peterbirks: (Default)
Reading Graber's "Debt, the First 5,000 years", it struck me that I could create my own early economic and monetary system by getting an allotment, growing excess food, and "giving" it to my neighbours, along with a note that, if they had any skills or produce of which they had an excess, some kind of return, at an unspecified time in the future, would be appreciated.
This would not be barter. I could quite easily write paper notes saying "X - 10 tomatoes", and, if X signed it, that person could be said to owe me the equivalent of 10 tomatoes, with tomatoes thus becoming a de facto "currency", equal to whatever X and I decided was a fair service in return (say, 15 minutes' work).
So, if my neighbour was an accountant, they might one day help me with a small tax problem. Or if my neighbour were a lawyer, they might one day help me with a legal problem. Electricians, plumbers, cleaners, writers, administrators,etc, could all partake in this neat little economy, which would add to the national wealth, but which would not appear in the state's records of GDP.
But there are two areas, quite different from each other, where my neighbour could not be a member of this system. The first would be where my neighbour was in human resources, or marketing (I am sure there are other types of job that fit into this category, but those were the two that first occurred to me). What could that person offer me in return?
It's tempting to say that this shows how useless these professions are, but that would be too simplistic. They are in essence jobs which are a product of a developed economy. In the simple kind of economy, they have no place. Marketing is, I feel, essentially zero-sum. It's not increasing total wealth; but it can increase individual companies' wealth at the expense of others. Human resources, meanwhile, is a product of large organizations. It is not needed in small mini-economies. It is, in effect, a small "price" to be paid for the far greater production levels that can be achieved by larger organizations and more complex economies.
The second area is one where the state has nationalized the service and made it one that is supplied without cost to the individual user and that cost is shared by all members of the economy who pay tax. Why should I operate my own mini-economy with a person whose services I can get for no payment elsewhere?
I do not know if this area of economics has been covered at length elsewhere, but it's an interesting point. Once a service is made "free", any person offering that service has no value within a mini private economy, unless that person can offer an added value (such as out-of-hours service, more personal service) that can be assigned a value.
So, if any of my neighbours are electricians or plumbers or lawyers or accountants, they could become part of my new economy, but people in marketing and human resources must, I fear, work within the large economy alone.
peterbirks: (Default)
One of the more interesting sideshows from the Cypriot "bail-in" was the cause of the effective insolvency of Laiki (Popular) Bank and the impact that everything had on the Bank of Cyprus.

Although people talk of the "eurozone crisis", that is somewhat misleading. While the fundamental causes of the problems are the same – monetary union without fiscal union, an initial set of exchange rates that woefully undervalued the old Deutschmark and (implicitly) woefully overvalued nearly all of the other currencies that joined the euro, and interest rates set at the levels required by Germany rather than those required by the peripherals – the problems expressed themselves in a number of different ways. They also expressed themselves with different degrees of urgency.

In Ireland and Spain, as we have seen, the problems arose because the low interest rates created an asset bubble. In Greece the problems arose because the Greek government fudged the statistics, concealing how much more they were consuming than they were producing. In Italy the problem was no more a problem under the euro than it had been under the lire – eventually the country would go broke, but it wouldn't go broke straightaway unless there was a crisis of confidence.

But why did the problems arise in Cyprus? There was no massive property asset bubble, and the country was not anywhere near as profligate as Greece. Indeed there was optimism as late as early last year that Cyprus was on track to reduce its deficit to 2.7%.

You can see, therefore, that if you said that it was all one big problem, and if you pointed out that the problems in Italy (and, to a certain degree, Spain) were ones of confidence rather than fundamental insolvency, then you could pretend that the entire problem was one of a crisis of confidence.

But if you saw that in some cases (in particular, Italy), the problem today was really one of confidence, even though the problem in the distant tomorrow was one of forthcoming insolvency, but in other cases (particularly, Greece), it was one of absolute stone cold insolvency, then you could also see that "solutions" in one part would not work in others.

Now, let's fast-forward from the crises of 2008/09, when half the banks in Europe effectively had to be bailed out, to early 2012.

In those three years (a vital three years for banks and insurers) one of the things that nearly all financial institutions did was offload their Greek bonds – frequently at a significant discount to par. They buyers were, in the main, hedge funds and private equity punters who reckoned that, eventually, saving the euro would be more important than anything else, and that Greek bonds would be saved.

Unsurprisingly, some of the banks with the biggest exposure to Greek bonds, as a proportion of their capital, were the Cypriot banks. Cyprus, in fact, had a problem that was closest to that in Iceland. It had a banking system far too large for its GDP. It also had a problem that Iceland did not have – it was in the euro.

But, as we have seen, Cyprus was not guilty of lunatic lending to any wide-boy property dealer. Indeed, Cyprus has fairly strict building laws. There was none of the mass over-development that blighted Spain and Ireland.

Although there were clearly TOO MANY banks in Cyprus, that problem disappeared if you started thinking of Cyprus as a kind of in-house Cayman Islands, or Guernsey, or Bermuda. All of these territories have financial systems that are huge compared to their GDP. But they survive. Indeed, they prosper, with the average GDP per capital approaching $100,000.

In other words, having a financial sector that dwarfs the rest of the country's production isn't necessarily a recipe for disaster. And Cyprus had other products – mainly tourism. Sure, banking was bigger, but not necessarily to the degree that meant inevitable disaster.

It is here that the Greek bond default, for that is what it was, becomes phenomenally significant for Greece. Last March the owners of Greek debt agreed to exchange their bonds for new ones, with a longer term, at a lower interest rate, and with a lower face value. You may recall that the European Central Bank, for reasons of politics rather than economics, actually managed to sidestep a write down on its own Greek bonds, but that is a story for another day. The Cypriot banks were not so lucky, and it was on March 9th that the death sentence for Cyprus was written.

