Climbing Mount Improbable

I've touched on this before, but Mark Thoma has another sound reason for why we need a new Glass-Steagall act - the evolutionary pressures on banks. The argument is quite elegant, really.

Given a choice between a retail-only bank and a bank that's 99% retail but has a small investment-banking arm, the latter will (in the boom times) show greater profits and dividends, hence will be preferred by shareholders. This encourages them to play the markets, rewards those who do, and punishes those who do not. Similarly, a highly-levered bank will turn greater boom-time profits than a less-leveraged one - so anyone not using as much leverage as possible will turn lower profits and hence be less "fit". Thus banks are encouraged to do ever-riskier things with their money.

In nature, what stops risk-taking behaviour is death and serious injury: we've been conditioned by millennia of evolution to have various rational (and irrational) fears precisely because heights and snakes and fire and dogs are dangerous, and fear is nature's way of codifying that hard-won knowledge for the benefit of the species.

But that doesn't apply to banks now: they're too big to fail, the governments have implicitly (and explicitly) guaranteed their survival. Risk-taking no longer has any risk, so leverage to the hilt and trade whatever instruments offer the greatest upside - there is no downside, thanks to the taxpayer! Departments will keep on growing, as more people and more trades means more profits, making the banks bigger and hence securing their existence.

Whether this is a conscious decision to pursue short-term profits at all costs, or just organic growth of companies and teams who the markets reward for their success, is largely unknowable and almost completely irrelevant. The lesson from evolutionary biology is that a species without natural predators will specialise to an alarming degree, even to the point - like the dodo and the kakapo - where their survival is threatened by even the slightest shock, and a mildly-bored housecat can decimate the population. With no predation, and financial gravity repealed by governments, banks will maximise their profitability by becoming huge and fragile: exactly what we saw in the 1920s and in the 2000s.

The cure is simple, and was correctly enacted in 1932: separate the retail banks (who must be saved) and the investment banks (who can take risks... but who might be killed by them).

- KoW

UK "Out of Recession"

The BBC has the story here - pre-announced as usual, but this quarter they got it right - by the smallest possible margin, 0.1% of GDP.

The article notes that this is weaker than estimates, is based on only 40% of the figures, and that the figures for every other quarter since 2007 have been significantly revised later - the previous figures changed by 0.2% of GDP from the initial release.

More to the point, the deficit is something like 130x greater than the margin of 'recovery': if the government weren't borrowing, and spending, £178bn/year then we would be much deeper in recession. In real terms, we still are, since this artificial "growth" is paid for by debt which will have to be repaid at some point.

Still, following Laura Kuenssberg's observation on the cabinet going in to Number 10 yesterday, this could well be the news that sends Gordon Brown to the Palace... if the figures are later revised down to 0.0% or negative, he's lost the "recovery" message to hammer the Tories with.

I don't know - and I'm not convinced it's worth worrying about the election date. The Tories have (some) policies and Labour are clapped out and engaging in nothing but bitter points-scoring. Whenever it happens, the outcome is likely to be the same...

- KoW

Iceland Strategy

A quarter of the population of Iceland have signed a petition asking to be let off for the country's debts.

They didn't seem to mind when the billions in cash were flowing into Iceland, but now they've pissed it all away they don't want to give any back. Hmm. Pretty sure that's not how it works.

Since the debt is in Euros, Iceland can't just devalue its currency and inflate away the debt (and its assets). Iceland can, of course, default on its debts - but as an isolated volcano in the North Atlantic that's not going to help much, as tariffs on (needed) trade will just claw the debt back another way. There's the option that everyone the UK and Holland would like: paying up (over a couple of decades).

Or there's a fourth option: prostitution. Get someone else to pay the debt for you, in return for... services. There are three candidates I can see there: the US, the UK, and Russia.

The UK, despite overwhelming naval superiority, lost the Cod Wars - the expansion of Icelandic fishing rights from 4nm in 1958 to 200nm in 1976. We could take that back, write off our portion of the debt, and revitalise the northern ports - Hull (Alan Johnson and John Prescott), Grimsby (Austin Mitchell since 1977) and Fleetwood. A Labour government so profligate with tax money should easily be able to afford a bung to its heartlands, and might even be able to turn a profit if fishing rights were negotiated well.

Russia doesn't have much access to the Atlantic for shipping, and its submarines are tracked by the sea-bed sonar across the GIUK Gap. Strategically and commercially, Iceland is in a prime location for access to the West. It is also a good source of geothermal power, if the Russian oil/gas oligarchs want to broaden their remits. Of course, the Russian ambassador has publicly refused to get involved.

The US, until 2006, maintained an airbase at Keflavik as Iceland was recognised as strategically important in the Cold War. Given the still-endemic fear of "commies" in the US, if Russia were to show an interest in Iceland then it would be easy to find the money to reopen the base and thereby pump enough money into the economy to pay off the debts. If there's no Russian interest, the US has already shown its intentions by closing NAS Keflavik.

I can't see the EU being interested - too many internal squabbles and no real interest. The most likely involvement would be on trade tariffs if Iceland should default on her debts. China would probably love to help, to be owed a favour, but is literally too far away.

Of course, nice though it would be for the UK to get involved and get some fish to go with our chips, we have already shot ourselves in the foot by invoking anti-terrorist legislation to seize Landsbanki assets when the problems started. So that's about as hostile a relationship as you're going to find anywhere outside of a divorce court.

I think Iceland are screwed.

