and everything that is material and useful is too-cheap-to-meter, subjectivocracy may become the preferred form of government.
I think they call this "mob rule".

Related reading:

The Subjectivity/Exploitability Tradeoff - Vitalik Buterin

* In this piece I am taking it as read that Jesus existed and his trial and execution was as documented in the Gospels. I am aware of the lack of reliable historical record and the controversy over whether he existed at all. But as I am using the story simply as an example, I do not think it matters whether or not it is true in fact. Truth is a matter of opinion, after all.

** Schroedinger did this first. Indeed I thought of entitling this piece "Schroedinger's Jesus".

Monday, 2 May 2016

Dangerous assumptions and dodgy maths

The last published accounts for the NI Fund show that, contrary to popular mythology, it does not have an enormous surplus. In fact it is currently running a deficit, as it has been for the last five years. Its reserves have fallen to the point where the Government was forced to top them up to prevent them falling below the statutory minimum of 1/6 of payments out of the fund.

So I was somewhat surprised to read written evidence to the Work and Pensions Select Committee which appeared to contradict the accounts. The evidence comes from Rita Abrahams and references the Social Security Up-Rating Report by the Government Actuary, published in January 2016.

Here is how Ms. Abrahams has interpreted the Government Actuary's findings:
The latest Actuary report published in January projected that by April 2021 our National Insurance Fund will have a balance of £58 billion; thus after setting aside the working balance requirement of £18.52 billion (1/6th of payments) a surplus would remain of £39.48 billion.  
The surpluses over the working balance for each of the next 5-years roughly breaks down as follows.
2016-2017: - £ 9.78 billion
2017-2018: - £ 3.85 billion
2018-2019: - £ 5.65 billion
2019-2020: - £ 9.10 billion
2020-2021: - £11.10 billion 
....Therefore, contrary to belief there would be no requirement to increase general taxes going forward or use funds that have been set aside for other projects since that £39 billion is a totally unexpected surplus as in January 2015 the Actuary projected a fund value at April 2020 of only £10.2bn, so not even enough to cover the working balance: the Actuary's latest projection for April 2020 stands at £46.299 bn. 
I fear Ms Abrahams has misinterpreted the Government Actuary's findings. She has failed to take into account the components of the baseline forecast for 2015-16, upon which all the later forecasts are built. And she has treated as "firm" a forecast that the Government Actuary says needs to be treated with extreme caution - and is already out of date.

Firstly, about that baseline. The Government Actuary has uprated the closing forecast balance for 2015-16, from £11.531bn in the 2015 published accounts to £24.682bn. This enormous rise is explained by four factors:
The relative improvement in Fund level in comparison with last year is mainly due to a combination of more optimistic economic assumptions, payment of Treasury Grant, a downward revision in contributory ESA and updates to contribution modelling using more recent information sources 
Of these, by far the most significant is the Treasury Grant. The Government Actuary's central forecast - upon which Ms Abrahams has based her evidence - is as follows:

We already know, from the 2015 accounts, that the NI Fund received a grant from general taxation of £4.6bn in 2014-15. Footnote 2 indicates that a further grant of £9.6bn will be paid in 2015-16. The central forecast assumes firstly that this second grant is paid in full, and secondly that neither grant is ever paid back. In other words, the projected £24.682bn surplus in 2015-16 includes a subsidy from general taxation of £14.2bn. Taking that out leaves the NI Fund reserve balance well below its statutory minimum. And since the reserve balance is cumulative, taking out the Treasury grants would also reduce the projected balance for April 2020 to £43.8bn.

It is also worth noting the large rise in NI contributions due to the ending of contracting-out from April 2016, and the fall in payments due to reduced ESA benefits. Both of these are already causing a storm of protest from those affected. The ending of contracting-out will eventually be offset by increased payments under the flat-rate pension scheme, though this is cold comfort to those facing large rises in their NI contributions. But it is not at all clear why the projected surplus should be used exclusively to provide would-be pensioners with relief from cuts to their entitlements. There would surely be a strong case for giving higher priority to restoring the ESA cuts.

That is, if there is a surplus. Forecasts of revenues into and payments from the NI fund are extremely sensitive to economic conditions. Because of this, the Government Actuary has given several forecasts. However, Ms. Abrahams has relied only on the Actuary's central forecast, and as already noted, she has treated it as "firm". But we already know the central forecast is over-optimistic, since it was based upon the OBR's economic forecasts from November 2015, which were downgraded in March 2016.

NI Fund receipts come from NI contributions, which are determined by earnings levels. Here are the Government Actuary's earnings growth assumptions for the next five years, with those underpinning the central forecast outlined in red:

And here is OBR's March 2016 economic forecast with earnings growth assumptions also outlined in red, along with the change in those assumptions since November 2015:

As the OBR's revised estimates for earnings growth are substantially lower than those used by the Government Actuary, and no significant improvement in employment is forecast, the central forecast for NI Fund reserve balance in 2020 must also be downgraded absent a significant ADDITIONAL fall in payments.

On present projections, the NI Fund surplus for 2020 will come in somewhere between the Government Actuary's central and -1% forecasts. This is the -1% forecast:

So we could perhaps assume that the 2020 reserve balance will be somewhere in the region of £45bn. Should this projected balance be spent in advance of receipt to enable certain groups of people to receive state pension earlier than their current legislated state pension age? The NI fund cannot borrow on its own account, so this would mean the Treasury making additional grants funded by government borrowing. Is this a good idea?