It may seem a little unfair, therefore, that a write-down forced on (some) unwilling bondholders by the EU (and, in particular, Germany) should lead less than a year later to mainly Russian deposit holders having to take a massive haircut on their Cyprus deposits.

But, as is the case with virtually everything in the euro crisis, all is not as it seems.

In late 2009 and early 2010 the Bank of Cyprus spent billions of euros buying Greek bonds. This was when nearly every financial institution that I was writing about was selling them off. The Greek debt was yielding very high interest rates and – and this is a significant point – the ECB (which had its own chunk of Greek bonds) and the regulatory system Basel II meant that sovereign bonds could be counted at 100% of redemption value. It was still maintained that sovereign bonds – when it came to calculating capital – were safe.

Here it gets murky. It would appear, but it has not been proved, that bank executives at bank of Cyprus were buying Greek bonds, but that they were keeping the details of those purchases from Board Directors. Indeed, in December 2009 the Bank of Cyprus claimed that most of the bank's Greek bondholding had been sold. And it appears that the Board of Directors believed that this was the case. Unfortunately, many, if not more, Greek bonds had also been bought.

The long-standing ties between Cyprus and Greece are well-known, but the purchase of Greek bonds from 2009 onwards was, let's face it, mental. It was as mental as the actions of the Icelandic financial system (buying up stuff for far too much money in an attempt to pay the interest rates that it had promised foreign subscribers).

Here Reuters takes up the story:
On December 10, 2009, Yiannis Kypri, a general manager at Bank of Cyprus, told a Cypriot website, Stockwatch, that the bank had "minimal exposure to Greek sovereign debt" after reducing its holdings from 1.8 billion euros to 0.1 billion.
The same day, according to the investigators' report, Andreas Eliades, then Bank of Cyprus's group CEO, instructed his treasury department to begin new purchases of such bonds. With these new instructions, that day the bank bought debt worth €150m, and a total of €400m by the end of 2009, according to the consultants Alvarez and Marsal.

Bank of Cyprus later tried to rewrite history by claiming that Kypri's statement referred to only a temporary sell-off. That, clearly, is bollocks. Kypri's statement was clearly interpreted as a permanent reduction in exposure. Did Kypri know this? If so, he said nothing to disabuse the markets of their interpretation. If he didn't, then he can't have been paying much attention.

By April 2010 Bank of Cyprus had €2.4bn worth of Greek bonds – above the Bank's own limit, but that limit was raised a month later. Bank of Cyprus bosses still maintain that "everybody was buying into Greek bonds at the time". Well, yes, there were lots of sellers (mainly banks) and lots of buyers (mainly private equity speculators). There were not many bank buyers. At the end of 2010, only two banks in Europe actually had bigger holdings than BoC (€2.2bn) and Laiki (€3.3bn). Those banks were the vastly larger operations BNP Paribas and Société Générale. And both these banks got hurt hard when the default came.

More interestingly, it appears that the Bank of Cyprus knew that it was in a bit of a mess. Notwithstanding the claim that Kypri was only referring to a short-term sell-off in response to market conditions, in April 2010 BoC moved €1.6bn in Greek bonds out of its trading book and into its "held to maturity" book. That meant that the bank could count the Greek bonds at the price it paid (the value of Greek bonds had been falling for some time). BoC said at the time that the move was made because Greece would redeem the bonds – a triumph of hope over reality, as the events of early 2012 proved.

Andreas Eliades, CEO of the group until April last year, still insists that no-one could have imagined that a European country in the euro could default.

That, of course, is an excuse we have heard from many others in the banking sector – not just in Cyprus. "No-one could have foreseen it; no-one predicted it", was said again and again, despite the fact that from 2000 onwards several people were foreseeing a credit bubble and several people were predicting that it would end in tears.

When the axe fell last March, Bank of Cyprus was €1.8bn in the hole. Cyprus, whose GDP outside of offshore banking was tiny, was never going to be able to bail out BoC and Laiki. I've written before about the farce that led to a short period where all bank deposits at Boc and Laiki were going to suffer a hit. That nightmare scenario, which within 18 months would have led to banking crises in several other countries in the eurozone (starting with Slovenia) was thankfully abandoned a week later. But the larger depositors had to take a hit, and the effect was to destroy the Cypriot financial system. No-one would leave money in the Caymans if they thought their money would be confiscated. For Cyprus, the game is over and the economy is shot.

But things get even murkier. As we've seen, it would appear that the managers of the bank were almost operating on their own, with a Board of Directors who didn't really know what was going on. Was this true?

We shall never know. As Reuters reported, one day last October a memory stick was placed into a desktop computer at the Bank of Cyprus. There was some clever software on that memory stick. It quickly erased a staggering 28,000 files, including internal emails in late 2009 and early 2010 – precisely when many of the Greek bond purchases were taking place.

As such we will never know who knew, and, more importantly, we will never know the motives of the people who decided to do the buying. Did they really believe, unlike nearly every other bank and life assurer in the western world, that Greek bonds were a good bet? Even if they did, such expenditure as defended by Eliades would have been grossly irresponsible in reality (but not in EU fiction, which still maintained that Greek bonds were rock solid in terms of capital requirements). Banks are not about taking good bets that are risk that, if they go wrong, will bankrupt both the bank and the country. That's just too big a risk, even if it is plus EV. It's the old story of Warren Buffett coming up to you and offering you two-to-one on the toss of a coin, but you have to put up your entire wealth. The marginal value of money comes into play.

Or were the buyers of those bonds less stupid than they pretend they are; were there other, familial, reasons for buying Greek bonds? Was it misplaced loyalty to a country that had supported Cyprus in the past? Were there incentives from the selling counterparties?

