The Filter^

Britain's Trillion Pound Horror Story

As econonomic documentaries go, this was one of the best I've seen in the UK. Once people recognise that it was deliberately polemic, serving to balance out existing biases in the mainstream media (as opposed to provide a grounded, impartial account), I think it should be added as a staple of economics courses up and down the country.

In terms of improving economic literacy through the use of metaphors I think it was highly effective - even The Guardian commentator conceded that "it brought the economic theory brilliantly to life". Using a running bath to show that there's still more public debt being added than is being removed through Osbourne's "cuts" was excellent. Showing an ailing patient and trying to remove blood from one arm only to pump it into another (spilling some on the way) was useful. I even thought the lobbying children - driving home the point that the debt burden is a future taxation and therefore deeply undemocratic, was effective. And indeed exposing politicians for not knowing the difference between the budget deficit and the public debt, was hilarious (and tragic).

Of course there were problems. The interviews with Brendan Barber and Alistair Darling came across more as Ali G style stich ups than revelations. I'm not convinced that public sector spending is now larger than the private sector, and I think a fair rejoinder would be to at least acknowledge that Labour's public spending record might make the debt burdon easier to pay. Debt isn't a problem in and of itself - it depends on what you are using it to fund. If it's comsumption (as much of it undoubtedly was) then indeed you have a problem. If it's investment, then that's part and parcel of economic growth. When Durkin showed how the salaries of front line services are a small fraction of overall spending, he might have pointed out that it is because so much of Labours's spending splurge went on salaries rather than capital investment that we will struggle to pay it off.

And of course it featured Kelvin McKenzie. And for that reason alone critics have a fair criticism.

The unintended consequences of heritage sites

I've mentioned previously my skepticism about heritage sites, so I noted the following with interest:

many within the conservation community are convinced Unesco is failing

The "Baxendale" Plan Part II

Stephan Kinsella and Steve Horwitz have both published a suggestion from Toby Baxendale, on a type of bank account that 100% reservers and fractional reservers might be able to agree on the legitimacy of:

This manager says this account is a timed deposit account in nature i.e. your money is locked away for at least a month, 3,6,9 18 months X number of years, but the bank will allow instant access , by exception for the liquidity that it keeps in reserve all the time. However, should there be too much call on liquidity, the bank reserves the right to point out that you the depositor are actually a de jure timed depositor / creditor to the bank for at least a month, 3,6,9 18 months X number of years and are going to he held to the time period you freely signed up to.

In my working paper on the sound money debate I say the following:

In addition to the option clause banks might also offer (and historically did offer) a “notice of withdrawal” clause, specifying that their customers were required to give 























































30 days notice prior to making a redemption claim. The fact that this clause existed (to protect the bank from a legal point of view if it were ever to suffer a liquidity crisis) does not mean it is always invoked, and banks could routinely not enforce this rule and satisfy immediate redemption requests.

(Note that I've received feedback on that paper suggesting that many US fractional reserve savings
accounts still do carry withdrawal clauses.) To repeat what I've said previously:

... in my theoretical working paper about sound money (and the corresponding policy proposal) I talk about how option clauses and notices of withdrawal are examples of contractual provisions that make anti-fractional reserve arguments mute. I intend for this to unite the two schools of thought, and show how 100% reserve arguments can be dealt with seriously. My concern is to find solutions that all Austrian school economists (and indeed all "good" economists) can get behind and support, rather than to further unnecessary antagonism.

I'm glad Toby shares that view, and encourage him to read (and cite) my paper!

Corporate Manslaughter

When negligence on the part of private sector companies leads to deaths, we tend to see prosecutions. So surely the same should apply in the public sector? Consider the case of Hatfield, where senior executives were cleared, but note that they were charged.

Under existing law, a company can only be convicted of corporate manslaughter if a senior individual in that company is guilty of "gross negligence manslaughter".

This Radio 4 show reveals:

Over three hundred people are killed each year as a result of corporate negligence, yet only three company directors have ever been successfully prosecuted for corporate manslaughter.

Here's Labour MP Peter Dismore:

Mr Dismore told the BBC: "It is only by putting the senior people in court that they will take safety seriously.

"They should have imprisonment and heavy fines and the courts must have the power to make companies put right the failings that caused the accident in the first place, again backed by very severe penalties if they don't."

The BBC is hot on this, see here and here for other stories. But how many politicians have even been charged (let alone prosecuted) for manslaughter?

on global warming

If we think that climate is affected by human activity, why aren’t we doing more research on the optimal temperature of the earth?
Gordon Tullock

Canada's budget triumph

I've just read David Henderon's working paper on the Canadian budget reforms of the 1990s.

the average interest rate on the federal debt was about 8 percent.  The growth rate of nominal GDP was about 4.5 percent.  The ratio of federal debt to GDP was approaching 75 percent.  That meant that in a given year, the government was spending eight percent of 75 percent of GDP, which is 6 percent of GDP, just for interest on the debt. 