- KoW

Degrees: Supply and Demand

Monday night's Standard/Yesterday's Metro story that the value of degrees has been slashed "by 75%" is hardly surprising, though the Department for Business, Innovation and Skills flat-out denial of it is. Interestingly, the story isn't online for Metro, and the BBC hasn't covered Lord Brown's comments - their last mention of him was a month ago when his review was announced.

The claim is that degrees add some X thousands of pounds of salary per year, and therefore graduates can afford to pay lots for their education. This was clearly true and X fairly large when 5% of the population went to university and graduates went into The Professions. Now the figure is more like 50%, and sending half of the population to university is a stated goal of the government.

As should be fairly obvious to anyone with a grasp of even the most basic economics or intuition about business, hugely increasing the number of graduates in the job market reduces the value of a degree - in fact, anecdotal evidence is that jobs now demand degrees where previously they were happy with A-levels. The simple fact is that the distribution of jobs available is broadly similar to what it's been in the past: a few % of high-paying professional jobs, a large block of office work, another block of services, and then unskilled/semi-skilled manual labour. The salaries are commensurate with the work involved and are unlikely to have changed much in real terms - after all, inflation tracks GDP reasonably closely so any increase in earning power is cancelled out by an increase in costs of living.

The inescapable conclusion is that a degree in 2009 is worth less in real terms than a degree in 1999 or 1989 or 1979. Why is DBIS denying something so obviously true?

- KoW

Quantitative Easing

So, the Bank of England is to print another £25bn to pump into the economy, but it will be spent over three months (half the previous rate). By my calculations, that means a shortage of about £8bn/month between QE and the government's borrowing - previously they were about the same. Are the global money markets able to pick up the slack

Now, obviously, the BoE cash isn't going directly to public-sector borrowing - that would violate EU law - but it is going indirectly, giving the banks a profit margin from buying new-issued Gilts and then selling them on to the Bank. The net flow is the same, though - newly-printed money is supporting the government deficit, and there'll be less of it in the near future. The further dilution of Sterling is unlikely to appeal to potential investors, though the "small" delta here probably won't make much difference in the short term; likewise, it's probably too small to have a significant effect on exports.

Which all adds up to bad news for the hopes of getting out of the recession this quarter - if the government can't push enough money through the economy, it can't raise GDP, which means no "technical recovery"...

- KoW

Are we depressed yet?

Alex comments on the BBC's volte-face (here to here) on the GDP predictions and makes an interesting point: a huge proportion of the GDP is government spending (from the £175bn-ish 2009 deficit), so the real economy is doing much worse. The BBC got the pre-announced figures but those were 60 basis points too high - a bit over £8bn (two weeks' deficit) of economic activity by my reckoning.

One thing I'd add, though: despite blowing £20m of borrowed money every hour, the government still isn't spending enough to rig the GDP figures.

The implication is that the deficit would need to be about half as big again, £260bn or so, to mask the decline in wealth creation. Of course, if they were able to borrow that much, they could give £30k/year to 2.8 million people... Hey, Gordon, I think I've solved the unemployment problem! (At least until the bailiffs arrive...)

- KoW

They think it's all over

The Guardian reports that government-funded¹ think-tank NIESR disagrees with George Osborne's pension figures, and doesn't feel that they'll raise as much as he wants. They may even be right. I've an assessment of the pension situation of my own waiting to be written-up, which doesn't paint a nice picture for the state pension.

The sixth paragraph in that article is an absolute jewel, however: "Opposition politicians said the miscalculation cast doubt on Osborne's fitness to be chancellor."

O RLY? Her Majesty's Loyal Opposition are united behind their Shadow Chancellor, the Lib Dems are (as ever) irrelevant, so should one draw the conclusion that even hardcore Labour supporters consider themselves to be in Opposition now? A Freudian Slip, perhaps? The choice of Phillip Inman to pair that line with a quote from Alistair Darling does amuse...

(Hat tip for the article's existence to Ben Wegg-Prosser and, I think, Flying Matters - not sure now where I got the retweet!)

- KoW

When £3k is more than £83k

I once had an argument with someone who took a nominal amount of time, multiplied it by the internal billing rate of the company's engineers, and the number of employees, and came up with a 'cost' of £83k in order to strike down a proposal.

This seems to be a fundamental misconception that occurs time and time again in large companies and in government: that something denominated as a currency is somehow money.

Money only exists at boundaries. Boundaries between people, boundaries between organisations, boundaries between countries, but boundaries nonetheless.

Aside from the fact that essentially nobody was actually paid at the internal billing rate, they were all on salary anyway. No matter whether they spent the time watching an installer's progress bar, picking their noses, talking at the coffee machine, or actually working, they'd be paid exactly the same amount.

The alternative suggestion related to a saving of only £3k, but £3k of incremental spending on energy bills: extra money that would have to be spent, that would have to leave the company. A transfer of wealth from us to the energy supplier.

My counterparty in this argument thought that, since £83k was much bigger than £3k, it was self-evident that his way was better. I disagreed. The £83k never existed, never would exist, and was merely a figment of some fevered imagination.

Now, at full utilisation, where time really was money and a delay would cost us sales, the internal billing rate would be a floating currency, with an exchange rate of around IB£2 to £1 - a sign that inflation had already bitten - but it was treated as though the IB£ was pegged 1:1 to Sterling and was somehow real rather than an accounting abstraction.

It got me wondering about where else such ideas crop up, and helped crystallise some arguments I'd been pondering for months. More to come.

- KoW