We shall never know.



Apr. 30th, 2013 07:46 pm
peterbirks: (Default)
London was particularly unpleasant today. I am beginning to wonder/worry that my fear of crowds might be re-emerging, although it's equally possible that all I have is a rational dislike of large groups of people moving randomly.

The walk back up Hatton Garden after the gym was particularly unpleasant. If people were in pairs or threes they were talking to each other and not paying attention to anyone else. If they were on their own then they were texting on their phone and not paying attention to anyone else. It being Hatton Garden there were groups of undesirables hanging around outside shops (these people have ill-defined jobs within the jewellery world and seem to spend most of their days either outside various stores talking to each other, or sitting outside the Costa Coffee talking to each other -- they remind me of some of the clients of the Mecca Bookmakers in Denmark St and North Row, in that they clearly have some kind of job involved with the area, but I'm never quite sure what) and there were couples walking in odd diagonal zig-zags, suddenly stopping to look in a window at a ring.

As I was walking up the street a woman about four feet behind me suddenly started a loud phone conversation with her boyfriend. I actually had to stop, step aside, and let her pass. I then carried on walking four feet behind her. I think that she thought I was some kind of weirdo, because she quickly cross the road, which was fine by me. But I find it very off-putting to be walking up the street with someone close behind you indulging in a loud conversation. I do the same when it's a pair of people talking to each other. And I don't care what they think when I stop suddenly and step to one side to let them pass. For me its the pedestrian equivalent of some lorry tailgating you on a B-Road.

So, basically the walk from Holborn Circus was one long sequence of avoiding walking into people, having people nearly walking into you, having traffic moving at you from any direction at any moment, and generally just trying to keep sane until you get back to the office -- which isn't, TBH, all that much better.

And people wonder why it's a relief to get back home, shut the door, and bid farewell to the outside world for another 14 hours. Why on earth people want to voluntarily GO OUT into central London again OF AN EVENING is something that escapes me.

The weather was to blame, I reckon. It was far too pleasant, and that just attracts the masses out of their offices and into the street -- never mind the fact that the street is remarkably unpleasant. There seems to be some kind of duty to be "outside" at lunchtime if the weather is nice.

Meanwhile, back in the inside that is civilization, I can have the pleasure of reading books and watching movies, of which I've been doing a fair bit. Nothing that I've got the energy to review. I've given up most of my commenting on Facebook because it's becoming increasingly clear that only a few people have anything worthwhile to say and that most people are likely to react aggressively to logical argument. I see poor Tony Dobson argue patiently and logically time and time again, only to come up against a brick wall of irrationality and personalization. Hazel Nicholson posted a marvellous Richard Dawkins strip cartoon that mocked many of the sillinesses of "alternative" treatments. What was interesting was reading the comments of those who cannot, will not, and damnity-damnation never will, accepot that their own particular piece of lunacy is anything but true. - Crystals, Raike, "energy forces", magnetism, you name it, there will always be one indisputable proof as far as they are concerned, that "proof" being "I've seen it work". Well, d'uh, sorry, but that ain't good enough. It's up there with the "online poker is rigged" argument. But once you start talking about proper testing, control groups, double-blind experiments and so on, you might as well be talking to the palm. You just can't win, so I've given up trying.

It's the same with economics, of course. David Graeber's "Debt, The First 5,000 Years" should be mandatory reading for everyone who is still tied up with the morality of debt rather than the reality of what is going to happen. But they won't read it, so why should I bother trying to explain it? Let's just wait 30 years and see what happens. I'll be proved right; I won't take any pleasure in being proved right (if I am still alive) and all of those people whose savings will have been taken away from them by one means or another will be bemoaning the immorality of it all until they breathe their last, instead of realizing now (as they should) that history has seen sequence after sequence of unsustainable debts being built up and then being summarily cancelled wither through revolution or royal edict. Morality doesn't come into it; practicality is all. It's not much use taking the moral high ground if a larger group is cancelling its debt and the police are part of that larger group cancelling the debt.

In other words, it's wearying. It all seems so obvious, but people are tied up in knots of logic than can easily be cut through if you throw away Protestant teaching and concepts of fairness. Wealth is not savings -- Power is wealth. You can work hard and save all your life, but if I have a gun and the law on my side, and I want your savings, then that is that.

This, roughly, is what we shall see in the next 30 years. Unless the older generation voluntarily give up their savings (or they have been clever enough to make sure they spent it all first) it will be taken from them by the younger generation. You will not see a balancing of the global books through austerity, or through the Americans suddenly being savers and the Chinese suddenly becoming consumers. You will see a balancing of the global books either through default or through war. So stop moaning about how this isn't "right" and start working out what you are going to do about it so that you don't get royally fucked when it happens.

Actually, don't start thinking about what you are going to do about it. because the fewer people who have worked it out, the easier it will be not to get fucked when it happens.

peterbirks: (Default)
The number €30bn is going to crop up more than once in this piece. It's the key figure in the mandatory "bail-in" of the Cyprus Banks, which the Cyprus government appears at the moment to be having difficulty getting through the Cyprus parliament.

We can come later to the (potentially profound) implications of this hit on depositors with Cypriot Banks. But let's look first at how it happened and why it happened.

One reason that we have not had many runs on banks since the Second World War is that lessons were learnt from the depression of the 1930s in the US (when many banks failed that were not insolvent, simply because no-one trusted any banks at all) and from watching the film It's A Wonderful Life.

As George Bailey (James Stewart) observes when depositors come asking for their money back:
"The money's not here. Your money's in Joe's house...right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why, you're lending them the money to build, and then, they're going to pay it back to you as best they can

To prevent this "madness of crowds", deposit protection schemes were invented. Under these systems your deposits were protected by a government guarantee, up to a certain amount. This meant, the theory went, that solvent banks would not be sent under by public panic. And, because banks were actually fairly solid institutions, that meant the deposit protection scheme, by its very existence, would not be needed.