So, simply cutting back spending on programs to equal revenue would leave a deficit of six percent of GDP.  With GDP rising by only 4.5 percent, the debt/GDP ratio would rise.  How could the government prevent this ratio from rising? 

You might think that the answer was to have the deficit equal ―only 4.5 percent of GDP.  But remember that the interest rate on this new addition to the debt would be eight percent, which means that the debt/GDP ratio would still rise.  The only way to keep the debt/GDP ratio from rising, it turns out, was to get the deficit down to 2.625 percent of GDP

The Appendix shows the arithmetic - has anyone done this for the UK in 2010?

The state of manufacturing in the UK

Further to my recent article on the state of manufacturing, Tim Leung's "Economy class" column in Prospect makes a similar point. First off the crude facts:

The number of manufacturing workers has fallen from 6.5m to 2.5m over this period [1980-2010]

But hang on a minute...

overall manufacturing output is around 70 per cent higher than it was in 1980

What explains this? Well, economic growth and productivity. Leung points out that we reach satiation for manufactured goods quicker than for services (e.g. as we get wealthier having another washing machine is less important than having another holiday). He claims that:

Just as agriculture falls as a share of the economy when nations progress from being underdeveloped to developed, so manufacturing's share of the eocnomy falls as a nation moves from being developed to being affluent

Ignoring the methodologial individualism concerns, it's a point well made. He points out that Britain is the sixth larget global manufacturer, with around the same level as France or the US (relative to GDP). But he goes on to suggest the downside risks of being dependent on manufacturing:

1. The rise of China as a serious competitor
2. The fact that most value is passed on as consumer, not producer surplus
3. The fact that it's more volatile than service output in the wake of recessions

Well worth a read.

The emerging view on QE2

Further to my article on QE2, I've read some good articles on the subject.

Raghu Rajana offers a measured overview:

Clearly, the Fed’s objective is to increase bond prices, in the hope that lower long-term interest rates will propel corporate investment. In addition, the Fed hopes that lower long-term interest rates will push up asset prices, giving households more wealth and greater incentive to spend. Finally, by demonstrating a willingness to print money, the Fed hopes to increase inflationary expectations from their current low levels.

In the FT Martin Fieldstein provides a nice intro:

Under the label of QE, the Fed will buy long-term government bonds, perhaps one trillion dollars or more, adding an equal amount of cash to the economy and to banks’ excess reserves. Expectation of this has lowered long-term interest rates, depressed the dollar’s international value, bid up the price of commodities and farm land and raised share prices.

Mr Bernanke’s argument for QE is based on the “portfolio balance” theory which stresses that, when the Fed buys bonds, investors increase their demand for other assets, particularly equities, raising their price and increasing household wealth and spending.

He goes on to list several downside risks:

• Like all bubbles, these exaggerated increases can rapidly reverse when interest rates return to normal levels 
• The lower US interest rates are causing a substantial capital flow to those economies, creating currency volatility. The economies hurt by the increasing value of their currencies are responding with measures to protect their exports and limit their imports, measures that could lead to trade conflict 
• the increased cash on banks’ balance sheets will make the Fed’s exit strategy harder

Even better, writing in Prospect, Faisal Islam writes a fantastic essay trying to assess the impact of QE1. I'll provide some commentary. Firstly, I wasn't the only person paying attention to Willem Buiter - in short ideas matter:

David Cameron’s response was more measured. I met him at that time and he seemed to have recently mugged up on advanced monetary economics. He referenced economist Willem Buiter’s blog in depth and regaled me with his knowledge of the difference between quantitative easing (the sheer amount of buying the central bank could do) and qualitative easing (an attempt to lower interest rates in specific markets, such as mortgage debt and corporate credit).

Islam provides a nice account of the actual provess by which QE operates:

On any given morning the debt management office (DMO), an arm of the treasury, sold billions of pounds worth of British gilts to the world. Then in the afternoon, barely 400 metres away, the Bank held a reverse auction where it, in effect, bought up billions of similar government debts. Under EU rules it would have been illegal for the DMO and the Bank to trade with one another. So instead the City stepped in, making profits on trading both sides of this  bizarre monetary merry-go-round for over a year.

As I said on the day after it launched,

Although we are not monetising the government debt in the same way that Zimbabwe has, it is hard to make any clear distinction. Yes, the Bank of England is purchasing assets on the secondary market (not directly from the Treasury). Yes, the Bank has every intention to mop up this additional liquidity once the economy recovers, but "directness" and "intentions" are largely semantic.

The head of the DMO does little to deny this:

“On the other hand, we must make the distinction—we are raising money by selling new gilts but the Bank is buying old gilts in the secondary market.”