In my view, emphatically no. It is always a bad idea to spend unrealised gains. They can evaporate like the morning mist, leaving you substantially out of pocket. If average earnings do not increase as forecast - and even the downgraded forecasts make pretty heroic assumptions, particularly towards the latter end of the five-year period - then the NI Fund will not recover. Here is the Government Actuary's gloomy prognostication for the NI Fund's finances if earnings growth and CPI remain as stagnant as they have for the last few years:

Far from having surplus funds, the Fund's reserves would be entirely exhausted by 2020, and it would be dependent on rising Treasury subsidies to keep its working balance above the statutory minimum. So under the "no change" economic scenario, the Fund will be effectively insolvent in five years' time even with the planned NIC increases, SPA rises and benefit cuts. Remember that in this scenario, the Actuary has not assumed an economic downturn, only stagnation. The OBR's outside forecasts are even worse.*

So Ms. Abraham's analysis assumes that the NI Fund is considerably more robust than is in fact the case. But I think she knows this, really, since the rest of the piece is all about other ways of increasing the NI Fund surplus. And she thinks she has found a good one.

Currently, the NI Fund partly funds the NHS. In 2003, NI contributions were raised by 1%, and all of that increase went to the NHS. Ms Abrahams argues that the increase should have been distributed more equitably between NHS funding and contributory benefits:
When looking at the years prior to and after the 1% increase in 2003 one can see a dramatic boost that almost doubled the amount of our NICs that was directly transferred by HMRC into the NHS account. NHS allocation funded from NICs between 2001-2015: 
2001-2002 - £7.8 billion
2002-2003 - £8.0 billion
2003-2004 - £14.9 billion
2004-2005 - £16.8 billion
2005-2006 - £18.4 billion
2006-2007 - £18.9 billion
2007-2008 - £21.0 billion
2008-2009 - £20.7 billion
2009-2010 - £20.3 billion
2010-2011 - £20.4 billion
2011-2012 - £20.6 billion
2012-2013 - £20.5 billion
2013-2014 - £20.8 billion
2014-2015 - £21.5 billion  
If the 1% increase in our NICs had instead been shared out in the same proportions, as before, then between 2003 and 2015 our NIF account would now have a surplus of over £100 billion more than the working balance.  
Unfortunately, it seems that the Government at the time decided that our NIF did not required extra funding; maybe it’s time to reverse that decision and share out our NICs in the same ratio as it was prior to the 2003 change.
But Ms. Abrahams has ignored the other side of the cash flow statement. The 1% increase can in no way be said to have gone entirely to the NHS. On the contrary, receipts into the Fund substantially exceeded payments out, including the NHS funding, for some years after 2003. By 2009/10, the Fund's reserves had risen to over £50bn:

On this basis alone, there seems little justification for Ms. Abrahams' assertion that the NHS share of the NI Fund payments should be reduced. The present deficit is not due to NHS costs, but the rising cost of pensions.

However, it is true that NHS funding takes a higher proportion of the NI Fund than it used to. Ms. Abrahams likes the idea of reverting to the pre-2002 percentages:
Currently around 20% of NICs is transferred into the NHS fund with 80% into our NIF, if in 2020 we revert to the 2002 percentages so with around 12% going into the NHS fund and 88% into our NIF then that would give our State Pension Scheme an extra uplift in just that one year alone of around £12 billion.
But simply reducing the share of NI Fund payments going to the NHS is silly. Why not transfer all NHS funding to general taxation and be done with it? Ms. Abrahams likes this idea too. It would create an even bigger NI Fund:
And if the Government ran it more like a company pension scheme so all NI contributions went into our NIF and none to the NHS then that would result in an extra uplift that year of around £30 billion and when added to the expected balance at the end of that year of £58 billion, that’s a massive pot of £88 billion and some £70 billion over the working balance.
And funding the NHS entirely from general taxation would resolve an anomaly:
Admittedly that would mean less being transferred from our NICs to our NHS and therefore that shortfall would need to be made up from our general taxes but that would be more appropriate as all taxpayers would be contributing into this and not just working people under the state pension age who are the only ones who pay NICs. 
Very true. It's a sensible suggestion.

But then her maths goes badly astray. She rightly says that removing NHS funding from the NI Fund would enable employer and employee NICs to be reduced. But this isn't remotely compatible with her idea of paying out the NI Fund surplus to everyone who had less than 10 years' notice of a state pension age rise:
Who should be eligible and why? All who’ve not received 10-years notice of a change to their SPA, so including both men and women, thus men 55 or older who’s not received notification should still be allowed to take their State Pension at 65 and women 50 or older who’s not received notification should still be allowed to take their State Pension at 60. 
That is a LOT of people. Far more than those ever envisaged by the WASPI campaign. It is clear that if all these people are to be excused the state pension age rises currently planned, NICs could not possibly reduce as Ms Abrahams suggests. Indeed, they might even have to rise. This would be in addition to increases in other taxes to fund the NHS spending moved to general taxation.

Under Ms. Abrahams' plan, the overall tax bill for working people (of any age) would rise - possibly substantially. The principal beneficiaries would be those who currently are not eligible for state pensions due to SPA rises.

So Ms Abrahams' proposal amounts to a disguised demand for rollback of the 1995 and 2011 Pensions Acts, funded by significantly higher taxes for working people and dependent on some highly optimistic actuarial forecasts. It should be rejected.

Related reading:

The Fund that isn't a fund
Research briefing: National Insurance Fund 1975-2014
OBR Economic and Fiscal Outlook, March 2016

* Really, this is telling us that unless the UK economy performs a lot better than it has in recent years, the Triple Lock is unaffordable. But that's a story for another day.