You can possibly see the flaw in this line of thought. What if, heaven forbid, a bank WAS insolvent?

The impact was that there still wasn't a run on the bank, because, hell, the money was guaranteed, so it didn't matter a toss whether you banked with a solvent bank or an insolvent bank. So long as the amount you deposited with them (i.e., lent to them on an unsecured basis) was guaranteed by the government, there was no need to withdraw the funds.

This had two effects – both of moral hazard. One was that it encouraged depositors to deposit recklessly, and the other was that it encouraged banks to lend recklessly.

Now, if a bank actually IS insolvent, eventually it won't matter if there's a run on the bank or not; it will still go bust. And, in Cyprus, Laiki, the country's second-largest bank, was very, very bust. Bust to the extent that the cheap ECB loans that have been used by several zombie banks in the weaker parts of the eurozone for day-to-day operations were no longer available to Laiki. And, if Laiki went, then the Bank Of Cyprus would go too. That would be about 50% of the Cypriot banking market.

The Deposit Protection Scheme would stop functioning as it was meant to function – as a scheme that would never be needed because it provided the confidence that would be enough to keep the banking system stable – and would actually come into play as a protection for depositors.

And it was at this point that the Deposit Protection Scheme in Cyprus was proved to be a fraud. Because the collapse of the two largest banks in Cyprus would cost the government €30bn, And the Cyprus government didn't have €30bn.

If the Cypriot government did have €30bn, it would have nationalized the two banks, guaranteed the deposits, and the system would have continued. This is precisely what the UK did on the weekend of October 2008 when RBS was on the verge of having to close its doors.

But, the Cypriot government didn't. It was broke. That was why it was having the "bail out" talks leading up to last weekend, looking for €17bn.

At last the Finns, who have been itching to get at southern Europe for its profligate ways ever since the crisis erupted, saw an opening. After all , much of the money deposited in Cypriot banks was said to be laundered Russian money, a benefit of rather lax oversight procedures when it came to asking where the cash came from. By insisting that depositors take a €7bn hit of the €17bn bail-out, and allocating them "shares" in the banks in return, it could be argued that the right people were being penalized.

As it happens, the amount of money the Russians have invested in Cypriot banks is, about, €30bn. That in effect means that the haircut imposed at the weekend amounts to a €3bn expropriation of Russian cash. It's a staggering act of protectionism that verges on piracy. It certainly won't do much for cross-border trade between Russia and the EU.

The haircut (a "bail-in" of depositors into the banks because a loan is turned into a shareholding) also cut out the bankrupt middleman. Because Cyprus could not offer cash to depositors and take on the shares itself, it has transferred the (probably worthless) shares directly to the depositors.

It is, in effect, a sovereign default, passing to unsecured creditors some probably worthless paper instead of cash. The alternative for the government would have been a double banking collapse and either a complete wipe-out of all deposits, or a complete wipe-out of the Cypriot government debt.

At the time of writing, the vote in the Cypriot parliament has been postponed, indicating that it might not get through if the haircut remains as originally proposed. I would not be surprised it the banks didn't stay shut again tomorrow. If the vote does not go through, then we have Cypriot financial armageddon. The banks fail. The government fails. The Sovereign Debt defaults. I don't actually see all of those things being allowed to happen. It could therefore be interesting to see how Germany and the Finns react if the Cypriot parliament (with Russian encouragement?) votes down the proposal, and Russia then starts flexing its diplomatic muscle.

This has been a victory for the IMF, under Lagarde, over the European Commission and the ECB, under Barroso, although as victories go this one could turn out to be more pyrrhic than most. And it all happened because in September 2000 a €100,000 deposit protection scheme was enabled without anyone actually thinking what this would signify were a bank to actually go bust.


There have been not a few commentaries already about the implications. From reading the above, at first glance one would have expected the euro to fall off a cliff on Monday morning. But it didn't.

Why not?

Because, basically, the IMF has found another way for a country to be broke without officially being declared broke. If by some chance the hit on depositors does not cause mass withdrawals from banks elsewhere. If the "Russian connection" could be played to a level that Cyprus was seen as a unique case, then the "solution" could be seen as euro-positive. Although the state of the disaster in Cyprus was thrown into sharp relief, the view was that, if the hammering of depositors could be pushed through, the euro was more likely to survive, not less. It would be a case of "someone else taking the pain" (€3bn Russia, €4bn to sundry others, including not a few British expatriates).

That's the good news. The flip-side is unremittingly bad.

The minor point is the impact on relations with Russia, a country which, remember, has a hefty degree of control over energy supplies. Finland was the loudest noise in favour of this solution (supported less manically by Germany and Netherlands) but one wonders whether they will be so enthusiastic about it if they woke up to see that Russia had sealed the borders and cut off Finnish/Russian trade.

The major point is the impact on the psychology of ordinary savers. It has just been demonstrated, quite explicitly, what some of us have been writing for several years. No matter how safe you think your wealth is, it isn't really safe. The confidence that "money in the bank" is 100% safe just vanished down the Cypriot plughole. No matter that Cyprus is a special case, that it had too many banks, too many pampered staff, made too many dubious loans, and basically were not very well-run. What matters is that people will no longer think that a bank in your own country is just about the safest place for your money to be. This isn't like a savings account with Kaupthing or Icesave. This is everyday cash from week to week, the account into which your wages are paid (remember, we no longer have the legal right to insist on being paid in cash).