In my assesment of QE1 I tried to identify the winners,

banks have benefited. QE served as a bailout by the back door

Islam adds more detail:

"It’s not to say that what the Bank [of England] is doing is useless—it has helped the banks, but it doesn’t inject new money. That is only injected when the money leaves the banking sector and goes into the economy. So far the money has just been passed from central banks to commercial banks,”

Indeed:

Winners from QE include the City trading desks that saw the value of their bond portfolios soar. Other beneficiaries include the sovereign bond dealers who passed bonds from the DMO to the Bank at almost no risk, and the commercial banks who gained a supportive source of free funding.

The losers, on the other hand:

director general of Saga, Ros Altmann, says: “QE is the worst thing that could happen to pensions, it is devaluing and destroying pensioners’ income.”

Islam interviews Alistair Darling for the article, and although you'd have thought Darling might have made this point before authorising £200bn of spending, he says (remarkably candidly):

We need a treasury and Bank of England evaluation as to where it is. Is it in circulation, or sitting in bank vaults?”

Audit the Bank? Here here.

The article also gives a lot of attention to the notion of NGDP targetting

“The Bank needs to set a nominal GDP growth target,” he [Richard Werner] says. A nominal GDP target incorporates a bit of inflation and a bit of growth in one target

Wener is the economist who coined "quantitative easing" to argue that Japanese policy was not radical. A further argument that Austrian's might be interested in, is the distinction between an expansion in the money supply to offset an increase in the demand for money, and an expansion in the money supply as a means to stimulate aggregage demand. According to Simon Ward:

“QE1 wasn’t inflationary, it was antideflationary, but QE2 would be very dangerous, because there is no shortage of liquidity and the banking system is stronger.”

Finally, as I keep trying to point out we are yet to solve the underlying problems that caused the crisis - and if we learn one lesson from Japan it should be that zombie banks are not conducive to monetary nor fiscal stimuli. Danny Gabay's thoughts on this are interesting:

He contends the failure to cleanse Japan’s bank balance sheets of zombie property companies (insolvent companies kept afloat by the banks) caused its lost decade. Zombie households with large debts and overvalued property is the British equivalent. QE could be used to buy up houses at a discount, jump-starting a stalled property market.

I'd argue that house prices need to drop, and policy should be directed towards how this might happen without consigning millinos to a lifetime of debt, but the bottom line needs to be bank restructuring. I don't think we can see a recovery until some banks go bankrupt.

The sound money proposal

Last night I gave a talk at the Libertarian Alliance (I believe the video will shortly appear here). The proposal is: “2 Days, 2 Weeks, 2 Months" (also see my comments here). There was a good discussion afterwards, and I was rightly put to task for identifying deposit insurance as a key problem. Indeed when I talk about deposit insurance, I am implicitly referring to taxpayer funded deposit insurance. There is nothing wrong at all with private deposit insurance, and indeed note that the Financial Services Compensation Scheme is industry (not government) funded.

But this brings up a curious possibility - recollect that 100% reserve advocates often claim that banking and insurance are not comparable, because whilst the former abuses it's creditors that latter do not. So what if, instead of offering a 100% reserve account with a storage fee a bank offers a slightly less than 100% reserve account with a fee for deposit insurance? Wouldn't this satisfy the argument that such desposits need to be "safe"? And by definition this is an insurance, and not a banking product. I don't know the answer, but it's these sorts of innovation that make it very difficult to prescribe particular forms of banking.

Another interesting topic during the Q&A was the strategy for reforms. My plan is written to be a set of guidelines that could be followed when the next banking crisis hits. To be sure, we can't just sit back and think that if we have an alternative it will even be considered, let alone used. Hence the importance of the Carswell Bill, which seeks to solve the problems within banking from where we stand today. I did raise the possibility, however, that a public debate would reduce the chances of radical reform.

Think of the difference between how Estonia and the Czech Republic adopted the flat tax - my own work* suggests that when you have a Prime Minister who's only read one economics book in his life, uncertainty about the right policy solution, and a void of debate - radical solutions become possible. With a large civil society you run the risk that the economically ill informed media majority corrupt that debate and spread ignorance. We know that people's priors tend to favour regulation over freedom - whilst I am a public intellectual and seek to debate economics on as wide a platform as posible, I am a realist in the sense that giving ideas an airing doesn't automatically lead to greater acceptance.

* 2008 “The Spread of the Flat Tax in Eastern Europe: A Comparative Study” (with Paul Dragos Aligica) Eastern European Economics Vol. 46 No. 3 pp. 55-74  *

Ending the "big four"?

I've just seen that Lisa Buckingham has written about the "big four" accountancy firms. In the policy report that I submitted to the FRC in May 2006(.pdf), I said:

the notion of a “Big Four” is a mirage; and ... the audit market is
competitive (regardless of concentration or switching rates). Despite this the paper
suggests broad institutional reforms that could make the market function more
smoothly: permit cross-ownership; reduce the geographical basis of regulation;
relocate the burden of large-scale risk; and pursue measures to get company
information into the public realm.

Don't forget, it wasn't long since people thought the Premiership had a "big four". Look how that's turned out...