For the first time in many years, the question can be asked rationally: "is my money safer in the bank, or in the mattress?"

peterbirks: (Default)
An excellent email from Mr Young about the current macroeconomic situation that merits quoting:

the view from ten thousand feet looking down is simple - Laws are made by old people, not the young. And they are inevitably made with the interests of older people in mind. In some countries it leads to interference in the labour market (much of Europe). In some it's interference in the land market (UK and Japan). In all it's interference in the social security system. In every case, the laws favour older workers, older property owners and older welfare users.

The young people of today are actually astonishingly forgiving and unselfish about all of this. Or astonishingly misguided and misinformed. Why there isn't rioting about the cost of housing here I cannot understand.

Most of those who have retired, even most of those of my generation, will doubtless deny this analysis. So, let's look at the UK numbers.

The numbers are not particularly easy to come by, but I found this analysis, which shows distribution of wealth by age: Pages 17 to 19 show wealth distribution by age.

Table 3.5. Home ownership, by age
Age, Have mortgage, Own home outright
<25, 4, 0
25–29, 37, 1
30–34, 57, 2
35–39, 67, 4
40–44, 76, 6
45–49, 78, 14
50–54, 78, 26
55–59, 84, 39
60–64, 77, 58
65–69, 74, 64
70–74, 75, 69
75+, 63, 60,
Total, 53, 24

Looking at the other graphs in the analysis, one conclusion is inescapable, the older generation (particularly in the 60 to 74 age group) are in many cases, immeasurably wealthier than the young. I use the word "immeasurably" without exaggeration, because those aged from 20 to 34 often have a negative net wealth.

A second conclusion is also inescapable. Any claim by the elderly that they "deserve" their retirement income is nonsense. The wealth that they have accumulated, and the retirement benefits that they enjoy, far outweigh the money that they have put aside during their working life. If one takes the south-east, the situation is even more marked, but wven in the country as a whole, with an average house price of £200,000, and about 60% of people in the relevant age group owning their home outright, that would require a saving of £3k a year in current money terms just to pay for the home that they are living in. Let's assume a retirement income of about £16,000 all told (including state pensions, annuity income or final salary scheme). That would require an investment of about £250,000 in current money terms. Over a working life that's a saving of £6k a year in current money terms. We can knock off about a quarter of National Insurance (the other three quarters goes to benefits and other outgoings) or about £500 a year.

So, ignoring all other benefits that the retired receive (free TV licences, bus passes, discounts for rail travel, leisure club membership, adult education, and so on) they would have needed to have saved about £8k a year of their earnings at current money values, every year, throughout their life, to be "entitled" to the living that they now receive. Throw in all other benefits and I reckon the current retired would have needed to save about £12k a year throughout their working life.

So, how much DID people save?

You can look here for some numbers:,

or here:

These don't go back far enough, but I reckon that an estimate of 6% wouldn't be far off the mark. At current average salary levels that would be £1,800 a year.

Whoa! How much? You can add to that the money that went "into" government and which is now coming back out (even though technically you can't, because the pension system runs on an unfunded basis). Let's be generous and call that £3k a year at current values.

That means that, by my rough calculations, today's retirees are taking out what they would have needed to have put in £12k a year to deserve, but which in fact they only put in £4.8k a year (all at current money values). Put crudely, for every £12,000 a year in total benefits they are receiving, they only deserve £4,800.

So, that's £7,200 that has to come from somewhere (and this is assuming a FUNDED pension system, which it isn't). This is basically the annual transfer from the working population to the retired population above and beyond what is merited. There's about 20% of the population that are retired. About 50% are working, and about 30% are either too young to work or are unemployed.

That means that, at the moment, each working person is contributing about £2,800 to each retired person above and beyond what that retired person merits if one looks at the amount "saved" in his or her working life.

(The working person is also contributing about £3,600 to the other part of the non-producing part of the country, the unemployed and the young, but that's a whole different argument).

As far as David is concerned, and I agree with him, this constitutes a completely unjustified transfer of wealth from the young to the old. And it takes no account of other iniquities, such as the old maintaining the value of their capital (in houses) by stopping the young from building houses in which to live.

One way to get this country moving again would be to slash retirement benefits, either gradually or suddenly. In many cases this would create legal disputes, but usually these can be subverted. And, I suggest, they have to be subverted. Because we cannot carry on in this way, and the alternative will not be the old living a comfortable old age on income that they do not deserve. It will be a youth that will eventually see what is happening and who will make it much, much worse for the misnamed "old and vulnerable".

Old and vulnerable my arse. "Old and comfortable" vs "Young and vulnerable" would be a better combineation.
peterbirks: (Default)
"Work hard at your job and your boss will appreciate you" is one of those well-worn conventional wisdoms that probably springs from the naive belief that life is fair. Do good and good will be done to you. What goes around, comes around.

But, is any of it true? Perhaps in the days of small companies and situations where you had a personal, non-economic, relationship with your boss, as well as a strictly economic one, it might have been. These days, I think that things are different.

My bosses are uncomfortable with me being good at my job. More specifically, they are very uncomfortable with the thought that I might be irreplaceable in my job. Now, as we know, the cemeteries are full of people who thought that they were irreplaceable. But with two senior people leaving from Insurance Day, both of them very knowledgeable about insurance and both of them good journalists, it has come home to roost that, as a breed, we are not that common. In times of full employment, we are no less common and are even harder to find in an "available" state.

Economically, if you could make the same profit on a product that was less good because it employed less competent people, that would be the sensible way to go.

In times of full employment, being unusually good at your job can be a bad idea on at least two fronts (from the point of view of your employer). In the immediate sense, it might make your boss feel bad about the fact that he or she isn't working as hard as you are (a point I wish I hasten to add doesn't apply to my case personally) and in the more general economic sense, you are creating a monopsonistic situation which no sensible company wants to find itself in. Just ask all the farmers who supply Tesco, and no-one else, what happens when you have only one buyer.

So, kids, the next time someone (such as a teacher) tells you to work as hard as you can at your job because then your boss will appreciate it, point out the economic flaw in their argument. Far better to be just a little bit better than everyone else. But don't, whatever you do, make yourself irreplaceable. Because, if you do, there's a good chance that a sensible employer will simply change his business structure so that your "irreplaceable" job doesn't exist.
peterbirks: (Default)
The Bank of France said yesterday that the tools being used by banks to measure risk were now "obsolete".

Well, I've been wittering on about this for years, so I suppose that it's nice for at least one Central Bank to fall into line behind me.

Thinking poker players are, of course, well-versed in the land of what, for want of a better phrase, we shall call the "one-outer". So, let's compare the thinking banks with those players who know that, every so often, you will be hit by not one, not even two, but by something apparently impossible like three one-outers on the trot. Now, let's compare the vast majority of the smaller banks in the world with the vast majority of poker players, who seem utterly amazed that even one one-outer can occur. As soon as three appear on the spin, they will be shouting "impossible!" and "conspiracy" faster than their opponent can trouser the money.

Anyway, our good old Bank of France isn't talking about the one-outers -- not yet, anyway. It's talking about the fact that many of the investments held by the more innocent banks in mainland Europe entail risk which they haven't even measured or, if they have, have failed to measure properly. In other words, they have no idea whether their "opponent" is drawing to one out, two outs, or an open-ended straight flush draw. In particular, the Bank reckons that the derivatives in which a number of these innocents-by-night have invested are rather more dependent on low interest rates than they realized.

All that the BoF can do about it is urge the banks to tighten their stress test models, and then to publish the results so that the potential dangers can be seen.

Yeah, some chance of that happening.

Although the products that have been designed can be hideously complicated (deliberately so) the problems are fairly simple. They tend to come down to two things:

1) a lack of appreciation of correlation between two events, and
2) a lack of appreciation that an apparently liquid market can get very illiquid if everyone wants to do the same thing at once.

This last point is, it appears, finally getting appreciated by at least some people. The standard time frame for liquidating a portfolio under the "value at risk" measuring system is, wait for it, 10 days. That kind of timeframe would have Warren Buffett choking on his latest petty cash acquisition (say, $1bn). There are some portfolios out there (for example, SocGen's) which, if they had to liquidate them in 10 days, would send several derivatives markets into a tailspin reminiscent of the crashing plane in Lost.

In fact, if it happened, a desert island might be where you want to be. You never hear them worrying about a possible rise in interest rates, do you?


Mar. 18th, 2006 11:48 am
peterbirks: (Default)
Those of you with longer-than-average memories may recall that I put some money into Vodafone sometime last year when they were at, well, a little bit of a higher price than they are at now (and a lot higher price than they were eight weeks ago), on the grounds that the new management might spot that Vodafone was now in a mature industry, and that Vodafone would sell of its US and Japanese stuff and return a bundle to its shareholders in the form of a special dividend.

As usual, timing is everything and, as usual, I was ahead of my time. As Stravinsky said to Diaghilev of The Rites of Spring, "it's years ahead of its time!". To which Diaghilev replied sagely "Yes dear, so why do it now?"

It would appear that Vodafone has, at least in part, come round to my way of thinking. If I had timed my assessment of the situation as did a certain French lady (who does have the advantage of being a senior Vodafone executive) who bought shedloads of Vodafone shares at 110p at the end of January, then I could have cleaned up. As it is, after the special dividend, I shall just be minorly in profit. Bastards.


Here's an interesting piece from this week's Hedgeweek. Now, first you must realise that these people are investment managers. And you know my opinion of investment managers. However, of more interest is the immediate analogy to how some people play cash games.

Merrill Lynch Investment Managers has launched "Target Driven Investing" for defined contribution investment schemes. I won't go into the fluff surrounding the justification for this, which basically says that the predominant "lifestyle" approach is too risky (this is the one that gradually reduces your exposure to equities as you approach retirement age). The interesting part is MLIM's "solution".

"DC Target Return has twin objectives: generating a target return of cash plus 3% and preserving accumulated capital. ... DC banking works on the principle of setting a long-term target rate of return measured over a member's career and includes a regular banking mechanism whereby a proportion of the risk assets is switched into safer assets every time the return target can be locked in.

Now, read that carefully, because this is what in poker is called "eating like a mouse and shitting like an elephant". What, for example, do you do when you are way short of cash plus 3%? Logically, you have to shift into riskier assets.

In fact, this is either the strategy of "quit when you are up by a certain amount" or "play weak-tight when you are up by a certain amount".

If I had an investment manager who told me that whenever a particular asset class had performed well enough for the year he would immediately switch into safe assets to preserve the gain, my first question would be "and would you switch into riskier assets if I was down? Or would you just increase the stakes? And, if I may ask, what's wrong with taking your locked-in profit and smacking it into something really risky, provided you are plus EV on the deal?"

Target-driven investing just about makes some sense if you are getting very close to the end of the investment period (i.e., the member is nearing retirement); because, in a very real sense, it is getting close to the last hand that you will ever play, so 52% edges aren't that good an idea. But for someone in their 40s, a TDI approach is madness.

Still, it's Merrill Lynch. People will fall for it because they haven't got a clue. I just hope some of the guys working at MLIM are playing on Party Poker.
peterbirks: (Default)
As regular readers of this blog will know, I am a great admirer of Financial Times columnist Philip Coggan. His analysis is usually spot on. But even our Philip seems to get tied up in logical knots at times. In yesterday's piece he wrote an excellent column summarizing the various views of economic forecasters, but then blew it with the headline "Even the bears are divided between two camps".

One of the pieces of faulty logic brought to bear by the bulls (er, so to speak), is that the pessimists can't agree with each other on what is going to go wrong. Standing aside from the fact that the line "I know that there is going to be a disaster, but I can't tell how" is not a flawed line of thought (a penny rolling down a hill will eventually fall over to the left or to the right. I may not know in which direction it is going to fall, but I do know that its current position is unsustainable in the long run) Coggan also makes the error of putting the "pessimists" in the same camp as the "bears".

Referring to the "two bear camps" he says that:

one half believes inflation is the inevitable result ... the steady rise of gold is a sign, they believe, that investors are worried about inflation ... Eventually, the bears argue, high debt levels will overwhelm consumers. When it does, the Fed will allow a "helicopter drop" of money into the US economy. The resulting inflation will alleviate the debt problem but result in the collapse of the dollar".

I've cut out the bits on the "Greenspan Put" (a fascinating area to which I must return at one point) and I may disagree slightly on Coggan's interpretation of the inflation-theorists (of whom I am one) -- to my mind Coggan's interpretation is a bit Friedmanesque, whereas my view is that inflation can develop even without the helicopter drop of money. But the main area with which I disagree is that inflation-theorists are necessarily bears.

Although increased inflation has a short-term downside impact on equity levels, if you look at it logically, equities are one of your best places to park money when inflation gets going -- particularly if the company in which you invest has managed to borrow money at fixed rates over a reasonable time period and it makes stuff which is going up in price. In other words, I can be an inflation-theorist and a long-term equity bull at the same time.

I know that we are beginning to look like Southern Christian sects here, splitting into ever small camps, but the argument which Coggan imputes to me, that equities are overpriced because inflation is going to return, is not one that I am making. In fact, my observation that inflation is going to return is not "pessimistic" at all -- it's simply an economic interpretation to which I ascribe no value. The result will be a shift in wealth from savers to borrowers. That's what inflation does and my theory is that, when the distribution of wealth moves too far in favour of one sector of society (as in our long-term recent period of real positive interest rates) then things happen, somehow, to redress the balance.

Far from damaging equities, this inflationary shift (I've been saying that the year 2012 will see the big shift for about five years now, so I might as well stick to it) will eliminate a lot of personal debt (or at least ease it), will bring house prices back to a sustainable level (3.5 to 4 times average earnings in UK) and will stop comsumption falling into a black hole. All good news for equity investors, I would say.
peterbirks: (Default)
OK Harrison, I bet you haven't been playing this music choice in the past few weeks!

It always amuses me when people battle against the closure of final salary pension schemes. My employer is the result of millions of mergers/takeovers, and because of this there are myriad schemes within the company. However, since turnover outside editorial is quite high (let's face it, would you stay in sales or marketing for longer than two years?), there are only a few employees in my building on the final salary scheme offered by the now-no-more Lloyd's of London Press (yes, we publish Lloyd's List, the world's oldest daily newspaper).

As they fret that this scheme might be taken away from them, I say that I wouldn't enter a final salary scheme if it was thrown at me. Money purchase schemes, I tell them, are far preferable. Since these people tend to believe what they read in the newspapers (you would think that they would know better) they look at me as if I am mad.

Look, I say, if you are in a final salary scheme you are effectively lending money to your company at a very generous rate. And, if they spunk it all away so that there is none left, you are very near the bottom of the pile (just above shareholders) when it comes to getting any money back. And the government compensation scheme recently introduced merely exacerbates the moral hazard. I, meanwhile, get the money that is placed in my pension scheme parked somewhere else, every month, where the company can't get near it. Now, which would you prefer?

Hmm, they say, when you put it like that...

The only people who might logically argue in defence of final salary schemes are employees in the public sector. But I suspect that even here there may be trouble ahead. What happens if urban councils can't put up their local taxes enough to pay for existing pensions? Already we have local councils doing a fair impersonation of General Motors or Ford in that a large part of their budget is now allocated to people who aren't doing any work any more. It can't go on forever.

Centrally funded civil servants probably have the right to feel safest. Governments, after all, never default, do they?

Tell that to retired teachers and army staff in Russia. The ones selling any old trinkets on street corners, because their pensions are now, basically, worthless, thanks to the clowns running the country when Yeltsin was in power.


And, speaking of sovereign debt, a subject dear to my heart (particularly the misleading phrase "emerging markets", when it isn't clear where they are emerging from or, indeed, where they are emerging to — but "sub-prime" markets doesn't have the same ring, does it?) I see from today's Lex Column in the FT that yields on Italian sovereign debt (Birks opinion, little better than shite, triple B minus) are a mere 20 basis points above that of Germany (Birks opinion, double A plus). The only logical exxplanation for this narrow spread is that investors continue to hold the naive belief that the EU will not allow a member's debt to default. That might have been the case when there were six, nine, or even 12 members, but I don't think it holds true now. There is a tangible, and not minute, chance that Italy will fall apart. There is a definite chance that it will default on its debt within the next 20 years — perhaps not up there with the chance of GM defaulting within the next five years (now happily sitting at above 50% probability), but a significant chance nevertheless. If I were in the markets, I'd be punting on widening spreads between triple A sovereign debt (T-Bonds) and, ahem, "emerging market" debt. Italy's yield will be somewhere between the two.
peterbirks: (Default)
Where does spare time go? I'm sure that I had some when I got up. But since then I've been, well, doing things, and none of it seemed to leave any spare time. These days, you just keep running and running in order to stand still.

So, welcome to Pete's Saturday "we are all doomed" mode. First we can take the view of Morgan Stanley's chief economist Stephen Roach, perfectly summarised by the excellent columnist Stephen Schurr in today's FT. Mr Roach is saying, in blunt terms, that the US can't go on like this. Alan Greenspan and Warren Buffett and Bill Gates say the same. The only real difference between any of them is that Greenspan thinks the situation can be managed down, while Roach thinks we will reach a "tipping point". Whatever, it still seems like no-one in politics or in the public household is listening. Do you know what the personal savings rate was in the US in July (and I will admit that this number shocked even the normally unshockable me when it comes to observing the fiscal irresponsibility of Joe US PUblic)? It was minus 0.6%. Man, they must have good advertisers and marketers out there (or very stupid consumers). I'm not sure what the savings rate is in Germany and Japan is at the moment, but I can tell you for sure that it isn't negative (probably somewhere between 10% and 15% would be my guess).

The current account deficit in the US will climb above 7% as money is spent rebuilding New Orleans (wherever it is rebuilt) as expensive condos and "San Franciso on the Gulf", but no-one realizes that this also means that there should be a concomitant cut in personal consumption. All these numbers aren't just mad -- they are irredeemably nuts. The US overspend is funding about three-quarters of the rest of the world's current account surpluses. If and when the US stops being able to borrow against its future, there will be either a massive economic upheaval or a massive political upheaval, or both.

However, another obscure number slipped through this week which did not get the same kind of attention as is rightly being paid to the "spend on the never-never" economy which is keeping the rest of the world's economy moving. That number was the spread that investors in fixed income bonds were prepared to accept compared to T-Bills. In July it shrank to 44bps. Now, I can see why that might not make the headlines, especially since it only shrank something like .01bp from the month before. But let's put this in terms of simple numbers.

It basically means that investors are prepared to invest in a company that might go bust, rather than in US bonds, for just an extra 0.44% return. People in the market euphemize this as "an increased appetite for risk". We in the land of common sense prefer the slightly less technical term "insane beyond belief". If you ignore the tulip economics argument (that being, "yes, I know this bond is mispriced, but someone will pay more for it next week") then you are, as far as I am concerned, in a land where real risk has walked miles away from the price of risk. And you know what I blame? Yes, my old favourite, collateralised debt obligations. I think that, because investors tell themselves that they are investing in mathematically sophisticated relatively non-correlated "baskets" of 125 companies, they can afford a greater appetite for risk. But, it seems to me, this is Alice in Wonderland mathematics. If you get 125 companies all investing in CDOs consisting of 125-company baskets, no risk has disappeared. All that happens is that 125 companies suffer a bit of damage rather than all the damage lumping onto a single investor. In a sense this is like insurance -- everyone suffers a bit rather than one investor suffering a lot — but it doesn't eliminate the total amount of pain felt. The big worry is where the non-correlated turns out not to be non-correlated at all. The other worry is that if all the investors suffer "a bit", that means they will all shift in the same direction when there is a bad hit (say, for example, Ford and General Motors going broke). This could lead to a tipping point where the liquidity that Greenspan believes will keep us out of the shit will just vanish in a puff of smoke.

Of course, as this prophesier of doom, I desperately hope Greenspan is right and I am wrong, because the implication for the global economy is so horrifying that one has to see political upheaval following on.

How do these two topics tie together? Well, if Roach is right and there is no way to soft-land the current imbalance in global economies, then the only way to get things back in sync is to have a discrete event (or, in less technical terms, one hell of an economic and political shock). My own hunch is that that tipping point is going to come when the "appetite for risk" shifts from the currently absurdly low levels to something more in touch with reality.
peterbirks: (Default)
Some time ago I wrote about the mysterious goings-on in the equity markets, with the rapid rise in equity levels since May defying logical explanation in the face of rising commodity prices, poor profits expectations and rising interest rates. I presumed that there was some kind of short squeeze of the small players taking place, although the reasons might have been less complex -- perhaps certain institutional investors were increasing their equity weighting because they felt that they had to put their money somewhere, that gilts looked a horrible bet, and they felt inflation was a threat (see recent performance of gold as a support for this hypothesis). This would indicate a much longer timeframe on the part of the investors than I usually allow for -- say, 10 years, rather than the normal maximum of 18 months. Such long-termism is commendable, even if it is happening for the wrong reasons.

I mention the 10-year timeframe because we currently have an even more recession-indicative situation (although I will return to this point later). The US yield curve has flattened to such a degree that 10-year treasuries now pay 12 basis points more than 2-year treasuries. Now if you are talking to an individual investor, I reckon it would be fairly hard to try to persuade him to tie up his money for 10 years rather than two for an extra 0.12%. But institutional investors are not like you or me. They want to match liabilities to investments. And pension funds in particular like long-distance certainty.

But a 0.12% spread, while not actually an inverted yield curve, is still fairly pathetic, particularly since only a year ago the spread was 1.8%. That seems massive now, but in the grand scheme of things, an extra 1.8% for an extra 8 years of money tied up is nothing to write home about.

Of course, you might say that the money is not tied up. You can trade these products in a very liquid market, and if you had made a swaps trade for 10-years over 2-years a year ago, then you would be sitting on a nice profit today.

But the fundamental nature of the product remains the same. One is a 10-year product and the other is a 2-year product. One has far more certainty attached to it (what will happen in the next two years) than the other (what will happen in the next 10 years). To accept an extra 0.12% for 8 years of uincertainty implies either that you are very certain nothing untoward is going to happen in those 8 years, or that the general appetite for risk is so great that people are prepared to accept a very low price for taking on that risk.

Why is the flattening curve an indicator of a possible recession? Ahh, I'm afraid that you have got me on that one. I think that it's related to a pessimism about the two-year horizon, rather than optimism about the 10-year horizon. But this kind of indicator (most associated with the inverted curve) would imply an expected low appetite for risk over 10 years and and even lower appetite over two years. What we have today is a high appetite for risk over two years and a ridiculously high appetite for risk over 10.

It will end in tears, I tell you.

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